Distressed sales – buyer beware?
A recent case reframed the remedies courts have at their disposal where a company has transferred an asset at undervalue before its subsequent insolvency.
And it may prove particularly relevant given the challenging times we’re operating in now, not least with the COVID-19 lockdown as well as the associated collapse in the oil price.
Whereas we can only hope we safely emerge from this sooner rather than later, it's sadly inevitable cash will simply run out for some.
Yes, there are various government schemes available aimed at preventing this; however, even if a business takes advantage of business interruption loans, and deferred payment of VAT, for example, this would simply be parking liabilities: the pressure’s back on cashflow at a later date.
It is always the case that difficulties for one are opportunities for another.
Those in a stronger financial position may think they can pick up a bargain from a cash-strapped business.
With this in mind we consider the Supreme Court judgment in Macdonald & Another as Liquidators of Grampian Maclennan’s Distribution Services Limited v Carnbroe Estates Limited, which was handed down on 4 December last year.
Grampian was a distribution services company in financial difficulty. It had already been struggling, but when its invoice factoring facility was withdrawn its cashflow also collapsed.
Unable to obtain alternative funding, Grampian sold off its trucks, which were on hire purchase, to reduce outgoings. It also intended to sell its one other asset — its distribution centre, which chartered surveyors had valued in March 2013 at £1.2million on the open market.
The value would fall to £800,000 if there was a restricted marketing period of 180 days.
In May 2014, Carnbroe had intimated an interest in purchasing the property for £950,000, and another company also expressed an interest in acquiring the property at £900,000. A couple of months later though, Grampian sold the property to Carnbroe for £550,000.
Carnbroe had become aware of Grampian's difficulties, and the reduced price reflected a quick sale.
While the price allowed Grampian's secured lender, NatWest, to be repaid in full and the standard security over the property to be cleared, it left some £500,000 owing to HMRC. Consequently, HMRC presented a petition for winding Grampian up.
Liquidators were appointed, and they challenged the sale of the property to Carnbroe as a gratuitous alienation — “adequate consideration” as required under section 242(4)(b) of the Insolvency Act 1986 had not been received.
The Insolvency Act contains certain protections for creditors of companies, including the requirement that adequate consideration be received for assets of the company disposed of in the period leading up to insolvency.
Otherwise the company would have disposed of its assets and received nothing, or less, in return, with less than what should properly be available to distribute to its creditors as a result.
Progress through the courts
At the court of first instance it was held that Carnbroe had established the sale of the property was made for adequate consideration.
Grampian was fighting for its survival and a quick decision had to be made. While the purchase price fell short of the open market value, Grampian had limited options because —
- It was in a perilous financial position. It could not afford a lengthy marketing period
- NatWest was threatening to call up the standard security and to use other diligence against it in terms of the bond and floating charge it held
- There was no other offer on the table. The earlier expressions of interest were just that. There was no solid proposal to accept
Expert surveyors had also agreed that a price of £550,000 was not inappropriate if the property had been marketed on a closed basis for six months.
The liquidators appealed to the First Division of the Inner House.
The court there reduced the disposition of the property and ordered Carnbroe to execute a disposition of the property in favour of the liquidators.
In the court’s opinion, the most important issue in the appeal was whether it was correct to say a quick sale was justified because Grampian had an immediate need for funds. The court concluded it was not and identified four important factors —
- Grampian’s severe financial difficulties when the finance house withdrew its invoice factoring facility
- Grampian’s balance sheet insolvency
- The sale of the trucks on which Grampian depended to provide its distribution service
- The sale of the property which was its principal place of business and depot
It considered on an objective analysis there was no realistic prospect Grampian’s business could continue in existence after the sale of those assets and, as such, this was not a situation where a quick sale would save the business.
As such, the court held, "For these reasons we are of opinion that the need for a forced sale to provide immediate liquidity is not normally a factor that should be taken into account in determining the adequacy of consideration obtained for a sale of the debtor’s assets in any case where the debtor has ceased business or is about to cease business."
It was then Carnbroe's turn to appeal to the Supreme Court.
The Supreme Court
The Supreme Court considered that "adequate consideration" should be not less than would reasonably be expected in the circumstances, assuming that persons in the position of the parties were acting in good faith and at arm’s length from each other.
It also agreed —
- There may be circumstances in which an insolvent, acting in the interests of its creditors, needs to achieve a quick sale; however, here there was no justification for the off-market sale of the property at a price so far below market value on the ground of urgency
- The distribution centre sale, following the sale of Grampian’s vehicles was, in effect, seen as part of an informal winding up of the business. There was no possible salvation of the business through a reduced price sale of the property as might ultimately improve Grampian's trading position and lead to creditors being repaid
- In the circumstances, the adequacy of the consideration achieved on a sale should be measured by comparing the consideration which the insolvent company has accepted against the likely outcomes which a formal insolvency would achieve through the sale or other disposal of the asset by a liquidator or administrator, taking into account the fees which the insolvency practitioner would charge for effecting the sale
- It was for Carnbroe to show it had paid adequate consideration, but it had failed to demonstrate that the price it paid was at least as much as would likely have been obtained by a liquidator
You will recall that the Inner House had ordered the reduction of the purchase. There was better news for Carnbroe in its appeal here.
It had long been accepted that where inadequate consideration had been given, the appropriate remedy was the reduction of the transaction and the restoration of the asset in question to the insolvent estate.
Whereas section 242 of the Insolvency Act does expressly provide the court can order such "other redress as may be appropriate", the prevailing view was that this alternative was only open where reduction was no longer possible.
Therefore, Carnbroe would be faced with the double whammy of not only having to give the property back to Grampian (in liquidation), but also having to rank alongside other ordinary creditors in its claim to repayment of the £550,000 price Grampian owed it.
The Supreme Court held that this was neither appropriate nor prescribed.
The court is perfectly entitled to order credit be given in some way for the consideration which a bona fide purchaser has paid when devising a remedy for the gratuitous alienation by restoring property or value to the insolvent’s estate in a particular case. Previous cases suggesting the contrary were wrongly decided and should not be followed.
And the court added that "the First Division be given an opportunity to consider whether it is appropriate in the circumstances of this case to qualify the remedy of reduction which it has given to take account of all or part of the consideration which Carnbroe gave for the purchase, for example by requiring the liquidators to pay a specified sum to Carnbroe as a condition of the reduction" – a heavy hint as to the direction to take, although we await the outcome!
So what should a would-be purchaser do when offered a deal which may seem too good to be true?
One of Carnbroe's arguments at the Supreme Court was that the first division’s judgment lacked commercial practicability: a purchaser in a commercial deal looks after its own interests and is entitled to exploit a vendor’s financial distress to obtain a favourable price in an arm’s length transaction.
Sales at less than open market value are the norm where there are problems with liquidity.
But the purchaser cannot know whether the vendor in pursuing an urgent sale has a realistic possibility of preserving its business or is otherwise acting in the interests of its creditors (where apparently a reduced price sale is acceptable). It argued that if this analysis were correct, prudence would require the purchaser to refuse to deal with a company in distress and instead wait to see if a formal insolvency eventuated which would enable it safely to purchase from a liquidator.
The double whammy whereby the purchaser takes a risk and accepts the bargain, only for the transaction to be reduced in a subsequent liquidation of the seller, with the purchaser having to hope that it gets something of the purchase price returned to it as an ordinary creditor is unacceptable.
The Supreme Court realised the unfairness of this.
It did not see the legislation as compelling such a harsh result. As noted above, it contemplates account being taken of the consideration which a bona fide purchaser has paid the insolvent in devising an appropriate remedy.
This goes some way in addressing the concerns of a would-be purchaser.
A seller may well offer assets for sale at a discount for a quick sale. It may be entitled to do so where it considers it has a chance of using those proceeds to keep its business going. If the seller is solvent at that time or at any time after the sale, then the purchaser will indeed have done a good bit of business.
If, however, the seller does subsequently become insolvent, the purchaser's bargain may well be challenged as a gratuitous alienation. The purchaser's bit of business may ultimately prove to be not so good.
It might, for example, be required to pay a "top-up". But at least it might now be spared the double whammy of losing the assets and losing its cash.