Adequate Consideration? Gratuitous alienations in the Supreme Court
MacDonald v Carnbroe Estates Limited [4.12.19]
The Supreme Court has clarified the meaning of ‘adequate consideration’ but at the same time caused uncertainty in holding, for the first time, that the court’s remedy for a gratuitous alienation, may give credit for the price paid by the bona fide purchaser for the property.
In Scotland, under section 242 of the Insolvency Act 1986 (the Act), a liquidator may challenge, within certain time-limits, transfers of property made for no or inadequate consideration by an insolvent company to another party (known as gratuitous alienations). If successful, the remedy provided by the Act is “decree of reduction or restoration of the property to the company’s assets or other redress as may be appropriate”.
If the transferee can establish that the transfer was for ‘adequate consideration’ the challenge will fail.
In July 2014, Grampian Maclennan’s Distribution Services Limited (Grampian) was in significant financial difficulty, owing in excess of £1 million to HMRC and NatWest. Grampian’s principal asset was its business premises, valued in 2013 at £1.2million, over which NatWest held a standard security.
NatWest threatened to call up its security. Grampian therefore sold its premises in an ‘off market sale’ to Carnbroe Estates (Carnbroe) for £550,000 and paid NatWest.
Grampian’s financial situation did not improve. Due to the debt outstanding to it, HMRC raised proceedings for Grampian’s winding up and in November 2014 Joint Liquidators (the Liquidators) were appointed.
The Liquidators challenged the sale of property to Carnbroe as a gratuitous alienation under s242 of the Act. Carnbroe argued that it paid ‘adequate consideration’ in the circumstances.
The case at first instance
At first instance, the court agreed with Carnbroe. It held that while the sale price was below open market value, it was nevertheless ‘adequate consideration’ in the particular circumstances - Grampian had very limited options due to its financial position, could not afford a lengthy marketing period, and needed a quick sale. The Liquidators reclaimed (appealed).
Appeal to the Inner House
The issue before the court was whether a quick sale at undervalue, driven by the seller’s need to maintain liquidity, were relevant to assessing ‘adequate consideration’ in terms of the Act.
The Inner House held that ‘adequate consideration’ should be assessed by an objective test and that a relatively strict view of the adequacy of consideration should be taken, particularly where a business has ended, or is about to end, due to the need to protect the interests of creditors. Consideration should be not less than would reasonably be expected in the circumstances and on the assumption that persons in the position of the parties were acting in good faith and at arm’s length.
Whether or not a ‘distress sale’ or threat to the company’s business were relevant considerations depended on whether the business could continue after the sale. If a business had ended or was about to end, there was no need for a ‘distress sale’ to maintain liquidity and the general law of insolvency (to act in the best interests of the company’s creditors) took over.
Even if the end of the business was not expressly contemplated it would usually be clear whether or not a business could continue following the sale, taking into account the company’s commercial situation.
In Grampian’s case, it was already in significant financial difficulty by the time of the sale, and on ordinary principles was insolvent. There was no possibility of the business continuing after the sale because it had no premises or delivery vehicles. Considering those circumstances together and on an objective basis, there was no realistic prospect Grampian’s business could continue in existence. A quick sale was not going to save it. Putting the creditors’ interests first, the sale ought to have proceeded on an ordinary ‘open market basis’. Accordingly, the sale amounted to a gratuitous alienation. Carnbroe was ordered to transfer the property to the Liquidators. Carnbroe appealed.
1. Adequate consideration
The Supreme Court confirmed that ‘adequate consideration’ was to be judged objectively, having regard to the commercial justification of the transaction in all the circumstances, on the assumption that hypothetical people in the position of the insolvent and transferee would be acting in good faith and at arm’s length.
It agreed that the company’s insolvency and the objective purpose of the sale were relevant considerations. Like the Inner House, the Court recognised there might be circumstances where a company, acting in the interests of the creditors, needs to achieve a quick sale, for example, in the hope of trading out of insolvency and preserving its business as a going concern.
However, in cases where there was no such prospect and the company was in reality carrying out an ‘informal winding up’ (as Grampian had), it would depend on the circumstances of the insolvency, and taking into account the aim not to prejudice creditors, whether or not there had been adequate consideration.
Where the company could have carried out a proper marketing exercise for the property to enhance the price, ‘adequate consideration’ should be measured against what would have been achieved in that proper marketing exercise. Alternatively, if the company could not support a proper marketing exercise (i.e. a ‘quick’ sale), ‘adequate consideration’ would need to be measured according to what the insolvency practitioner (IP) might have obtained by selling through the insolvency process, and taking into account the IP’s fees for same.
Applying those principles, the Supreme Court held that Grampian’s sale of its premises and vehicles amounted in reality, to an ‘informal winding up’ of its business. There was no justification for the off-market sale at a price well below market value on the ground of urgency. Even if it could be inferred that a marketing exercise wasn’t possible, Carnbroe led no evidence to suggest that a sale by the bank or liquidator would have been likely to achieve a price comparable to or less than the price of £550,000.
The sale therefore comprised a gratuitous alienation. Carnbroe had not established that adequate consideration had been paid. The Supreme Court next addressed the appropriate remedy in the circumstances – a point not argued before the Inner House.
2. Available remedies
Until now, the Scottish courts had interpreted section 242 of the Act as permitting reduction and/or restoration of the property as the principal remedies on successful challenge of a gratuitous alienation. Only in circumstances where those remedies were not available would the court make an alternative order (for example, an order for payment). In essence, the courts could not grant any other form of order, even in circumstances where that produced an inequitable result as between the bona fide purchaser of the property and the insolvent company.
The Supreme Court has now decided that the previous Inner House cases on this issue were wrong and that the court has the power, in devising an appropriate remedy, to give credit “in some way” for the price paid by a bona fide purchaser to the insolvent company. That decision addresses the court’s concern (not argued before the lower courts) that restoration of the property to the insolvent company could, in some circumstances, result in a windfall to the creditors (receiving the property back) and an injustice to the transferee (having paid a significant, albeit inadequate sum for the property) who would simply rank as an ordinary creditor in the liquidation.
The case has been remitted back to the Inner House to decide the appropriate remedy in this case, with a suggestion from the Supreme Court that the liquidators may be required to pay a specified sum to Carnbroe as a condition of the reduction.
While the decision provides clarity and certainty as to the meaning of ‘adequate consideration’ in challenges to gratuitous alienations under section 242 of the Act, what is now far less certain is the remedy that might be granted by the court on a successful challenge. It remains to be seen what remedy the Inner House will ultimately devise, and how future courts will interpret the Court’s departure from previous settled authority on this issue.