Out-Law News | 05 Dec 2019 | 4:43 pm | 4 min. read
Up until now, purchasers in so called 'gratuitous alienation' deals were liable to lose the property they acquired to liquidators of insolvent companies and be left with nothing other than a claim in the insolvency, but David Crossan of Pinsent Masons, the law firm behind Out-Law, said the Supreme Court had essentially ruled that such an outcome would not always be fair.
Crossan was commenting after the Supreme Court ordered the Inner House of the Court of Session in Edinburgh to review the remedy in one case.
The case before the Supreme Court concerned the Scots law of gratuitous alienations on insolvency. That law protects creditors by enabling liquidators, and administrators, to challenge transactions where businesses who have subsequently fallen into insolvency had disposed of assets too cheaply. Such transactions are known as gratuitous alienations and liquidators have scope to challenge them where they occur within two years of the insolvency or five years where the purchaser is an associate of the company.
Section 242 of the Insolvency Act 1986 provides courts with scope to order that property sold under a gratuitous alienation is restored to the company’s assets, among other potential remedies. However, purchasers can prevent such an order from being made if they can show that their purchase was made for "adequate consideration".
Crossan said: "The recovery of gratuitous alienations is one of the most powerful tools available to insolvency practitioners. The remedy can deliver great results for creditors, albeit sometimes at the expense of buyers who paid a purchase price falling below what would be classed as 'adequate consideration'. The remedy in such cases would see the asset returned to the estate of the insolvent company and the purchaser would be left to claim what it had paid in the insolvency - along with all the other creditors.
"Now, the Supreme Court has sought to build in protection for purchasers and bring the remedy more in line with its English equivalent. However, we don’t know what the remedy will look like yet as it has been left to the Inner House of the Court of Session to draw up the protection," he said.
"Ultimately, I anticipate it will involve a balancing of the sums paid by the purchaser and the value of the asset. For example, the insolvency practitioner could get the asset returned but be obliged to pay back the purchaser’s money from the sale proceeds. There are tricky issues for the Scottish court to navigate, however, including who suffers the losses resulting from deterioration of the asset or market fluctuations," Crossan said.
In the case before the Supreme Court, family company Carnbroe Estates had appealed against an earlier ruling by the Inner House of the Court of Session which had ordered it to give up property it had previously acquired. The Scottish court said the liquidators of insolvent company Grampian MacLennan’s Distribution Services were entitled to sell off the property to raise money for Grampian's creditors as Carnbroe Estates had acquired the property – Grampian's business premises – for less than 'adequate consideration'.
Grampian's business premises had been valued at £1.2m on the open market and at £800,000 on a restricted marketing period of 180 days in March 2013. The company was bought by a new owner, Kevan Quinn, in 2014 when it was experiencing financial difficulties. When those problems worsened, Quinn sold some of the company's assets, including its trucks, and then opened negotiations on the sale of Grampian's business premises with another businessman, James Gaffney, who Quinn had known for more than 30 years.
Gaffney negotiated the purchase of the property on behalf of his family business Carnbroe Estates in a quick, off-market deal, for a price of £550,000. Carnbroe Estates paid the sale price to NatWest bank, to release its security over the property, but Grampian's other principal creditor, HM Revenue and Customs (HMRC), went unpaid.
In its ruling, the Supreme Court said there was "no justification for the off-market sale of the property at a price so far below market value on the ground of urgency" as there was no prospect of saving Grampian's business. It also said Carnbroe Estates had not been able to show that there had been 'adequate consideration' in its purchase "as it led no evidence to support the view that a sale by NatWest or a sale by the liquidator with NatWest’s consent would have been likely to achieve a price net of expenses which was comparable to or less than the sale price which Grampian accepted".
However, the Supreme Court, in a departure from the previously accepted position, said that courts have scope to devise an appropriate remedy to account for cases where purchasers have paid some money for property that did not amount to adequate consideration. It said that it would be "wholly disproportionate and unfair to annul the property transfer without giving the bona fide purchaser credit for the consideration which it has paid" in some cases.
"It is necessary to afford the [Inner House] an opportunity to consider whether it is appropriate in the circumstances of this case to qualify the remedy of reduction which it has given to take account of all or part of the consideration which Carnbroe gave for the purchase, for example by requiring the liquidators to pay a specified sum to Carnbroe as a condition of the reduction," Lord Hodge said in the Supreme Court judgment.
Crossan said that, in addition, the ruling provided helpful guidance on the test of 'adequate consideration'.
In this respect, account can be taken of a party’s financial difficulties but only where those difficulties are known on the market. If only the purchaser knows the purchaser is distressed, it is not a relevant factor.
The court also confirmed that a quick, off-market sale can be justified if the seller has liquidity problems and the sale will allow it to trade through the problems.
In cases where the sale wouldn’t enable the business to continue trading, such a sale can still be justified if the price is no less than that which could be obtained through a sale by insolvency practitioners or by a secured creditor selling to enforce its security. However, Crossan said that the court was at pains to emphasise that its guidance does not provide a justification for a low price in these circumstances. It referred to the duties that insolvency practitioners owe to realise value and the restrictions placed on secured creditors by legislation.
The Inner House's re-formulation of the remedy is now keenly awaited.