Gratuitous alienations, good faith and adequate consideration under the Insolvency Act 1986

The Supreme Court recently set out their view regarding Section 242 of the Insolvency Act 1986, ‘gratuitous alienations’, ‘good faith’ and ‘adequate consideration’. Iain Penman of Brodies details the case of MacDonald v Carnbroe Estates Limited.

Gratuitous Alienations Good Faith Adequate Consideration Insolvency

What is gratuitous alienation in insolvency?

Section 242 of the Insolvency Act 1986 (“section 242”) allows the challenge of certain alienations by a company in insolvency in Scotland within two or five years of the commencement of its winding up, depending on who the alienation favours. While the rules can be complex, in basic terms, gratuitous alienations are disposals of property for no or inadequate consideration during insolvency.

Under section 242, if the court concludes that there has been a gratuitous alienation, it is obliged to “grant decree of reduction” (ie reverse the transfer of property) or such "other redress as may be appropriate."

In the recent decision of the Supreme Court in MacDonald v Carnbroe Estates Limited [2019] UKSC 57, Lord Hodge sets out the views of the court towards gratuitous alienations in detail. 

The case of MacDonald v Carnbroe Estates Limited [2019] UKSC 57

Background of the case

The case of MacDonald v Carnbroe Estates Limited concerned the sale by Grampian MacLennan’s Distribution Services Limited’s (“Grampian”) main premises at a substantially lower value than that which had been estimated by experts as achievable on the open market.

In March 2013, surveyors had valued the property at £1.2million on the open market with that valuation falling to £800,000 in a restricted marketing period of 180 days. Approximately a year later Grampian found itself in financial difficulty and was sold to a Mr Kevan Quinn. By this point Grampian owed over £500,000 to HMRC and a similar amount to National Westminster Bank Plc.

Mr Quinn entered into what the Court later described as ‘a process analogous’ to an unofficial winding up, by seeking to realise as many of the company’s assets as possible. Carnbroe Estates Ltd (“Carnbroe”) acquired the property for £550,000 as part of that process.

Interestingly, whilst Grampian transferred the property to Carnbroe by way of Disposition, dated 24 July 2014, in which the consideration was stated at £555,000 with entry being given to the property on that date, Carnbroe did not pay the agreed consideration but instead paid the sum of £473,604.68 to NatWest on 14 August 2014 to obtain a Discharge of the Standard Security over the property. Carnbroe did not pay the balance of the purchase price to Grampian until 9 June 2016 after the completion of the original Proof before the Lord Ordinary.

Following the appointment of liquidators, they challenged the transfer to Carnbroe on the basis it was not for adequate consideration. The Lord Ordinary took the view that in the light of the facts the consideration was adequate, however this was appealed.

Court Decision

Decision of the court

On Appeal the Inner House reduced the transaction and ordered Carnbroe to transfer the property back to Grampian, now in liquidation. Lord Hodge gave the Decision of the Court providing a detailed analysis of section 242.

Of particular interest is Lord Hodge’s commentary on what represents “adequate consideration”, emphasising the objective nature of the test of adequate consideration and advising that regard must be had to the commercial justification of the transaction on the assumption that those involved are acting in “good faith” and at arm’s length.

Commenting on the specific facts of this case, Lord Hodge noted that there was no justification for the off-market sale of the property at a price so far below market value. This was as Carnbroe had failed to establish that there was adequate consideration and had led no evidence to support the view that a sale by the secured creditor or liquidator would have been less likely to achieve a price net of expenses which was comparable to, or less than the price which Grampian had accepted. As such, the Inner House was therefore entitled to interfere with the Lord Ordinary’s assessment as to whether there had been adequate consideration.

Implications of the decision

In considering the statutory remedies, Lord Hodge observed that the test for adequate consideration is an objective one which takes account of all the circumstances, including circumstances of which one or both parties to the transaction may not have been aware, such as the transferor's insolvency and the objective purpose of the transaction.

There is therefore a significant risk that a good faith purchaser without knowledge of the seller’s insolvency, or the reason why the seller is willing to sell at a price substantially below market value, could be exposed to a challenge which such a purchaser cannot defend. This brings into focus the wording of section 242, in particular: “The Court shall grant decree of reduction or for such restoration of property to the company’s assets or other redress as may be appropriate.”

Lord Hodge concluded that the statute words are broad enough to allow the Court to take account of the consideration which a good faith purchaser has paid the insolvent party in devising an appropriate remedy and that: “The Court in an appropriate case, and if justice requires it, to devise the remedy to protect the bona fide purchaser of property for and reversal of its purchase which would otherwise give the creditors of the insolvent a substantial windfall at its expense.

The question for the Court is simply whether in devising the remedy for their gratuitous alienation by restoring property or value to the insolvent estate in a particular case it should order the credit be given in some way for the consideration which a bona fide purchaser has paid.”

The Court’s decision was therefore that it was necessary to remit the case back to the First Division to consider whether it is appropriate in the circumstances of this case to qualify the remedy of reduction to take account of all or part of the consideration given, for example by requiring the liquidators to pay a specified sum to Carnbroe as a condition of the reduction.

It will be interesting to see what approach the Inner House takes in future cases, as it seems likely that whilst this decision has provided guidance on the question of how adequate consideration is to be approached, it may increase uncertainty by allowing the Courts to innovate in applying remedies under section 242.

About the author

Iain Penman is a Senior Associate at Brodies LLP. Iain has almost 20 years’ experience of practising as a litigator and resolving disputes. Over the last 12 years, Iain has focused on developing his specialism in restructuring and insolvency disputes.

See also

Everything you need to know about debt management plans

The pros and cons of pre-pack administration for insolvent companies

Find out more

Insolvency Act 1986 (Legislation)

MacDonald v Carnbroe Estates Limited [2019] UKSC 57 (Supreme Court)

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Publication date: 17 January 2020