Property – Insolvency – Valuation – Transaction at undervalue – Defendant applying to validate transaction for purchase of property registered after winding up of vendor company – Whether transaction void as being made after winding-up of defendant – Whether transaction being made in good faith and at arm’s length – Application granted
The second claimant company purchased a property in Hatton Garden, London EC1 for £1.2m (“the property”). In the same month, it purchased a freehold development property known as Broadhey Farm for £370,000. Broadhey provided a development opportunity for four barns which had all been sold by 2 April 2014. The second claimant had obtained a short term loan for £600,000 from the second defendant, secured by means of a charge registered over the property which was sold to the first defendant in March 2014 for £850,000. The second claimant was wound up in April 2014 and the first claimant was appointed liquidator.
The proceeds of sale of the property had been used to repay the debt owed to the second defendant and release the charge. The balance was paid into the personal bank account of the third defendant who was the sole director of the second claimant at all material times. On completion, the third defendant purported to execute a form TR1 for and on behalf of the second claimant to transfer the property to the first defendant. The Land Registry raised a requisition in respect of the form and, by the time it was re-submitted, the third defendant had ceased to have any authority as a director of the second claimant because of the winding-up.
The first defendant applied for an order that the contract for the sale of the property to it be validated pursuant to section 127 of the Insolvency Act 1986 as being made in good faith and at arm’s length and not at an undervalue. The claimants brought a Part 8 claim seeking a declaration that the transaction was void.
Held: The application was granted.
(1) The policy behind section 127 of the 1986 Act was to prevent and remedy reaches of the second fundamental principle of insolvency law, namely that all the insolvent’s estate should be distributed rateably among creditors of the same class. The section also had the function of preventing dissipation which acted by its mere operation and might be traced back to its origins. It prevented a disposition of the company’s assets to the prejudice of its creditors and prevented improper alienation by making every post-petition transaction void. The operation of the section would bite equally if: full value was provided for a company asset after a petition was presented in circumstances where the directors paid one of many creditors in full (breaching the pari passu principle); and if a substantial undervalue was provided to a company in the same situation but the directors decided to ensure that every creditor in the same class was paid pari passu: Re Wiltshire Iron Co, Re (1867-68) L.R. 3 Ch. App. 443, Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711 and Coutts & Co v Stock [2000] 1 WLR 906 applied.
(2) Ultimately, the court exercising its discretion, mindful of the policy behind section 127, carried out a balancing exercise weighing the interests of the general body of creditors against the target transaction under scrutiny. In a different sort of case, different factors might be relevant but the policy consideration remained constant. Therefore, each case had to be determined on its own facts. The court would be slow to validate a transaction if there were a significant reduction in the company’s assets available to the general body of creditors. Good faith in the context of section 127 related to knowledge of the petition (the narrow view), but might extend beyond that (the wider view). A transaction which significantly depleted the assets of a company to the detriment of the general body of creditors was unlikely to be made in good faith. Where good faith existed in the narrower sense, there needed to be a balance between the rights of the general body of creditors on the one hand and an innocent third party on the other: Denney v John Hudson & Co Ltd [1992] BCLC 901 followed; Clifton Place Garage Ltd [1970] Ch 470, Re Tramway Building & Construction Ltd (1987) 3 BCC 433 and Re Fairway Graphics Ltd [1991] BCLC 468 considered.
(3) The court accepted the first defendant’s evidence that it had not known about the presentation of the winding-up petition before the agreement to purchase the property. The transaction had been made in good faith and at arm’s length within the context of a tight time frame imposed by a concerned and pressing secured creditor who would have taken possession and sold the property as mortgagee in possession if not paid.
(4) In the light of the expert valuation evidence, the realities of the market pointed strongly in favour of an investment basis for valuation, rather than an owner-occupation valuation and the appropriate rental yield was 5.75%. Using the calculations provided by the experts, capitalising the agreed rent at a yield of 5.75% and deducting the costs of purchase, refurbishment and other costs, the appropriate value of the property at the date of the transaction was £900,000. A special assumption that the market value should be based on a constrained marketing period applied because of the mortgagee’s intention to take possession, which would have resulted in a distressed sale. Applying a 5% margin of error for valuations, the general body of creditors would not have suffered significantly or at all, even applying the special assumption. The policy behind section 127 was not undermined as the transaction had not favoured a pre-liquidation creditor. In any event, there had been no significant loss to creditors. Accordingly, the court would exercise its discretion and validate the transaction.
Christopher Harrison (instructed by Wedlake Bell LLP) appeared for the claimants; Hugh Sims QC (instructed by Hausfield Solicitors LLP) appeared for the first defendant; the second and third defendants did not appear and were not represented.
Eileen O’Grady, Barrister