Being found to have entered into a Transaction at an Undervalue can result in you, as a director, being held personally financially liable and even banned from acting as a company director in the future. As part of your directors' duties, if your company becomes insolvent (or you believe it is about to become insolvent), you must switch to acting in the best interests of the business's creditors. This means being alive to the risk of entering into undervalued transactions that may result in the company being accused of giving some creditors preferential treatment over others.
What are Transactions at an Undervalue?
Transactions that the Court can set aside once a company is in liquidation or administration, which were entered into before those proceedings began, are commonly referred to as reviewable or antecedent transactions. Transactions at Undervalue are one type of antecedent transaction.
Transactions at undervalue apply to companies who have entered administration or liquidation, where the transaction has been entered into within two years of the organisation becoming insolvent. The law relating to Transactions at Undervalue is covered under section 238 of the Insolvency Act (IA) 1986.
There are two types of transactions at undervalue:
- The insolvent company makes a gift or transaction, and no consideration is given to it by the receiver. This falls under section 238(4)(a) of the IA 1986. Examples of this are transferring assets for free or providing a service without charge.
- Under section 238(4)(b), a transaction involves consideration of significantly less value than the consideration originally provided by the company. An example of this could include A selling land valued at £10,000 to B for £100.
What is 'Consideration' in Relation to a Transaction at Undervalue?
Consideration is the value a person or entity provides in exchange for receiving an asset, product, or service. Typically, consideration is the money paid, but it can take other forms, such as the exchange of an asset of similar value.
The crux of a Transaction at an Undervalue is the lack of or vastly reduced consideration.
How Does an Insolvency Practitioner Uncover Transactions at Undervalue?
If your company falls into insolvency, the appointed Insolvency Practitioner will examine every transaction your business entered into over the previous two years. To protect the interests of the company's creditors, they will look for any transfers that may have unfairly reduced the company's assets.
Even transactions that you believed were honest and legal could be challenged. This is because the Insolvency Practitioner must ensure all creditors are treated equally. If some received transactions at undervalue, this could impact the amount other creditors can recover.
What is the Legal Test for a Transaction at Undervalue?
Section 238 of the IA 1986 provides that a company has entered a transaction at undervalue if it:
- Made a gift or otherwise entered into a transaction on terms that provided for the company to receive no consideration; or
- Entered into a transaction for a consideration, the value of which, in money or money's worth, is significantly less than the value of the consideration provided by the company.
- The transaction was entered into during the two years before the onset of insolvency.
If an Insolvency Practitioner, acting in their capacity as an Administrator or Liquidator, makes an application to the Court for a suspected Transaction at Undervalue to be set aside, a final decision is unlikely to be made without a full hearing. This is because the Court will need to examine all the evidence, including any relevant defences.
What are the Defences Available If I am Accused of Making a Transaction at an Undervalue?
The Court will not set aside a transaction if you can show:
- The company entered into the transaction in good faith and did so as part of carrying on its general business, and
- There was a genuine belief at the time the transaction was made that it would benefit the company.
In Ingram (Liquidator of MSD Cash and Carry plc) v Singh and others [2018], the High Court stated that once an Insolvency Practitioner had proved a Transaction at Undervalue had been made, it was for the directors to explain why the transaction was legitimate and made in good faith.
What Happens if the Court Concludes Transactions Were Made at an Undervalue?
If the Court finds a transaction was undervalued, it can reverse the transaction and order the Insolvency Practitioner to take control of the asset and use it to benefit the creditors of the company.
The consequences for directors can be severe. You could be disqualified from acting as a company director for between two to fifteen years and also pay back the 'undervalue' portion of the transaction.
If the Insolvency Practitioner cannot recover any of the undervalue from you, they can bring a claim against the beneficiary of the transaction.
Avoiding Undertaking Transactions at Undervalue
Company directors need to be aware of the financial position of their company at all times. If you are in any doubt as to whether a particular transaction could later be criticised, get professional advice from a Solicitor or an Accountant. It may cost money to do this, but it will be nothing compared to the reputational damage and financial consequences of being found to have made a Transaction at an Undervalue.
It is also vital for directors to get at least one independent valuation when selling company assets, including property.
Finally, all significant transactions, especially those involving the sale of company assets, should be regularly discussed at board meetings, and the reasons and thinking behind valuations and benefits to the company should be documented. This ensures that if any decisions are challenged in the future, you can refer to these records to show the transaction in question was made in good faith.
How We Can Help
Facing financial challenges? Our experienced insolvency lawyers at Witan Solicitors can provide tailored solutions. Contact us today at 0330 173 6983 or by email.
