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Discussion i) Ratio |
The statutory provisions STA |
Section 242 of the 1986 Act enables among others the liquidator of a company to challenge a gratuitous alienation in Scotland if the alienation took place not earlier than two years before the commencement of the winding up or not earlier than five years before that date if the alienation favours an associate of the co... |
Subsection (4) provides: On a challenge being brought under subsection (1), the court shall grant decree of reduction or for such restoration of property to the companys assets or other redress as may be appropriate; but the court shall not grant such a decree if the person seeking to uphold the alienation establishes ... |
Several points may be made about the section 242. Ratio |
First, the liquidator or creditor is entitled to make the challenge if the alienation occurs at a date not less than two years before the commencement of the winding up or five years before that date if the transferee is an associate of the insolvent company: section 242(3). Ratio |
Secondly, subject to the next point, the court must give at least one of the remedies specified (section 242(4)). Ratio |
Thirdly, to prevent the court from giving such remedies, the transferee of the alienation must establish one of the listed circumstances (section 242(4)(a)-(c)). Ratio |
In this case the circumstance which Carnbroe asserts is that the alienation was made for adequate consideration. Ratio |
The burden is thus placed on the transferee to establish that the consideration given for the alienation was adequate. Ratio |
Fourthly, as I shall show when I discuss case law below, the test as to whether the consideration is adequate is an objective test. Ratio |
Fifthly, where a remedy is given against the transferee, the subsection protects any right or interest which a third party has acquired in good faith and for value from or through the transferee (the proviso in section 242(4)). Ratio |
This is relevant to the interest of the Bank in this case. Ratio |
Subsection (7) preserves the Scots common law of challenges to gratuitous alienations by providing that a liquidator and an administrator have the same right as a creditor has under any rule of law to challenge an alienation of a company made for no consideration or no adequate consideration. Ratio |
Section 242 of the 1986 Act applies to corporate insolvency a regime for challenging gratuitous alienations which was introduced in section 34 of the Bankruptcy (Scotland) Act 1985, which governs the bankruptcy of natural persons and partnerships in Scotland, following a recommendation of the Scottish Law Commission in... |
The relevant provision in bankruptcy is now section 98 of the Bankruptcy (Scotland) Act 2016, but I will focus on the predecessor statute in discussing the genesis of the relevant provisions. Ratio |
Essentially the same regime was introduced into corporate insolvency by section 75 of and paragraph 20 of Schedule 7 to the Bankruptcy (Scotland) Act 1985 which inserted section 615A into the Companies Act 1985. Ratio |
Thereafter, it was replaced by the provision in the 1986 Act. Ratio |
I therefore refer to the new regime for gratuitous alienations as the 1985 statutory reforms. Ratio |
In chapter 12 of the report which led to the 1985 statutory reforms, the Scottish Law Commission set out its proposals to make more consistent the rules of Scots law, both common law and statutory, in relation to the challenges to gratuitous alienations and unfair preferences to creditors on insolvency. Ratio |
Scots common law has built on the principle of the actio Pauliana in Roman law which allowed a challenge to a gift made by an insolvent donor on the basis that the gift was a fraud upon his or her creditors. Ratio |
Under Scots common law it is not necessary to prove an intention to defraud if the creditor mounting the challenge can show three things: (i) the debtor was absolutely (ie balance sheet) insolvent at the time of the challenge and was either insolvent (in that sense) at the time of the alienation or was made insolvent b... |
As it was difficult for a creditor to prove such insolvency at the date of the alienation, the Scottish Parliament by the 1621 Act (c 18) (the 1621 Act) strengthened the creditors position in challenges to alienations which an insolvent made to a conjunct and confident person (ie a close relative, business partner, emp... |
The 1621 Act, which the Scottish courts interpreted liberally, had the effect that, if the creditor could establish that the debtor was insolvent at the date of the challenge, it was presumed both that the debtor had been insolvent at the date of the alienation and that the alienation was made without onerous considera... |
It was not necessary that the alienation be wholly gratuitous as the challenge could be made to an alienation which was for a materially inadequate consideration in money or moneys worth. Ratio |
Under both the common law and the 1621 Act the challenger of the transaction did not have to prove that the debtor or the transferee was aware of the debtors insolvency or that the debtor was seeking to harm his creditors: McCowan v Wright (1852) 14 D 968, 970 per the Lord Justice-Clerk (Hope). Ratio |
Under the 1621 Act the challenger had to prove only the debtors insolvency at the date of challenge and that the challenger was prejudiced by the transaction if it was at an undervalue. Ratio |
Nor is it necessary when alleging fraud at common law, as a general rule, to prove that there was fraud or complicity on the part of the recipient of the alienation: McCowan v Wright (1853) 15 D 494, 496-504 per the Lord Justice-Clerk (Hope), 509 per Lord Cockburn, 512-515 per Lord Wood. Ratio |
A successful challenge led to the annulment of the alienation; where there had been a purchase at an undervalue there was no requirement that the retransfer of the property to the debtors estate was conditional upon the repayment of the consideration which the transferee had paid: Tennant v Miller (1897) 4 SLT 318. Rat... |
Both Scots common law and the 1621 Act protected a third party who took the alienated property from the transferee in good faith and for value; in such a circumstance the only remedy for the creditor or insolvency practitioner was to claim the sale proceeds from the transferee. Ratio |
The common law and the statutory provisions have been applied to companies as well as other debtors: Abram Steamship Co Ltd v Abram 1925 SLT 243; Bank of Scotland v R W Forsyth Ltd 1988 SC 245. Ratio |
Alongside these provisions concerning gratuitous alienations, Scots common law allowed creditors of an insolvent to challenge as fraudulent preferences voluntary preferences which the insolvent granted to a creditor during insolvency. Ratio |
Such fraudulent preferences could take the form of a grant of security for a prior debt or facilitating a creditors attempt to execute diligence or obtain a decree to enforce the debt. Ratio |
The common law was reinforced by another Act of the Scottish Parliament in the Act 1696 (c 5) (the 1696 Act), which nullified all deeds which a bankrupt granted within 60 days before or during his insolvency and which gave a preference to a creditor over other creditors. Ratio |
Like the 1621 Act, the courts gave this Act a broad interpretation. Ratio |
The Scottish Law Commissions expressed aim in promoting the reform proposals was to achieve a consistent and logical scheme for the annulment of alienations and unfair preferences. Ratio |
There is no suggestion of an intention fundamentally to alter the law in relation to gratuitous alienations on the repeal of the 1621 Act. Ratio |
Section 242 of the 1986 Act reflects many of the Commissions recommendations. Ratio |
The wording of the remedies which the court was empowered to give in section 242(4) tracks the Commissions recommendation in para 12.19 of the report but there is no discussion in the report of any prior case law on the nature of the remedy or remedies open to the court and no statement of policy to explain the recomme... |
The report thus gives no guidance as to whether it was envisaged that the court would enjoy a discretion in devising a remedy. Ratio |
I return to this matter in paras 44 - 69 below. Ratio |
Both before and after the 1985 statutory reforms, the consequence of the annulment of an alienation by reduction was and is that the property is transferred back to the insolvents estate. Ratio |
If the court is not empowered to or does not impose conditions on the reduction, the transferee who has paid a substantial but inadequate consideration may only have a claim in unjustified enrichment against the insolvents estate for repayment of the consideration paid. Ratio |
In making that claim the transferee ranks as an ordinary creditor and may receive only a dividend or nothing at all, depending upon the balance between the insolvents assets and the debts due to secured creditors and other creditors. Ratio |
A claim for the recovery of the transferred asset itself or the proceeds of its sale ranks as a postponed debt: rule 4.66(2)(a) of the Insolvency (Scotland) Rules 1986 (SI 1986/1915), which has now been replaced by rule 7.27 of the Insolvency (Scotland) (Receivership and Winding Up) Rules 2018 (SSI 2018/347). Ratio |
There are three principal innovations in the 1985 statutory reforms which are relevant in this case. Ratio |
The first is that the presumptions in the 1621 Act which applied only to alienations to conjunct and confident persons have been extended to all gratuitous alienations, including those in which a purchaser at arms length buys an asset from the insolvent at an undervalue. Ratio |
The second is the introduction of new time limits for the challenge: the difference between associates and other transferees now lies only in the provision of different time limits in section 242(3) (para 20 above). Ratio |
The third is the specification in section 242(4) of the different remedies available to the court in place of a statutory statement that the transaction was a nullity. Ratio |
ii) Adequate consideration Ratio |
As I have said, before the 1985 statutory reforms to the Scottish law of insolvency, an alienation could be challenged not only if it was wholly gratuitous but also if it was at an undervalue. Ratio |
What amounted to a relevant undervalue before 1985? The leading Scottish textbook on bankruptcy before the 1985 statutory reforms was Goudy, A Treatise on the Law of Bankruptcy in Scotland, 4th ed (1914), which provided a commentary on both the common law and the Bankruptcy (Scotland) Act 1913, which was repealed in 19... |
Goudy answered the question by explaining what was not an undervalue. Ratio |
His analysis of the prior case law was that at common law consideration for an alienation was not an undervalue if it was fairly equivalent to what is received (p 25) and similarly, under the 1621 Act if, it was fairly adequate for what was given (p 47). Ratio |
Support for Goudys view can be found in Bells Commentaries on the Laws of Scotland, 7th ed (1870), vol ii, p 179 which, in a commentary on the 1621 Act, stated: In proving the consideration of the deed, every case must depend on its own circumstances. Ratio |
It may be observed, however, in general, 1. Ratio |
That it is not in all cases necessary to prove that the highest price possible has been got for the subject; but quite sufficient if what is commonly called a fair price has been received, ie a price, which, in the whole circumstances of the case, indicates a fair and bona fide transaction. Ratio |
The Lord Justice-Clerk (MacDonald) in the Second Division of the Inner House used the concept of fair consideration in Gorries Trustees v Gorrie (1890) 17 R 1051, 1054. Ratio |
See also Glencairn v Birsbane (1677) Mor 1011, in which a defence that adequate consideration had been given was held to be relevant in the face of an assertion by the pursuer that he would have paid more, and Millers Trustee v Shield (1862) 24 D 821, in which, in a challenge to an allegedly unfair preference under the... |
The courts have adopted a similar approach to adequate consideration since the 1985 statutory reforms. Ratio |
The leading Scottish authority on the meaning of adequate consideration in section 242 of the 1986 Act is the opinion of Lord Cullen, when he was a Lord Ordinary, in Lafferty Construction Ltd v McCombe 1994 SLT 858. Ratio |
Both the appellant and the respondents accepted his statement as the proper approach to adequacy under section 242(4)(b). Ratio |
He stated, 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. Ratio |
On the other hand, the expression adequate implies the application of an objective standpoint. Ratio |
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 arms length from each other. Ratio |
Lord Eassie expressed a similar opinion in relation to the identical term in the equivalent provision in section 34(4) of the Bankruptcy (Scotland) Act 1985 in Aitkens Trustee v Aitken, 26 November 1999, reported as Kerr v Aitken [2000] BPIR 278, in which he stated, at p 282: In my opinion the expression adequate consi... |
The only qualification which I would make to Lord Eassies formulation is that I would not speak of ordinary commercial circumstances, but, like Lord Cullen, would look to the circumstances of the case, which might (as I discuss in para 34 below) in an appropriate case include the sellers need to obtain a prompt sale to... |
Both judges correctly emphasise the objective nature of the test and that regard must be had to the commercial justification of the transaction in all the circumstances on the assumption that hypothetical people in the position of the insolvent and the transferee would be acting in good faith and at arms length. Ratio |
In my view, the requirement that the hypothetical parties are acting at arms length means that the hypothetical purchaser would not have knowledge of the sellers financial distress unless the insolvents financial embarrassment was known in the relevant market. Ratio |
It would not be a relevant consideration that the actual vendor had disclosed its financial embarrassment to the purchaser and that the purchaser had exploited that disclosure in its negotiation of the purchase price. Ratio |
There is nothing to suggest that the 1985 statutory reforms sought to innovate in this regard. Ratio |
As a result, the statutory provisions apply during the specified period before formal insolvency (in this case liquidation) whether or not the insolvent is aware of his, her or its insolvency and whether or not the transferee or purchaser is so aware. Ratio |
One of the relevant circumstances is the fact of the bankrupts insolvency. Ratio |
As Lord Drummond Young records in para 13 of the Inner Houses opinion [2018] CSIH 7, by reference to Bells Commentaries, (above), (pp 171-172), the restoration to the bankrupts estate of assets gratuitously alienated is based on the principle that on the occurrence of insolvency, it is the creditors who have the real i... |
There is an analogous principle in United Kingdom company law which, on the occurrence of insolvency, requires company directors to have regard to and act in the interests of the companys creditors as part of their fiduciary duties owed to the company as a whole: West Mercia Safetywear Ltd v Dodds [1988] BCLC 250; Comp... |
The mischief which led to the enactment of the 1621 Act was the practice of bankrupts of creating secret trusts in favour of family members or close associates to protect their assets from their creditors. Ratio |
That mischief remains relevant. Ratio |
But the current statutory regime and the common law extend to business transactions at arms length and require the insolvent vendor to obtain an adequate consideration for its assets in the interests of its creditors, if a successful challenge is to be avoided. Ratio |
Another relevant consideration, as the Inner House states, is the objective purpose of the sale. Ratio |
As is clear from the expert evidence in this case, there is generally a close relationship between the time which is spent on marketing a commercial property and the price at which it will sell. Ratio |
Such property, if sold in a hurry, will usually obtain a significantly lower price than if it were exposed to the market for a longer period. Ratio |
On the occurrence of insolvency, the requirement that the insolvent has regard to the interest of creditors points towards the hypothetical vendor in the objective assessment having to carry out an adequate marketing exercise to obtain a good price for the property. Ratio |
If the insolvents property is not exposed to the market but is disposed of by private sale, there is an obvious risk of an inadequate price. Ratio |
But there may be circumstances in which an insolvent, acting in the interests of its creditors, needs to achieve a quick sale. Ratio |
An example of such a sale is where the insolvent is facing a liquidity problem and needs to obtain cash to pay its debts promptly in the hope of trading out of insolvency and preserving its business as a going concern. Ratio |
In such a circumstance, it may be objectively reasonable for the insolvent to accept the lower price from a quick sale of an asset in order to gain the chance of saving the business, as that outcome is likely to be in the interests of its creditors. Ratio |
An analogous example is the case of John E Rae (Electrical Services) Linlithgow Ltd v Lord Advocate 1994 SLT 788, in which an insolvent company, in order to continue to trade, needed certificates from the Inland Revenue that exempted it from the requirement that persons who employed it as a contractor or subcontractor ... |
To obtain those certificates from the Inland Revenue the company granted a bond in respect of past tax liabilities of an associated company, whose business had been transferred to the company, arising from underpayments of income tax and national insurance contributions in respect of payment made to subcontractors. PRE |
The liquidator raised an action under section 242 of the 1986 Act in which he sought reduction of the bond and repayment of sums which had been paid to the Revenue under it on the basis that it was an alienation in favour of the associated company. PRE |
But Lord Clyde rejected the liquidators challenge. PRE |
Adequate consideration had been given because the company, in return for undertaking to pay the associated companys debt, had obtained in effect the right to continue trading and had thus staved off its imminent demise. PRE |
That approach may be questioned where there is no evidence to show that the projected cash flow advantage, which the certificates gave the company, was measurable in money or moneys worth and, as so measured, was adequate as Lord Cullens formulation envisages. PRE |
But if there is such evidence, that approach accords with the section. PRE |
Where there is no question of a sale to preserve a companys liquidity or otherwise in the hope of enabling it to remain in business, and where the insolvent company is ceasing or has ceased to carry on business and is, in reality, winding up its business in an informal way without the involvement of a liquidator or an ... |
The answer, in the context of the objective exercise which the law mandates, will depend upon the circumstances of the insolvency. Ratio |
The aim of the common law and section 242 is to make sure that the creditors of the insolvent company are not prejudiced by an alienation by that company which brings into the insolvent estate materially less than would be obtained in an arms length transaction between bona fide commercial parties in the circumstances ... |
Where the directors of the insolvent company, mindful of their duty to creditors, have an opportunity to place a property on the market and carry out a proper marketing exercise to enhance the price which the property will command, adequate consideration should be measured against the likely result of such an exercise.... |
Where the insolvent company is not able to support such a marketing exercise, the adequacy of the consideration achieved on a sale is to 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 dispo... |
Where the asset in question is the subject of a security with a power of sale, it would be relevant also to consider the likely outcome of that sale. Ratio |
The aim of the common law and section 242 in that context is to make sure that the creditors of the insolvent company are not prejudiced by an alienation by that company which brings into the insolvent estate materially less than would be obtained by the formal insolvency process or the sale by the security holder. Rat... |
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