Banking & Finance

For many years an insolvent company’s creditors have had their cake and eaten it where a gratuitous alienation for inadequate consideration has been successfully challenged.

Where a company transfers property for no or inadequate consideration (known as a ‘gratuitous alienation’, the Scottish cousin of the transaction at an undervalue) and subsequently becomes insolvent within a certain period, that transfer can be challenged by a creditor or the liquidator where the company is in liquidation, or by the administrator, where the company is in administration.  A successful challenge can result in the transfer being reduced and the asset returned to the company.  Where the transferee has paid money for the asset the general body of creditors receive an uncovenanted windfall – the company keeps the purchase price and gets the asset back, to sell again in all likelihood.  The good faith purchaser who has paid money, albeit not an adequate amount, is left out of pocket having had to return the asset to the company and rank as an unsecured creditor for the purchase price.  As the company is insolvent the purchaser will at best get a small refund of what it paid.

That is how gratuitous alienations have played out in the Scottish courts in recent times.  Few would deny it is an unfair outcome where the purchaser has paid significant consideration in good faith. Yet until a Supreme Court decision earlier this month, the courts, faced with these situations, have said their hands are tied.  The shackles, the courts have said, lie in the wording of s242 of the Insolvency Act 1986 which they believed compelled them to order a decree of reduction regardless of the disproportionate and unfair effect on the good faith purchaser. Section 242 directs the court to reduce the transaction or grant “other redress as may be appropriate”.  Until now courts have consistently taken the view that this wording didn’t give them discretion to decide a case on equitable principles or empower them to order anything less than a full return of the property transferred.

The Supreme Court, however, in its judgment in MacDonald and another v Carnbroe Estates Ltd, has taken a significantly different approach. The facts were that in a quick off-market sale a purchaser in good faith bought property valued at between £800k and £1.2M for £550k shortly before the seller entered liquidation.  The Inner House had found that the sale was not for adequate consideration and should be reduced.  The Supreme Court agreed that the sale was not for adequate consideration but took the view that the wording in s.242 gives the courts power to devise an appropriate remedy where the reduction of a transfer to a good faith purchaser, without giving the purchaser credit for the consideration it paid, leads to a wholly disproportionate and unfair result.

We will have to wait to find out what the appropriate remedy will look like as the Supreme Court has remitted the case back to the Inner House to consider whether it is appropriate here to qualify its remedy of reduction to take account of the price the purchaser paid for the property.  The judgment gives a hint that this might involve requiring the liquidators to pay a specified sum to the purchaser as a condition of the reduction. Other possible options would be an order requiring the purchaser to pay an additional specified sum to the liquidators and retain the property itself, or requiring the purchaser to sell the property back to the insolvent company for a specified sum.  While each option comes with its own difficulties as to what the specified sum should be, it is clear that going forward the Scottish courts will have a much wider discretion in devising an appropriate remedy.  This aligns the position in Scotland more closely with that in England and Wales where the equivalent provision of the Insolvency Act (s238) allows the courts to restore the position to what it would have been had the transaction at undervalue not taken place. In Scotland the creditors having their cake and eating it no longer has to be the result.

If you have any questions about corporate insolvency in Scotland please contact Shirley Li-Ting, Louise Laing or Amy McVey.

Lindsay Lee

Practice Development Lawyer at Brodies LLP
Lindsay practised as a corporate then as a banking lawyer with Brodies LLP for 12 years before taking on the role of Practice Development Lawyer within the Banking and Financial Services team. In addition to her experience advising on financial services and consumer finance projects and working with retail banking clients, Lindsay has worked in-house with several banks.

Lindsay provides banking support and knowledge management services, including practical up-to-date resources and training materials for clients and the Banking team.
Lindsay Lee