The Insolvency community in Scotland has watched with interest the case of Grampian MacLennan's Distribution Services Ltd v Carnbroe Estates Ltd and in particular Lord Woolman's eyebrow raising opinion at first instance that a distressed sale by a company of its major asset (an industrial unit comprising a warehouse, vehicle workshop and yard with gatehouse) had not constituted a gratuitous alienation where the sale has been off market at a price of £550,000 whereas the property had been valued at £1,200,000 on the open market or at £800,000 on a restricted 180 day marketing period. The Inner House has reversed that decision, restating the legal principles of insolvency underpinning section 242 of the Insolvency Act 1986.

The case provides a very welcome clarification as to the proper meaning of "adequate consideration" in the context of a defence to a gratuitous alienation claim.

The facts

Grampian was incorporated in 1984. It ran a distribution service throughout Scotland and other parts of the UK. Its main asset was an industrial unit which it had purchased in August 2005 for £630,000. Grampian had granted a Standard Security over the property to NatWest and also granted to NatWest a floating charge. The property had been valued at £1,200,000 on the open market or if a restricted marketing period of 180 were assumed the valuation was £800,000.

In July 2014 the shares in Grampian were acquired by a Mr Quinn. Mr Quinn was acquainted with a Mr Gaffney with whom he had business dealings for over 30 years. They had previously been Directors of the same Company. Mr Gaffney was the sole Director and shareholder of Carnbroe Estates Ltd.

Mr Quinn formed a view that Grampian was struggling financially and could not meet its monthly payments to NatWest. Its factoring facility had also been withdrawn creating serious cash flow difficulties. In a cost cutting exercise Mr Quinn sold the Company's trucks which were on hire purchase contracts. As a distribution service, the disposal of trucks meant that the business would have to cease.

Carnbroe Estates had previously written to Grampian stating they would be willing to pay £900,000 for the property. That was in April 2014. In July 2014 Grampian sold the property to Carnbroe Estates for a price of £550,000. The property had not been exposed on the open market. It was sold on an off market basis following private negotiations between Mr Quinn and Mr Gaffney.

Carbroe Estates financed purchase of the property with a loan from Bank of Scotland plc. The Bank in accordance with standard practice obtained a valuation for the property which was stated to be £1,200,000 on the open market or £800,000 if a restricted 180 day marketing period were assumed. The Bank was concerned that the purchase may be considered a gratuitous alienation but received assurances from Carnbroe Estates' solicitors to the effect that NatWest were calling for payment under threat of enforcing their securities, there was no willing seller and no willing buyer for the property and as a result the 180 day marketing period in which to dispose of the property was absent. The surveyors had indicated that even with a marketing period of 90 days the property valuation could be reduced by 50% and on that basis the transaction had been put through at £550,000. On those assurances, the Bank lent £600,000 to Carnbroe Estates which was secured by a Standard Security over the property.

On 18 August 2014 Carnbroe Estates paid £473,604.68 to Grampian. This happened to be the sum then due by Grampian to NatWest and Grampian immediately paid that money over to NatWest in settlement of its indebtedness. In return NatWest discharged the security granted by Grampian in its favour. Grampian remained liable for considerable unsecured debt including approximately £550,000 of unpaid tax due to HMRC, who subsequently initiated proceedings to wind up Grampian. The Liquidators subsequently challenged the transaction as a gratuitous alienation. After Proof, where much of the evidence turned upon expert evidence from surveyors as to the property's value, Carnbroe Estates paid the balance of the purchase price (£76,395.32), to Grampian.

The Judge at first instance, Lord Woolman, heard evidence from two expert witnesses, a surveyor for the Pursuer and a surveyor for the Defender. The Pursuer's Expert valued the property at £820,000. The Defender's Expert valued the property at £740,000. However neither surveyor considered that a price of £550,000 was unreasonable in all the circumstances where it was assumed that there was a distressed sale with a restricted marketing period.

Expert evidence was led as to the adequacy of consideration on certain assumptions, notably that because of Grampian's immediate need for funds a quick sale was required. The Court found the most important issue arising in the case was whether that assumption was justified.

Legal principles

The Court considered Section 242 of the Insolvency Act 1986 which empowers the Liquidator of the Company to challenge an alienation made two years prior to the commencement of a winding up. One of the defences available to the recipient of the property is in terms of Section 242(4)(b) that the alienation was made for adequate consideration.

In a detailed decision, the Inner House considered the legal background to Section 242 including underlying principles drawn from Bell's Commentaries, the Bankruptcy Act of 1621 and Roman Law. The Court distilled 3 critical features of this area of law.

First, once a debtor is insolvent, his assets must be managed in such a way as to protect the interests of his creditors.

Secondly, it falls from the first principle that if a debtor alienates the property once he is insolvent, he must obtain full consideration for the property alienated.

Thirdly, under the statutes that have addressed gratuitous alienations a series of presumptions operate so that it is for the person who received the debtor's property to establish that full consideration was given.

Amongst the authorities considered, reference was made to the Judgment in John E Rae (Electrical Services) Linlithgow Limited – v – The Lord Advocate whereby an Insolvent company had granted a bond in favour of the Inland Revenue in respect of past tax liabilities of an associated Company. In return for the Bond, the revenue granted Certificates exempting the Company and an associated Company from the requirement the persons who employed them should deduct tax from payments made to them as contractor or sub contractor. Had the bond not been granted, the Company would have been unable to continue to trade. The Court found "the effect of granting the bond therefore was to stave off the imminent demise of the Company and it is difficult to imagine a more valuable consideration than that". The decision to enter into the bond was an alienation for which valuable consideration was granted and was therefore not a gratuitous alienation within the meaning of Section 242.

Accordingly, the Inner House in Grampian found that avoiding a threat to the Company's business may amount to consideration but it is "essential … that the business should be capable of continuing after the payment of the debt or the granting of the security".

Against that background, on the facts, if a forced sale was justified in order to save the business then the valuations provided by the Expert Witnesses would be justification for the sale price in this case of £550,000. The critical question for the Court was whether or not a forced sale could be justified. Taking account of the fundamental principles of Insolvency once the debtor appears to be insolvent he is obliged to manage his assets in a way to protect the interest of his creditors as a general body. Adequacy of any sale must be assessed objectively. The need for a strict and objective approach is particularly important if the debtor's business has ended or is about to come to an end. 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 other words, considerations based on insolvency should prevail over the need for payment of debts as they fall due. The Court should examine the information available to it about whether or not the business as a whole is realistically viable. If it is not then the general policy of putting the interests of the creditors first applies with full force and the need for a quick sale to maintain liquidity will not normally be an element in assessing the adequacy of the consideration.

Applying the law to the circumstances on this particular case, first, Grampian was in severe financial difficulty. Second, it was balance sheet insolvent at the time of the sale. An objective assessment of a reasonable person would be that the Company was insolvent. Third, the sale of the trucks made it extremely difficult for Grampian to continue its business. Fourth, the sale of the premises would make it very difficult for Grampian to continue its business. Taking these factors together on an objective basis, the Court found it was an inevitable inference that there was no reasonable prospect of Grampian's business continuing. Consequently, the Court was of the opinion that it was not possible to assert with achieving a quick sale would save the Company's business and on that basis insolvency principles dictate that an attempt should be made to sell the property for its full market value assuming a willing buyer and willing seller without any time constraints. That is of course what would happen in the event of a winding up. On that basis the Defenders had failed to establish that they paid adequate consideration for the property.

Decision

The Court found that the sale of the property was a gratuitous alienation and granted decree of reduction.

Analysis

The case provides a very welcome clarification as to the proper meaning of "adequate consideration" in the context of a defence to a gratuitous alienation claim. Lord Woolman's decision at first instance had caused some alarm for Insolvency Practitioners that it could open the flood gates for rogue Directors to sell off the Company's assets well below market value on the basis that there was a pressing need to pay creditors. Such a defence is only available in circumstances where, on an objective view, the sale of the assets is necessary for the long term survival of the business of the Company. Where a sale will not achieve that purpose then it is the interests of the general body of creditors full market value be sought via an insolvency process if necessary.