The Inner House of the Court of Session has found that, where a business had no realistic prospect of continuing in existence, it was not appropriate to assess whether a property was sold at an undervalue by reference to a forced sale valuation.
The Court’s judgment serves as a valuable reminder of some fundamental principles of insolvency law.
In July 2014, Grampian Maclennan’s Distribution Services Limited (Grampian) sold a property in East Kilbride to Carnbroe Estates Limited (Carnbroe), for £550,000. The property was sold off-market following private negotiations between the director of Grampian and the director of Carnbroe, who had a long business relationship. The open market value of the property was £1.2 million.
In November 2014, Grampian went into liquidation. The liquidators sought to recover the property from Carnbroe on the ground that the sale was at a significant undervalue and therefore a gratuitous alienation in terms of section 242 of the Insolvency Act 1986 (the Act).
Following a proof in the Outer House of the Court of Session, the judge found that the consideration paid to Grampian was adequate in the circumstances of the sale of the property. While the price of £550,000 was less than the open market value, Grampian had very limited options in the circumstances. Grampian was in a perilous financial position, owing large debts to its bank and HMRC, and could not afford the leisure of a lengthy marketing period. The expert surveyors instructed by the liquidators and Carnbroe were of the view that a price of £550,000 was not unusual or inappropriate in the circumstances.
The liquidators appealed. The critical issue was whether the price of £550,000 was “adequate consideration” for the purposes of section 242 of the Act. The expert evidence led as to the adequacy of the consideration was based on certain assumptions, in particular that a quick sale was required because of Grampian’s immediate need for funds. But was that assumption justified?
The judgment of the Inner House
Lord Drummond Young took the opportunity to set out in detail the fundamental principles of insolvency law upon which the case depended. Those critical principles were that:
- Once a debtor is insolvent, they must manage their assets in such a way as to protect the interests of their creditors.
- If a debtor alienates property once they are insolvent, they must obtain full consideration for the property alienated.
- It is the person who received the debtor’s property who must establish that full consideration was given.
The judge noted that this case was an example of a situation that occurs 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 an immediate threat to its ability to continue in business. In such a case, it is relatively easy to infer that the threat is such that the consideration, for example from a forced sale at undervalue, was adequate.
But, he continued, if avoiding a threat to the company’s business is to amount to consideration, it is essential that the business should be capable of continuing after payment of the debt or granting of the security. If the company’s business is about to come to an end, the need for a forced sale of property to maintain the liquidity of the business, and therefore its continuation, simply disappears.
In that situation the company should observe the general policy of the law of insolvency by giving paramount importance to the interests of its creditors as a body. If a sale of assets is necessary in order to pay creditors, the sale does not require to be a forced sale, because the urgent payment of debts has ceased to be a relevant consideration. Instead, assets may be disposed of in the normal way, with appropriate marketing and advertising and time for potential purchasers to reach a considered view about the property that is for sale.
The need for a forced sale, to provide immediate liquidity, is not normally a factor that should be taken into account in determining the adequacy of consideration obtained for a sale of the debtor’s assets in any case where the debtor has ceased business or is about to cease business. In such a case, the continuation of the business will not be part of the consideration for the sale because the business is not going to continue (although there may be exceptional cases where the payment of a particular debt as a matter of urgency – and a forced sale that allows that payment – is necessary in order to protect the general interests of the creditors).
In this case, the Court found that certain facts were important to the assessment of whether, after the forced sale of the property, the business was viable. Grampian was in severe financial difficulties by July 2014: the company could not make loan repayments to its bank; the bank had indicated that it was not prepared to continue financial support; no alternative source of funding appeared available; and the company’s invoice factoring facility had been withdrawn. It was insolvent, on a balance sheet test, at the time of the sale of the property. It had also sold its trucks and its depot. That made it extremely difficult for it to continue its business, which consisted of a distribution service throughout Scotland and beyond.
There was an inevitable inference that, in those circumstances, there was no realistic prospect that Grampian’s business could continue. This was not a case where it was possible to assert that achieving a quick sale to pay a particular debt would save the company’s business. There was therefore no reason for Grampian to sell the property in the manner that it did. The property should instead have been sold for its full market value without any time constraints.
The Inner House duly concluded that Carnbroe did not pay adequate consideration for the property. The sale of the property contravened section 242 of the Act and fell to be reduced.