UK: Property Sold To Avoid Insolvency

Last Updated: 10 April 2013
Article by Laura Edwards and Richard Flenley

Where property assets have been disposed of prior to an insolvency there are a number of remedies available to Creditors and Insolvency Practitioners.

Undervalue transactions

Many companies are soldiering through these tough economic times. In some cases they can do so merely because lenders (and possibly HMRC) are reluctant to instigate insolvency procedures to enforce arrears. In doing so, the commercial question for the company of whether to preserve or seek to realise property and assets gives rise to potentially unexpected legal consequences. Such consequences derive from the range of provisions in the Insolvency Act 1986 ("IA86"), which enable insolvency office-holders (liquidators, administrators, trustees in bankruptcy) to look back, scrutinise and pursue remedies in respect of transactions entered into in the period preceding the commencement of formal insolvency processes.

One such provision, which is the focus of this article, is section 238 IA86. This relates to transactions at an undervalue ("TUV") in the context of corporate insolvencies. Officeholders have scope to challenge transactions (often disposals of land / properties) entered within a 2 year period preceding the formal insolvency of companies. It is also worth noting that, in the context of personal insolvency, transactions entered within 5 years of a bankruptcy petition are vulnerable to challenge. In this context it is not uncommon to see jointly owned properties having been transferred into the sole name of one of the parties during the build up to the bankruptcy of the other.

The policy

The rationale for the transaction avoidance regime (encompassing s238) is that an insolvent company should not dispose of assets or property so as to prejudice creditors i.e. by depleting the company's value and thereby reducing potential realisations in which creditors would hope to share as an outcome of the insolvency procedure. The policy of having a collective scheme of asset distribution for the protection of creditors outweighs the potential impact this has upon parties' freedom to contract.

The claim

Any transaction entered prior to the instigation of an insolvency procedure would be carefully examined by an office-holder. Under section 238, office-holders would be looking for any gift or other transaction for less than full value (i.e. where the incoming value to the company is significantly less than the outgoing value), which occurred within the 'relevant time'. This is the 2 year period prior to the company entering an insolvency process although, it must also be shown that at the time of the transaction, the company was insolvent or became insolvent as a result.

Where these elements are present, the office-holder may bring a claim against (among others) the recipient of the undervalue.

The defences

There are two noteworthy defences.

First, the court will not make an order under s238 where the transaction was entered into in good faith and for the purpose of carrying on the business of the company, and where there were reasonable grounds for believing that the company would benefit as a result (s238(5) IA86). For example, a sale of one of many of a company's sites / premises at less than market value may not be a TUV if it was a strategic step taken to release cash to support a refinancing or rescue package. Contemporaneous evidence of board meetings, negotiations and valuations would be important evidence in this respect as it would be necessary to demonstrate that the end goal was in the company's (and the creditors') best interests.

Second, the court will not make an order that would either (a) prejudice any interest in property which was acquired from a person other than the company and was acquired in good faith for value; or (b) require such a person to pay any sum to the office-holder. This protects innocent parties who acquire the property from the recipient of the original undervalue (s241(2) IA86).

The remedy

This leads to consideration of the remedy available in respect of TUVs. Under section 241 IA86, the court may make such order as it thinks fit to restore the company to the position it would have been in had the TUV not been entered into. The court has wide discretion, but section 241(1) sets out a non-exhaustive menu of possible orders that the court may make. For example, orders requiring:

- the property itself to be returned to the company;

- the proceeds of sale of the property to be to be paid to the company;

- a person to pay such sums to the office-holder as the court may direct (e.g. the difference between the value of the asset and the amount paid).

Due to the 'restorative' objective, there is a presumption in favour of an order returning the property to the company. However, that alone would not be an appropriate remedy if the property had been damaged or dissipated in the interim. Likewise, if the property had fallen into the hands of an innocent third party purchaser, (who may rely upon s241(2)), the company's primary recourse would appear to be to pursue the recipient for the proceeds of sale or compensation.

The query

This then leads to consideration of whether a company's right to a restorative remedy has the potential to give the company a proprietary interest in the undervalue asset. This would be a crucial issue if the asset remained intact in the hands of the recipient and the recipient were itself to enter an insolvency procedure (not unforeseeable in the current economic climate).

A proprietary interest would enable the company to recover the asset itself. The absence of a proprietary interest would position the company as an unsecured creditor of the recipient. As litigation against the recipient would be fettered by the recipient's insolvency, the company's recourse instead would be to prove for its debt in accordance with the insolvency regime (although obtaining permission to litigate may be a possibility). Often, however, unsecured creditors receive nothing if not a mere fraction of the amount of their debt through the mechanics of insolvency procedures.

The question of the nature of the remedy may therefore be the difference between on one hand, a true restoration of the pre-TUV position and, on the other hand, receiving nothing at all. The latter outcome is inconsistent with the policy rationale behind s238. However, it is difficult to see why a company's TUV claim should be prioritised over the ordinary claims of a recipient's other creditors. If it were necessary for a court to determine this issue it would need to balance the interests of the company's creditors against the interests of the creditors of the recipient. Even putting the policy considerations to one side, it appears unlikely that the court would consider TUV claim to give rise to a proprietary interest, although the position seems to be largely untested.

A viable alternative route to relief may lie in a claim by an office-holder against the company directors for causing or allowing the transaction to be entered. This is on the basis that such conduct would amount to a breach of the directors' duties.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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