Transactions by a company at an undervalue – s.238 IA 1986

TheLawStudent

Purpose

This concerns loss of value from a company, whether through gifts or a significant inequality in consideration, to the company’s detriment at a time when it is “insolvent”.

Who may bring a claim?

Only a liquidator or an administrator may make an application to the court to challenge the transaction (s.238(1)).

What is a transaction at an undervalue? (s.238(4))

  1. A gift; or
  2. a transaction for a consideration the value of which, in money or money’s worth, is significantly less in value than the consideration provided by the company. This involves a comparison in monetary terms between what the company gave away and what it received under the transaction. The comparison to be made is aimed at establishing if there has been an inequality of exchange adverse to the company under the transaction. A simple example would be where a company sells an asset worth £10,000 but only received £5,000 in payment.

Would the granting of security or the payment of a dividend by the company amount to a transaction at an undervalue?

It was generally thought that the granting of security by a company cannot amount to a transaction at an undervalue on the basis that the security does not itself deplete the assets of the company or diminish their value (Re MC Bacon Ltd [1990] BCLC 324). However, in Hill v Spread Trustee Company Limited [2006] EWCA Civ 542, it was found that the granting of security for no consideration (or for consideration significantly less than the value of the charge) can be challenged as a transaction at an undervalue. In Hill, the main purpose for the granting of security was to put assets beyond the reach of HMRC. The law is somewhat uncertain on this point because of the difference in view between the MC Bacon and Hill cases.

Similar uncertainty existed around whether a dividend, lawfully paid, could amount to a transaction at an undervalue. The case of BTI 2014 LLC v Sequana SA & others [2019] EWCA Civ 112 now suggests that a dividend can be attacked as a transaction at an undervalue (even though the Sequana case involved a transaction defrauding creditors under s.423, that section shares many elements with s.238).

In any event, such security or dividend can only be challenged as a transaction at an undervalue if the other requirements of s.238 are satisfied and the statutory defence is not available. (Note: the same facts which can give rise to a transaction at an undervalue may also be challengeable as a voidable preference under s.239).

When and how can the transaction be avoided?

The court may set aside a transaction as a transaction at an undervalue if:

  1. The company made a gift or otherwise entered into a transaction for a consideration, the value of which in money or money’s worth is significantly less in value than the consideration provided by the company.
  2. It took place within the ‘relevant time’ (s.238(2)) – in the two years preceding the ‘onset of insolvency’ (s.240(1)(a)), which is the commencement of the relevant insolvency procedure (administration or liquidation) (s. 240(3)).
    Note that the relevant time is two years regardless of whether the transaction took place with a connected person or not.
  3. It is proved by the applicant that the company was insolvent at the time of the transaction or became so as a result of it (s.240(2)).

    Where a transaction at an undervalue is entered into with a person connected with the company, insolvency is presumed unless the connected person proves otherwise (s.240(2)).

    Ss.249 and 435 set out the definitions of ‘connected persons’ and ‘associates’ respectively.

Defence (s.238(5))

Even if all of the requirements set out above are satisfied, no order will be made to set aside the transaction if the court is satisfied that:

  1. the company entered into the transaction in good faith and for the purpose of carrying on its business; and
  2. at the time there were reasonable grounds for believing that the transaction would benefit the company.

This defence is often relied on in practice and can save many transactions which would otherwise be open to challenge. One example when the defence may be available is where a company grants new security to stave off a genuine threat made by an unsecured bank to terminate facilities and begin winding up proceedings if the security is not granted, in circumstances where the directors consider on reasonable grounds that the company can turn around its financial difficulties and thereby avoid entering into an insolvency procedure.

Sanction

The court has a discretion to make such order as it thinks fit to restore the position as if the company had not entered into the transaction (s.238(3)).

S.241(1) provides a non-exhaustive list of the types of restoration order that the court might make under s.238 (and also under s.239 in relation to voidable preferences; see section 10 below).

Any such order should not prejudice a subsequent purchaser from the party which transacted at an undervalue with (or received a preference from) the company, provided they were acting ‘in good faith and for value’ (s.241(2)).

However, under s.241(2A) there is a rebuttable presumption that an acquisition by a subsequent purchaser was not in good faith where the subsequent purchaser either:

  1. had notice of the relevant surrounding circumstances (i.e. the transaction at an undervalue or preference) and of the relevant proceedings; or
  2. was connected with or was an associate of either the company or the party which transacted at an undervalue with (or received a preference from) the company.

In such circumstances the burden of proof shifts to the subsequent purchaser to show good faith.