Gratuitous alienation: a diversion tactic?

The recent Supreme Court ruling in Joint Administrators of Oceancrown Ltd v Stonegale Ltd [2016] UKSC 30 found that a series of conveyances of properties some nine months before the sellers went into administration was an attempt to divert assets away from creditors. It was considered "plain and obvious" that these conveyances were gratuitous alienations in terms of section 242 of the Insolvency Act 1986 ("the 1986Act"). A gratuitous alienation is a transfer of property from a debtor to another party for no consideration or an inadequate consideration.

Gratuitous Alientation Property Insolvency Adminstration Law Scotland

The Legislation

Section 242 of the 1986 Act allows an administrator of a company to challenge a transfer of assets made by the company to an associate within five years of the company entering administration. This challenge can be defeated if the transfer had "been made for adequate consideration" under section 242(4)(b) of the 1986 Act.

Background

Ralph Norman Pelosi ("RNP") controlled a group of companies which included Oceancrown Limited, Loanwell Limited and Questway Limited ("the Companies"). His son, Norman Ralph Pelosi ("NRP") was sole shareholder and director of Stonegale Limited ("Stonegale"). The Companies owned five properties: 110, 210, 260 and 278 Glasgow Road, and 64 Roslea Drive. Anglo-Irish Bank ("the Bank") held standard securities over each of these properties after providing a facility of £17.3million to Oceancrown Limited. The facility was also cross-guaranteed by the other two group Companies. In August 2010, the Bank was informed that a sale of the five properties was imminent and that the total sale price was over £2.4million conform to professional valuations of the properties. The Companies sought the discharge of the standard securities.

Later the property at 278 Glasgow Road was transferred by Oceancrown Limited to a company owned by RNP called Strathcroft Limited for £762,000. On that same day, Strathcroft Limited transferred the same property to Clyde Gateway Development Limited for £2,467,500. This sum was subsequently used by RNP to reduce the indebtedness to the Bank and to have the Bank discharge the standard securities it held over each of the five properties, the Bank believing that this was the total sum received for the sale of all of the five properties.

The properties at 110, 210 and 260 Glasgow Road were then transferred to Stonegale, and 64 Roslea Drive to NRP, neither of which received any consideration in return. A "loan agreement" was drawn up between Strathcroft Limited and Stonegale purporting to loan Stonegale the money to finance the Glasgow Road properties. NRP sold 64 Roslea Drive for £125,000.

Nine months after this series of transactions the Companies entered administration and the Joint Administrators challenged the conveyance of 110, 210 and 260 Glasgow Road and 64 Roslea Drive as gratuitous alienations under s242 of the 1986 Act.

The judge held that the appellants had no defence to the gratuitous alienation claims as there was not an adequate consideration paid for the properties. The three dispositions of the Glasgow Road properties were set aside and NRP had to repay the £125,000 he had received in selling 64 Roslea Drive. This decision was upheld in the Inner House. Stonegale and RNP appealed to the Supreme Court.

The appeal

It was claimed by the appellants that the correct remedy had not been utilised. Instead of challenging the dispositions as being gratuitous alienations of the properties there were a number of alternative remedies which should have been pursued, including a challenge to the alienation of 278 Glasgow Road to Strathcroft Limited at an undervalue, or recovering damages in fraud for the misrepresentation to the Bank.

The court therefore had to rule on whether the Lord Ordinary could hold that the appellants had not established the statutory defence of adequate consideration.

Decision of the Supreme Court

The decision of the Supreme Court was delivered by Lord Reed, with whom the other Supreme Court judges agreed, confirming the approach of the judge at first instance. The Supreme Court agreed that the Bank was misled into believing that the funds received in reduction of the indebtedness were from the sale of all five properties and not only of 278 Glasgow Road. If the Bank had had this information the funds would have reduced the overall indebtedness to the Bank but would not have seen the discharge of all five securities. The four remaining properties had an aggregate value of £1.525million and were now free of the standard securities and the Companies then placed these properties "entirely beyond the [B]ank's reach" by disponing them to Stonegale and NRP.

Lord Reed approved the judge's decision that "The dispositions under challenge were gratuitous alienations. Were it otherwise the bank would have received in excess of £4m, and the overall indebtedness would have been reduced by that amount". Instead the four properties were transferred and "[t]he companies received nothing whatsoever in return. There was no reciprocity between those disposals and the earlier payment to the bank. The purpose and effect of those transactions was to divert assets away from the companies' creditors: exactly what section 242 is intended to prevent. That they were gratuitous alienations is plain and obvious."

Points to note

  • This decision is not binding on the Courts of England and Wales although it will be in Scotland. Nevertheless is might be of interest to a court considering a similar issue in that jurisdiction.
  • It is important to note that in such an action the onus lies with the transferee to prove that adequate consideration was given in return for the transfer of property. There should be adequacy of consideration (transfer as repayment of indebtedness can count as consideration) and there requires to be reciprocity between the transfer of the property and the making of the sum said to constitute the consideration.

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The small print: This blog is for information purposes only and should not be construed in any way as providing legal advice.