TRANSACTIONS AT AN UNDERVALUE
The provisions of the Act relating to transactions at an undervalue [note 1] [note 2] allow the office-holder to challenge the gifting or undervalue transfer of property entered into by the insolvent in the period leading up to the commencement of the winding-up or bankruptcy.
The ability of the liquidator or trustee to challenge such transactions is subject to time limits (see paragraph 31.4A.66), the financial position of the company/debtor at the time of the transaction (see paragraph 31.4A.69), the relationship between the company/debtor and the recipient of the property (see paragraph 31.4A.70) and the purpose of the transfer (see paragraph 31.4A.100).
Crucially, unlike similar provisions relating to transactions defrauding creditors [note 3] (see Part 7 of Chapter 31.4B) there is no requirement to show that the transaction was carried out with the intention to put assets out of the reach of creditors, it is enough to show that the transaction was, in fact, a transaction at an undervalue.
(Amended August 2014)
The following are the areas on which the official receiver should, ideally, obtain information before instructing the contractor and include on the ‘details of conduct/transaction’ section of the ARIA form (see paragraph 31.4A.9):
In addition to the provisions relating to transactions at an undervalue, the Act contains provisions allowing for the challenge of undervalue transactions where an intention to put assets out of the reach of creditors can be shown [note 4].
Whilst the need to show an intention to put assets out of the reach of creditors makes this provision less useful to challenge suspect transactions, it does have the positive feature of having no time limit as regards the date in which the transaction must have taken place to be recoverable..
See Part 7 of Chapter 31.4B for more information on transactions defrauding creditors, particularly paragraphs 31.4B.141 and 31.4B.142 which outline the differences between the two sets of provisions.
The following transactions are identified in the Act as being those that are capable of displaying “undervalue” :
For a transaction to be voidable under the provisions of the Act, it must have been entered into by the insolvent (rather than a third party). The sale of property by a mortgagee under power conferred under its security would not, therefore, be a relevant transaction [note 10] – but the transaction could still be “attacked” [note 11].
Conversely, the court has held that a sale of property by a receiver could be a relevant transaction and open to challenge, as the receiver can be considered to be an agent of the company and its directing mind (see paragraphs 31.4A.115 and 31.4A.31) at the time of the transaction [note 12].
The word “transaction” is defined in the Act to include “a gift, agreement or arrangement” [note 13]. The definition can be taken to include the provision of services, loans or property and guarantees and does not require that the transaction takes place under a formal agreement such as a contract.
For a transaction at an undervalue to be successfully challenged, it must have taken place within a certain time period (see paragraph 31.4A.67) and under a certain financial circumstance (see paragraph 31.4A.68).
In a compulsory liquidation the transaction must have been entered into within two years of the “onset of insolvency” [note 14] (for a compulsory liquidation the “onset of insolvency” is the date of the presentation of the petition [note 15]).
In a bankruptcy the transaction must have been entered into within a period of five years ending with the day of the presentation of the petition [note 16].
Transactions that occur after the date of the presentation of the petition would be automatically void [note 17] [note 18] (see Part 5 of Chapter 31.4B for information on voidable property transactions).
Unlike preferences (see Part 2 of this chapter), the relevant time period (see paragraph 31.4A.67) is the same for connected parties or associates as it is for unconnected parties. There is, though, some relevance to the relationship between the recipient and the debtor as regards assumptions to be made regarding the insolvency of the debtor (see paragraph 31.4A.70).
In addition to the time limits detailed in paragraph 31.4A.68, it is also necessary to show that the company was unable to pay its debts at the time of the transaction or became unable to pay its debts as a result of the transaction (see paragraph 31.4A.108) [note 19]. Evidence in support of this would be items such as accounts and accounting information, demands for payment from creditors or Crown departments or increasing overdrafts on bank accounts.
So far as bankruptcies are concerned, if the transaction is more than two years prior to the presentation of the petition, it is necessary to show that the debtor was insolvent at the time of the transaction (see paragraph 31.4A.109), or became insolvent as a consequence of the transaction [note 20]. Evidence in support of this would be documents such as accounts and accounting information, demands for payment from creditors or Crown departments or increasing overdrafts on bank accounts.
Where the beneficiary of the transaction is a connected party (see paragraph 31.4A.110) or an associate (see paragraph 31.4A.111), insolvency is presumed, unless the contrary can be shown [note 21] [note 22].
In other words, where the beneficiary of the transaction is a connected party or an associate, the onus is on the insolvent (or the beneficiary) to show that they (the insolvent) were not insolvent at the time of the transaction.
As outlined in paragraph 31.4A.71 it is necessary to show that a transaction was entered into for no consideration or for consideration that was significantly less than the true value of the property transferred. There is no statutory definition of “significantly less” and courts have tended to decide each case on the particular facts. In one case [note 23] a difference of 10% between the consideration and true value was held to be the result of a genuine difference of opinion and, therefore, not a transaction at an undervalue. In another case, a difference of 20% was held to be a transaction at an undervalue [note 24].
In order to decide whether property has been transferred for money or money’s worth, it is necessary to value not only the property transferred (which should be relatively straightforward assuming that records are available for the insolvent’s affairs), but also the consideration received – which may not be quite so straightforward. Paragraphs 31.4A.73 to 31.4A.76 outline the areas to be taken into account when assessing the value of the property and paragraphs 31.4A.77 to 31.4A.81 give information and advice of the matters to be taken into account when assessing the valuation of the consideration given for the asset.
It should be noted, though, that it is not necessary to attribute an exact value to either the item transferred or the consideration received [note 25].
The valuation of the property disposed of by the insolvent should be considered from the perspective of the debtor, taking into account his/her position at the time of the transaction [note 26]. For example, it may be acceptable for a debtor to dispose of property for less than market value to ensure a quick sale to improve the cash position of a business.
An assessment of the value of the property disposed of by the insolvent should include only the actual value of the property, and not any consequent detriment to the insolvent’s affairs (for example, damage caused to the business by the sale of a key asset, perhaps to a competitor), unless that detriment was an agreed part of the transaction.
The court may take subsequent events into account when deciding the actual value of the property. For example, the sale of a life policy at a time that the debtor was terminally ill. At the time of the sale the policy may have had no value but, on the subsequent death of the debtor, it accrued a value. In this case the court took into consideration the likely potential value at the time of the transaction [note 27].
Where the official receiver is uncertain as to the value of property disposed of by the insolvent, he/she should consider the use of agents to carry out a valuation. See Chapter 32 for information on the employment of agents.
It is important to show that the debtor actually had an interest in the property transferred to demonstrate that a transaction at an undervalue has taken place. Where a third party has paid for an asset over which the debtor had use and subsequently transferred, it is likely to be difficult to show that the debtor had a beneficial interest [note 28] [note 29].
The term “consideration” is not defined in the Act. In one legal dictionary [note 30] it is defined as “a compensation, matter of inducement, or [the giving of one thing of value for another thing of like value], for something promised or done”. Consideration can take the form of benefit to the recipient or detriment to the donor [note 31]. See paragraph 31.4A.80 for further information on detriment as consideration.
For consideration to be considered valid in terms of the transaction, it should be made in relation to that transaction and it should be understood by both parties that payment is due under the transaction at the time that the goods or services are provided [note 32]. It is not sufficient to give payment for the goods or services when there was an original intention that they would be provided free – or, at least, no agreement that they would be chargeable (for example, a director of a company being paid retrospectively for “management services” in excess of his/her agreed contract in the period leading up to winding-up). In such circumstances the application of the provisions relating to the recovery of transactions at an undervalue should be considered.
For consideration to be considered valid, it need not be provided directly by the recipient of the property – what is important is that the insolvent benefits from the transaction. For example, it has been held that where company A agrees to sell an asset to company B on terms that C agrees to enter into some collateral agreement with A, the consideration for the asset will be the combination of any consideration expressed in the agreement with B and the value of the agreement with C [note 33].
Detriment to the recipient of the property (for example, the giving up of some right over the property of the insolvent) can be considered valid consideration so long as that detriment was an intentional part of the transaction [note 34].
An application for the recovery of a transaction at an undervalue where the stated consideration was the waiving of a debt repayment succeeded as the court held that the transaction would have been, in any case, a preference (see Part 2) [note 35].
Historically, marriage has been considered to be a valid consideration in its own right for the transfer of property [note 36]. Under the Act, however, any transaction in consideration of marriage or the formation of a civil partnership is automatically a transaction at an undervalue and is open to challenge [note 37].
Similarly, it has been ruled that consideration in respect of love and affection or similar emotional sentiments cannot be considered to have a value in excess of nominal [note 38] and, therefore, any gift or transaction where that is the only consideration is likely to be open to challenge [note 39].
It has been held that, generally speaking and assuming the court is in full possession of the facts when making the order, the spouse receiving property under a property adjustment order in divorce proceedings (particularly, contested divorce proceedings) is considered to have given consideration equivalent to the value of the property transferred, since it is the responsibility of the court to effect a fair distribution of the property of the marriage (see paragraph 31.4A.83) [note 40]. In such cases, the provisions of the Act in relation to transactions at an undervalue (see paragraph 31.4A.63) are not satisfied and the order cannot be attacked as a transaction at an undervalue.
It is anticipated that applications to set aside property adjustment orders as transactions at an undervalue will be rare.
It has been held that the responsibility of a Family Court is to seek to give a fair division of matrimonial property which allows each party to go forward – a fair division should not be confused with an equal division. One party may have greater need to the property – for example, if they have responsibility for caring for children of the marriage [note 41].
In exceptional circumstances it may be possible for the trustee in bankruptcy to demonstrate collusion, fraud, mistake, misrepresentation or some broadly similar circumstances and, in this case, the transaction is capable of being challenged [note 42]. It can be assumed that ancillary relief or property adjustment orders resulting from a hard fought trial are far less likely to be tarnished by collusion or fraud on the creditors than consent orders.
If property was transferred outside of the matrimonial proceedings, then it may be possible to show that the court was not aware of the true position when making the property adjustment order and, therefore, challenge to that order as a transaction at an undervalue could be considered.
If the property adjustment order was made on the basis of a “clean break”, with the court of the opinion that the property awarded was the only provision for the future financial needs of the spouse, but it transpires that the other spouse is continuing payments under a voluntary maintenance arrangement, or has returned to the former family home, then the order may be open to challenge.
Due to the need to establish the history, background and detail of the property adjustment order, it is necessary for the official receiver to make enquiries into the agreement reached by the divorcing parties.
The official receiver should obtain a copy of the property adjustment order and consider this against other facts regarding the bankrupt’s affairs of which he/she is aware. Apart from considering the bankrupt’s current circumstances (for example, has he/she really left the former marital home, does the spouse have the stated responsibility for childcare?), some consideration should be given to historical issues to ensure that assets were not transferred outside of the matrimonial proceedings (the usual enquiries, such as accounting for large sums expended or transferred).
Sale and lease-back schemes (sometimes called sale and rent-back schemes) are designed to allow a homeowner to sell their property but remain living in it by entering into a rental agreement with the purchaser. The benefit to the homeowner is that there may be a release of equity from the property and/or a lowering of the monthly accommodation expense (where the rent charged is lower than the mortgage payments) without having to leave the property.
Full information about sale and leaseback schemes can be found in Part 10 of Chapter 33.
Prior to regulation (see paragraph 31.3.319), the key feature of a typical sale and lease-back scheme was that the property was usually sold to the business operating the scheme at less than the true market value of the property. It is this aspect which may open the scheme up to challenge as a transaction at an undervalue where the entering into the scheme is followed by the bankruptcy of the former homeowner with the relevant time period (see paragraph 31.4A.67).
Assuming that all the other features of a transaction at an undervalue are in place then any agreement that provided for the property to be sold at less than its market value should be challenged as a transaction at an undervalue. It is likely that a below-market value sale of a property under one of these schemes would meet all the relevant conditions to be challenged as a transaction at an undervalue.
The decision on how best to attack the agreement would normally be left to The Service’s antecedent recovery contractor (see paragraph 31.4A.5) but options available to the sale and lease-back business are to restore the property to the bankruptcy estate (holding the rights of the original chargeholder – assuming they were paid in full) or making good the loss to the estate.
Where it can be shown that the sale of the property was conducted with the intention of putting assets beyond the reach of creditors, then the sale may be challenged as a transaction defrauding creditors (see Part 7 of Chapter 31.4B). For the reasons given in paragraph 31.4B.141 to 31.4B.142, the official receiver would not normally attack the transaction under these provisions, but seek recovery as a transaction at an undervalue.
Prior to regulation of the sector (see paragraph 31.3.319), it was not unusual for a sale and lease-back scheme to involve fees that might be described as exorbitant or, certainly, unreasonable. It is likely that the fees paid will be in excess of any true value in the service provided by the sale and lease-back business. Where the official receiver considers this to be the case, any unreasonable fees may be recovered as a transaction at an undervalue.
The Mortgage Rescue Scheme (“MRS”) is a programme of schemes operated in the public sector to support homeowners in financial difficulties.
Under the MRS, a homeowner whose house is at risk of repossession can apply to their local authority for assistance and support. One of the schemes available under MRS is the Mortgage to Rent Scheme. Under this scheme, the local authority (liaising with the CAB) can negotiate a sale of the property to a Registered Social Landlord (“RSL”), who will then rent the property back to the former homeowner.
Unlike many commercial “sale and leaseback” schemes (see paragraph 31.4A.86), one of the key features of the Mortgage to Rent scheme is that the property is purchased by the RSL at market value, following an independent valuation. 10% of the sale price is used to deal with the costs of the conveyance of the property to the RSL.
The fact that the property is transferred at market value means that a property dealt with under the Mortgage to Rent scheme is unlikely to be challengeable as a transaction at an undervalue. The official receiver should, though, inspect paperwork relating to the transfer to satisfy him/herself that there are no matters of concern. For further information see Chapter 31.3, Part 10.
Where a payment is made under contract, it would be difficult to argue that the transaction was undervalue, as it is likely that the employee would have provided services to the value of the payment made.
Where a payment is made outside of the contract, such as a bonus, it may, in theory, be open to challenge as a transaction at an undervalue. In a liquidation, however, such a payment may be defended as one made in good faith to the benefit of the company (see paragraph 31.4A.100) – where the goodwill of the employee was necessary during a difficult period financially. A payment made upon termination of employment would be harder to justify on the same basis. This defence is not available in a bankruptcy.
(Amended August 2014)
The fact that a gift is given as a present for a birthday, Christmas or other, similar, celebration or event does not prevent it being open to challenge under the Act. The official receiver, as liquidator or trustee, should seek to recover the gift if this is, otherwise, worthwhile when the value of the item is taken into consideration. See Part 1 for advice on making recoveries.
It is not just the disposal or undervalue sale of property that could be considered to be a transaction at an undervalue. The purchase of goods or services at an inflated price would also be caught under the relevant provision.
Where a debtor off-sets a debt by the transfer of property to a creditor, this could be considered to be a transaction at an undervalue if the property was worth more than the debt owed. Of course, this transaction could also be challenged as a preference - information relating to which can be found in Part 2 of this chapter.
Property transferred on a temporary basis could constitute a transaction at an undervalue. For example where property is rented out by the debtor for insufficient consideration or, conversely, where property is taken on by the debtor on a rental basis at an inflated price.
Where a debtor gives a guarantee for the debts of a third-party, this is considered to be a transaction at an undervalue which the official receiver, as liquidator or trustee, may seek to attack as a means to recover any payments made under the guarantee or to release the guarantee. Typically, this circumstance will arise where a company has guaranteed the debts of another in the same group or where a bankrupt has guaranteed the debts of a company of which he/she is a director.
It has been held that where a debtor grants a charge, he/she does not dispose of property of any value and, therefore, there cannot be a transaction at an undervalue [note 43]. The granting of a charge could be open to challenge as a preference (see Part 2 of this chapter).
The realisation of a charged assets has the effect of depleting the debtor’s assets but also the depletion, or extinction, of the liability secured by the charge and, therefore, there cannot be a transaction at an undervalue.
The sale of an asset at undervalue by a chargeholder could nevertheless give rise to a claim against the vendor [note 44].
As explained in paragraph 31.4A.59 the office holder (but, only the office-holder) has the power to apply to court for an order restoring the position where there is evidence that a company or individual has entered into a transaction at an undervalue [note 45] [note 46].
The general principle is that, on hearing such application, the court shall make such order as it thinks fit for restoring the position to what it would have been if the company/individual had not entered into that transaction [note 47] [note 48]. In this regard, the court has wide discretion as to the order it may make restoring the position. The Act provides a “menu” of possible remedies [note 49] [note 50], but the court is not limited to these options. The order can be made against the recipient of the property or their successors in title (though, see paragraph 31.4A.100 for an important defence for innocent third parties).
It has been held that the court has discretion to decline to make an order restoring the position (see paragraph 31.4A.98) where, for example, to do so would result in a hardship to the recipient [note 51]. Examples of this may be where the insolvent passed property to a charity or to employees at the cessation of trade.
The court may exercise discretion not to make an order even where there is evidence that a transaction at an undervalue had taken place – where, for example, the transaction was undertaken to correct a mistake in an earlier conveyance [note 52].
The court will also consider whether it is worthwhile making the order when the effect of the order may be to restore the insolvent to a worse position than arrived at following the transaction [note 53].
The general principle here is that the court should be satisfied that a reasonable board of directors could have genuinely considered the transaction to be beneficial to the company and the continuation of its business. Hindsight is irrelevant so far as deciding these matters is concerned.
This defence is not available in a bankruptcy case.
The position of the recipient of the property is irrelevant so far as deciding whether or not a transaction at an undervalue has taken place. It matters not whether the recipient was aware of, or was ignorant of, the financial position of the debtor [note 55].
Where the property is transferred from the recipient to a third party, the third party is protected from being subject to an order restoring the position (see paragraph 31.4A.98) if the property was acquired in good faith and for value [note 56] [note 57]. Where the third party who acquired the property had knowledge of the proceedings and surrounding circumstances, or is an associate (see paragraph 31.4A.111) or connected person (see paragraph 31.4A.110), then the onus to prove good faith is on that person [note 58] [note 59].
When deciding on the appropriate remedy to be ordered to restore the position of the estate, the court may also make an order providing for the extent to which the recipient of the property may prove in the proceedings as a creditor [note 60] [note 61].
The right of a liquidator to bring proceedings to set aside a transaction at an undervalue does not form part of the company’s property and is, therefore, incapable of being charged or assigned [note 62] [not 63].
The entering into a transaction at an undervalue may constitute a misfeasance and breach of duty on the part of the director(s) and, therefore, the liquidator may also consider bringing an action for misfeasance [note 64].
The advantage of this over an action to recover a transaction at an undervalue is that an order can be made against the director(s) to repay the sums personally.
An action for misfeasance may be brought alongside an action to recover a transaction at an undervalue, though the loss may only be recovered once and any sums recovered must not exceed the amount originally lost to the company.
See Part 4 of Chapter 31.4B for further information on misfeasance.