HM Insights

Harper Macleod action leads to Supreme Court reframing remedies for gratuitous alienations

The Supreme Court judgment in MacDonald and another v Carnbroe Estates Ltd addresses fundamental questions about the interpretation of the Insolvency Act 1986 (the 1986 Act). Most significantly, the decision reframes the remedies available to the court when there has been a transfer at undervalue.

Harper Macleod LLP represented the joint liquidators in this action, successfully arguing that the transaction should be reduced as a transfer at undervalue. James Lloyd, Partner, and Senior Associate Laura McCorquodale led the Harper Macleod team.

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The reviewable transaction

Grampian MacLennan's Distribution Services Ltd (Grampian) operated a distribution business from warehouse premises in East Kilbride which it had purchased for £630,000 in 2005.

Grampian's owners sold their shares in the business in June 2014, at which point the company had liabilities in excess of £1m, more than £500,000 to each of its main creditors HMRC and NatWest. Shortly after the sale, Grampian's invoice factoring facility was withdrawn and its cash flow collapsed.

Grampian's new owner was unable to obtain alternative funding and took steps to mitigate the company's financial difficulties. He sold the company's vehicles and then sold its premises to Carnbroe Estates for £550,000 in July 2014. The sale price for the property was substantially lower than the £1.2m open market valuation reported by surveyors in 2013. This was said to reflect that the buildings were in need of repair and upgrading and that a quick off-market sale was desirable because of mortgage arrears and the risk that the property would be repossessed.

Carnbroe did not actually pay the agreed consideration of £550,000 to Grampian; instead, it paid the sum of £473,604.68 directly to NatWest to repay Grampian's outstanding LIBOR loan and obtain a discharge of NatWest's standard security over the property.

The sale of the property and the repayment of the NatWest LIBOR loan left the other principal creditor, HMRC, unpaid. HMRC petitioned to wind up Carnbroe when it refused to pay the outstanding tax due. Liquidators were appointed and they commenced proceedings to reduce the sale of the business premises on the basis that the transaction was not for adequate consideration.

The Court of Session decisions

The Outer House judge held that adequate consideration had been paid, finding that the urgent disposal was justified in the circumstances to preserve Grampian's business.

The First Division, however, concluded that the transfer had not been for adequate consideration. On an objective analysis there was no realistic prospect that Grampian’s business could continue in existence after the sale of its vehicles and distribution centre so this was not a case in which the achievement of a quick sale of the property would save the company’s business.

The Inner House granted decree of reduction to restore the property to Grampian's estate. There was no order for the £550,000 purchase price to be paid back to Carnbroe, leaving Carnbroe to rank as an ordinary unsecured creditor for recovery of the purchase price.

The Supreme Court decision

The case came to the Supreme Court on appeal regarding three points:

  1. interpretation of the term “adequate consideration” in section 242(4)(b) of the 1986 Act;
  2. whether the Inner House was entitled to interfere with the Lord Ordinary’s evaluation that the consideration given by Carnbroe amounted to adequate consideration; and
  3. the interpretation of the words in section 242(4) of the 1986 Act that empower the court to grant a remedy.

What is "adequate consideration"?

The Supreme Court referred to the leading Scottish authority on the meaning of “adequate consideration” which is set out in the opinion of Lord Cullen in Lafferty Construction Ltd v McCombe 1994 SLT 858 at p 861:

“In considering whether alienation was made for ‘adequate consideration’, I do not take the view that it is necessary for the defender to establish that the consideration for the alienation was the best which could have been obtained in the circumstances. On the other hand, the expression ‘adequate’ implies the application of an objective standpoint. The 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.”

Applying that objective test to the circumstances in this case, Lord Hodge agreed with the First Division's finding that the property transaction was a sale at undervalue. Carnbroe led no evidence that the £550,000 which it eventually paid was equivalent to the price which the secured creditor or the liquidator could have obtained by selling the property on the open market. The Inner House was therefore entitled to interfere with the Lord Ordinary’s assessment as to whether there had been adequate consideration.

What remedies are available following a transfer at undervalue?

The Supreme Court took a particular interest in the remedies that are available under section 242(4) of the 1986 Act for an alienation where substantial consideration has been paid but that consideration is found to be inadequate.

Section 242(4) of the 1986 Act provides that:

"On a challenge being brought under subsection (1), 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;"

The question was whether this means that the court is limited to granting decree of reduction or restoration of property to the company's assets, with no restitutio in integrum, unless such reduction or restoration is not possible, in which case "other redress" will apply.

There is little authority on the interpretation of this section but there has been judicial scrutiny of the equivalent provisions in section 34(4) of the Bankruptcy (Scotland) Act 1985 (now re-enacted as section 98(5) of the Bankruptcy (Scotland) Act 2016).

Short's Trustee v Chung 1991 SLT 472 has been the authority on this point for nearly 30 years. In that case, the court held that it was bound to reduce the disputed dispositions and had no general equitable discretion to make an alternative order. The court held that the reference to ‘other redress as may be appropriate’ is designed to enable the court to make an appropriate order in a case where reduction or restoration of the property is not a remedy which is available.

This approach was followed in Cay's Trustee v Cay 1998 SC 780 and also in Baillie Marshall Ltd v Avian Communications Ltd 2002 SLT 189, which was an unfair preference case applying the equivalent provisions in section 243 of the 1986 Act.

Carnbroe's counsel argued that restricting the court to granting reduction only, without requiring the liquidator to pay back the purchase price, creates anomalous results. The issue only arises in cases where there has been substantial but inadequate consideration paid as, in those cases, the estate would have the benefit of both the property and the purchase price following reduction. This represents an uncovenanted windfall for the general body of creditors and penalises the bona fide purchaser who would rank as an ordinary creditor in a claim for unjustified enrichment.

Flexible interpretation of the remedies

The Supreme Court held that it was permitted to take a more flexible interpretation of the remedies available under section 242 of the 1986 Act as the statutory words are broad enough to allow the court to take account of the consideration which a bona fide purchaser has paid the insolvent when determining the appropriate remedy.

According to Lord Hodge, giving credit for consideration paid does not amount to exercising a general equitable jurisdiction as it does not go so far as to require the court to take account of the personal and financial circumstances of the defender. The decision is not therefore inconsistent with the prior case law which established that there is no such general equitable jurisdiction. However, the court held that:

"In so far as Short’s Trustee v Chung and Cay’s Trustee v Cay held that the court did not have this power [to take account of consideration paid], I respectfully conclude that they were wrongly decided and should not be followed."

Disposal

The action has been remitted back to the First Division to consider whether to qualify the remedy of reduction 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, now that the Supreme Court has held that this is a course of action that is available to them.

You can read the full judgment and summary here.

Comment

The most significant part of this judgment relates to an argument that was not considered in proceedings before the Court of Session, so the prevailing interpretation of section 242(4) of the 1986 Act may have remained undisturbed had it not been for the Supreme Court's interest in the lack of flexibility in the remedies and the resulting "harsh" outcome for bona fide purchasers.

This decision will have implications for the remedies available in future gratuitous alienation challenges under the 1986 Act as well as under section 98(5) of the Bankruptcy (Scotland) Act 2016.

Until now (based on the authority of the decisions in Short's Trustee and Cay) it was thought that the only remedy available following a successful challenge of a gratuitous alienation was the return of the asset alienated. Only if that was not possible could the Court consider alternative remedies such as payment.

The judgment of UKSC in this decision the courts greater flexibility to fashion remedies in such cases, something that is likely to be of greater practical use to insolvency practitioners than the blunt tool of simple restitution.

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