Thu 08 Feb 2018

Insolvency update: Gratuitous alienations and "adequate consideration"

The Inner House of the Court of Session has now delivered its hotly anticipated decision in the case of Joint Liquidators of Grampian Maclennan's Distribution Services Ltd v Carnboe Estates Ltd. In doing so, it held that where a business is about to come to an end and that business sells its assets, any subsequent assessment of whether those assets were sold at an undervalue should not look at the valuation applicable to a forced sale. 


Eyebrows had been raised by the first instance decision in the case, where it was held that a sale of a heritable property by a financially stricken company at a price substantially less than open market value did not constitute a gratuitous alienation (i.e. a sale at an undervalue) in terms of section 242 of the Insolvency Act 1986 since "adequate consideration" had been paid for the property. 

In the sequence of events leading up to the sale, the company's secured lenders had advised they were not willing to support the company any further, its invoice finance facility was withdrawn and the company - which ran a distribution service throughout Scotland and beyond - sold all of its trucks.  Against that backdrop, the company sold its heritable property (and principal place of business) to a company with whom it shared a registered office for a price of £550,000.  Only £473,604.68  - being the precise amount owed to the company's bankers - actually changed hands at this point.  The company was placed into liquidation a few months after the sale.

The liquidators challenged the sale on the basis that the property was sold at an undervalue and therefore a gratuitous alienation in terms of section 242 of the 1986 Act. They sought reduction of the disposition in favour of the purchasers, which would have had the effect of restoring the property to the company in liquidation.   The purchasers defended the action, arguing that £550,000 was adequate consideration for the purchase of the property in the circumstances of the case.  They paid the outstanding balance of the purchase price once the court action was up and running. 

Evidence from surveyors was led which valued the property at £740,000 (the purchasers' valuation) and £820,000 (the joint liquidators' valuation) although neither surveyor said a price of £550,000 was unreasonable in the context of the circumstances of the sale.    The court determined that, due to the dire financial position the company was in, although the sale price of £550,000 was short of the open market value it still constituted "adequate consideration" and so the liquidators' challenge failed.


Unsurprisingly, the joint liquidators appealed that decision.  They were wholly successful in their appeal.

In delivering the opinion of the court, Lord Drummond Young reminded us that section 242 "forms a fundamental part of the legislative structure governing corporate insolvency in Scotland" and said that there are 3 critical features of this aspect of the law:

  1. Once a debtor is insolvent, they must manage their assets in such a way as to protect the interests of their creditors.

  2. If a debtor alienates property once they are insolvent, they must obtain full consideration for the property alienated.

  3. It is the person who received the debtor’s property who must establish that full consideration was given.

Against that backdrop, Lord Drummond Young said that the situation in this case was something which happens with some frequency: a company (or partnership or sole trader) requires to pay a debt or to grant security for a debt as a matter of urgency to avoid a threat to its ability to continue in business.  However, he made it clear that "if avoiding a threat to the company's business is to amount to consideration, however, it is essential in our opinion that the business should be capable of continuing after the payment of the debt or the granting of the security.  If this condition is not satisfied, it cannot be said that the continuation of the business amounts to valuable consideration, for obvious reasons.".

He went on to say that if the debtor's business is about to come to an end, the need for a forced sale to maintain the liquidity of the business and hence its continuation simply disappears.  In that scenario, the company should give paramount importance to the interests of creditors as a body rather than paying particular debts as they all due. 

Applying that to the facts of this case, the court found that there was no prospect of the company being able to continue in business at the time of the sale.  It was in severe financial difficulties, had lost the support of its bankers, had sold its trucks (making it extremely difficult to carry on a distribution business) and had sold its principal place of business and depot.  In those circumstances, there was no realistic prospect of the company continuing in business and so there was no reason to proceed with a quick (or distressed) sale.    The court accordingly looked at the valuations of £720,000 and £840,000 and concluded that a sale price of £550,000 did not constitute adequate consideration.  The disposition in favour of the purchasers was accordingly reduced.

This case has been welcomed by the insolvency community and serves as a useful reminder of the fundamental policy that once a debtor is insolvent, their assets should be managed in a way that protects the interests of the body of creditors.

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