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Buyers should beware of "fire sale bargain" distressed businesses: Supreme Court insolvency case

On 4 December 2019, the Supreme Court handed down its judgment in MacDonald and another (Respondents) v Carnbroe Estates Ltd (Appellant) (Scotland) [2019] UKSC 57. The appeal concerned the interpretation of ‘adequate consideration’ under section 242 of the Insolvency Act 1986 (the “Act”) and the remedies that courts can apply if there is a gratuitous alienation, and inadequate consideration paid for the transaction in question.

The case is of obvious interest to insolvency practitioners when considering the appropriateness of pre-insolvency asset disposals but also a cautionary tale for those attempting to pick up assets at a knock-down price from distressed businesses; if a deal looks too good to be true, it possibly is.

Background

Grampian MacLennan’s Distribution Services Limited (the “Company”) held various assets including trucks and a property consisting of a warehouse, a vehicle workshop and a yard with gatehouse (the “Property”). In March 2013, the Property was valued at £1.2 million on an open market basis, and £800,000 on a restricted marketing period of 180 days.

In 2014, the Company fell into financial difficulties and in June of that year, the shares in the Company were sold to a third party, Mr Quinn. The Company owed both National Westminster Bank plc (the “Bank”) and HMRC over £500,000 each and shortly after the takeover of the Company, the loan repayments to the Bank fell into arrears. The Property was sold on to Carnbroe Estates Ltd (“Carnbroe”), which was owned by a business acquaintance of Mr Quinn, Mr Gaffney. With awareness of the Company’s financial difficulties and the potential risk of calling up by the Bank (together with some knowledge about the current state of the Property and the work required to bring into an adequate state of repair), Mr Gaffney negotiated a reduced, off-market, price of £550,000 (having previously made an offer of £950,000, prior to the sale of the Company to Mr Quinn). This allowed repayment of the Bank’s debt, but no payment to HMRC. As predicted, this resulted in HMRC petitioning for the winding up of the Company. Joint provisional liquidators were appointed on 12 September 2014.

Judgment

The joint liquidators challenged the sale of the Property to Carnbroe as a gratuitous alienation under section 242 of the Act. At first instance, it was held that adequate consideration had been paid for the Property, on the basis that there was justification for an urgent off-market sale, resulting in the lower purchase price. However, the Inner House held on appeal that there was no such justification and that the transaction should be reduced and ordered Carnbroe to transfer the Property to the joint liquidators. That decision was then appealed to the Supreme Court which upheld the Inner House’s decision, holding that since the Company was balance sheet insolvent (and was going to cease trading in any event), it owed its primary duty to its creditors, thereby requiring that full consideration be paid on any alienation of its assets (there were no circumstances justifying the urgent sale). In addition, there was no evidence that the price paid by Carnbroe was equal to that expected to be raised following a repossession and sale or a sale by a liquidator and therefore the ‘adequate consideration’ test had not been met.

The Supreme Court passed the case back to the Inner House to determine the appropriate remedy – whether that will be a return of the Property, a payment to the estate of the Company, or “other redress as may be appropriate”, in terms of section 242(4) of the Act. Deciding what to do will be a delicate balance between (on the one hand) making sure that the estate available to the creditors is not reduced by the absence of the Property (or the funds paid for it) and (on the other hand) not unfairly prejudicing a purchaser who has paid funds for an asset but is then ordered to return that asset – in these circumstances, that purchaser finds himself doubly penalised; he holds no asset and has lost the funds paid for that asset. He has no choice but to submit a claim for unjustified enrichment and rank as an ordinary unsecured creditor in the estate. However, in this case, it may be questionable as to whether Carnbroe rightly was a good faith purchaser, given Mr Gaffney’s knowledge of the Company’s state of affairs and whether this was exploited to Carnbroe’s advantage.

Fraudulent preferences

The case also referred to the Scots common law remedy of fraudulent preference. This remedy is not as common as the statutory right of relief but does allow a challenge to an alienation where the circumstances do not fit squarely within the legislative regime. Perhaps the most appealing aspect of this remedy is that there is no time limit, in stark contrast to the prescribed two year period for non-connected parties (and five years for connected parties) as set out in the Act. Insolvency Practitioners should bear this remedy in mind, if there are transactions which come to light which cannot be challenged under the Act.

Remedy

Whilst the Supreme Court’s decision has clarified slightly the position on ‘adequate consideration’, the opinion from the Inner House regarding the appropriate remedy will be even more eagerly awaited by the industry. We will provide a further update once this has been issued.

This publication is intended for general guidance and represents our understanding of the relevant law and practice as at January 2020. Specific advice should be sought for specific cases. For more information see our terms and conditions.

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