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Jennifer Angus is an associate in the restructuring and insolvency team at CMS Scotland. Jennifer offers a preview here of the appeal pending in the matter of MacDonald and another v Carnbroe Estates Ltd,  on appeal from the Inner House of the Court of Session in Scotland.

The UK Supreme Court has heard the appeal in the matter of MacDonald and another v Carnbroe Estates Ltd, on appeal from Scotland.  On 2 May 2019, a bench of five Justices considered the decision of the Inner House which held that the distressed sale of premises and other assets by a company constituted a gratuitous alienation under section 242 of the Insolvency Act 1986 (the “Act”). The judgment should be released later this year.

Background

 Grampian MacLennan’s Distribution Services Limited (the “Company”) operated throughout the UK providing distribution services. The Company was based in an industrial unit in East Kilbride. This unit (comprising a warehouse, vehicle workshop and yard with a gatehouse) was the Company’s main asset (the “Property”). The Company had loan facilities with National Westminster Bank Plc (“NWB”) and in return granted a standard security over the Property in favour of NWB, along with a Bond and Floating Charge. In March 2013 the Property was valued at £1,200,000 on the open market, or £800,000 if a restricted marketing period of 180 days was assumed.

Throughout 2014, the Company was in financial distress, and in July 2014 it owed £1,000,000 to its two principal creditors: HM Revenue and Customs (“HMRC”) and NWB. NWB indicated it was not prepared to support the Company further, and no alternative financing opportunities were available.  The Company’s invoice financing facility held with a third party was withdrawn, and the Company’s trucks (on hire purchase) were sold to reduce outgoings.

In July 2014, the Company sold the Property to Carnbroe Estates Limited (“Carnbroe”). The Property was sold off-market following private negotiations between the directors of the Company and the directors of Carnbroe for a purchase price of £550,000. Carnbroe purchased the Property using finance from the Bank of Scotland plc (“BOS”). BOS raised concerns to Carnbroe’s solicitors regarding the difference between the valuation of the Property and the purchase price. The solicitors acting for Carnbroe replied that because NWB were calling for payment under threat of enforcing their securities there was no willing seller and no willing buyer for the property and the 180 day marketing period was not possible. The surveyor instructed for BOS considered that even with a marketing period of 90 days the property valuation could be reduced by 50 per cent.

On 18 August 2014 Carnbroe made a payment of £473,604.68 to the Company. The Company paid this to NWB in full settlement of the Company’s indebtedness to NWB. The debt due to HMRC of approximately £550,000 remained unpaid and the Company had insufficient assets to make payment of that debt. HMRC filed a petition at Edinburgh Sheriff Court for the winding up of the Company. Joint Liquidators were subsequently appointed.

Current Law

On the onset of insolvency, certain transactions entered into by a company can be challenged if they are entered into at an undervalue and therefore constituted a gratuitous alienation under section 242 of the Act. If a court finds that a company disposed of assets without adequate consideration, they have the authority to unwind the transaction. In order to avoid the court reducing the transaction, section 242 provides that the person seeking to uphold the transaction must establish either:

  • that immediately, or at any other time, after the alienation the company’s assets were greater that its liabilities;
  • the transaction was made for adequate consideration; or
  • it was a gift (within certain parameters)

which, having regard to the circumstances, it was reasonable for the company to make provided the above defences are without prejudice to any right or interest acquired in good faith and for value from or through the transferee in the alienation.

Earlier Decisions

Outer House

The Joint Liquidators sought reduction of the disposition granted by the Company in favor of Carnbroe, arguing that the sale of the Property was a gratuitous alienation under section 242 of the Act. Carnbroe argued that the sale of the Property was for adequate consideration. Surveyors acting as expert witnesses for both the Joint Liquidators and Carnbroe agreed that the price of £550,000 was not unreasonable in certain conditions, most significantly that the Company needed funds and therefore a quick, distressed sale was required.  Should a proper marketing process be conducted (with a full marketing period) the Surveyors separately estimated a market value of £820,000 and £740,000 for the Property.

Lord Woolman held that Carnbroe had established that £550,000 was adequate consideration for the Property due to the Company’s limited sale options given its financial positon. However £473,604.68 was inadequate consideration (being the amount the Company had actually received at the time from Carnbroe).

Inner House

The case was appealed to the Inner House. The remaining purchase price for the Property (£76,395.32, being the agreed price of £550,000 less the sum of £473,604.68 already paid to the Company) was paid by Carnbroe to the Company in June 2016 in advance of the proof at the Inner House.

The critical issue for the Inner House was whether the purchase price of £550,000 for the Property was adequate consideration in the circumstances. Expert evidence in the Outer House had established that £550,000 could be adequate consideration in certain circumstances, the most notable being the Company’s immediate need for funds, requiring a quick sale. The Inner House was to determine whether these circumstances were present to justify the consideration of £550,000 paid by Carnbroe for the Property.

The Inner House considered section 242 of the Act, and the critical features of insolvency law, namely:

  1. once a debtor is insolvent, his assets must be managed in such a way as to protect the interests of his creditors;
  2. if a debtor alienates property once he is insolvent, he must obtain full consideration for the property alienated; and
  3. under the statutes that have addressed gratuitous alienations a series of presumptions operate whereby it is the person who receives the debtor’s property who must establish that full consideration was given.

These principles apply regardless of the debtor’s knowledge of their insolvency.

The Inner House concluded that given the Company’s financial difficulties, insolvency status and sale of its trucks, there was no realistic prospect that the Company’s business could continue in existence. There was therefore no need for the Property to be sold quickly, given the injection of cash achieved from the sale of the Property would not have saved the Company’s business. Instead the interests of the full body of creditors (not just NWB as secured creditor) should have been considered and the sale of the Property should have been conducted over a reasonable time frame to achieve full market value (between £820,000 and £740,000 being the estimates given by the surveyors before the Outer House). The Inner House concluded that Carnbroe had failed to establish that they had paid adequate consideration for the Property and issued a decree of reduction for the sale of the Property under section 242 of the Act.

The Supreme Court Appeal

On 2 May 2019, the UK Supreme Court heard the appeal against the decision of the Inner House. The decision is expected later this year and is eagerly awaited by the legal profession and insolvency practitioners.

The decision of the Outer House at first instance had justified the sale of the Property at below market value (should the Property have been marketed for sale with an adequate marketing period) given one creditor’s (NWB) need for immediate payment, which could have limited the scope for future gratuitous alienation actions. The Inner House had clarified that the interests of the full body of creditors should be taken into consideration, especially when there was no hope of rescuing the business as a going concern and therefore no justification for a short marketing period.

It will be of interest to see what the Supreme Court considers within the ambit of gratuitous alienations, and whether certain circumstances can justify a reduction of what meets the standard of adequate consideration.