With ever increasing numbers of corporate insolvencies, it is likely that the courts will see an increase in litigation raised by insolvency practitioners and creditors arising out of restructuring arrangements entered into by companies in an attempt to stave off insolvency.

While debt restructurings must always remain a significant part of the corporate recovery toolkit, all stakeholders must be aware of the underlying rules relating to the challengeability of transactions in the run up to insolvencies.

There are two main challengeable areas in Scots law:

  1. gratuitous alienations (s.242 of the Insolvency Act 1986); and
  2. unfair preferences (s.243 of the Insolvency Act 1986).

Gratuitous alienations can strike at those transactions entered into by a company in the period of 2 years (or 5 years where there is an association between the relevant parties) prior to an insolvency where the insolvent company has not received adequate consideration for the transaction. This obviously catches issues such as the sale of an asset at an undervalue but can also catch the unwary in the restructuring of debt facilities of a group of companies.

Unfair preferences strike at transactions entered into in the 6 months prior to an insolvency, where the transaction has the effect of conferring on a creditor a preference in the insolvency to the prejudice to the general body of creditors. The most obvious example of an unfair preference is the grant of a security for an old debt on the verge of insolvency, in an attempt to give to that creditor a better return in the insolvency.

The effect of transactions that fall foul of these rules may be that securities become unenforceable and months of planning can be unravelled to the detriment of all concerned.

It will be clear that these are highly relevant issues in many of the restructuring proposals that are currently being considered for troubled companies. Care must therefore be taken to ensure that the risk of challengeability in the event of subsequent insolvency is minimised.