Where a transaction by an insolvent company is annulled on the ground of inadequate consideration, the court can protect a good faith purchaser who has given substantial, though inadequate, consideration, rather than leave them to compete as unsecured creditors for the return of the price paid, the UK Supreme Court ruled today.

The court allowed an appeal, to the extent of remitting the case to the Inner House to consider the appropriate remedy, by the purchaser, Carnbroe Estates Ltd, of a warehouse which was the principal asset and place of business of Grampian MacLennan’s Distribution Services Ltd (“Grampian”), in a transaction challenged by Grampian’s liquidators as for a value lower than could have been achieved on the open market. 

The parties disputed the proper interpretation of “adequate consideration” in s 242(4)(b) of the Insolvency Act 1986, and whether the court had any discretion as to the remedy it may give under that section. The property had been valued in March 2013 at £1.2m on the open market and at £800,000 on a restricted marketing period of 180 days. The following year, Grampian fell into financial difficulty and was sold to Mr Quinn. Shortly afterwards, Grampian’s cash flow collapsed. Mr Quinn entered into discussions to sell the property with a businessman he knew, Mr Gaffney, whose family company was Carnbroe. They agreed a price of £550,000 in a quick, off-market sale. Carnbroe paid the price direct to the secured creditor to obtain a discharge of the standard security. This left Grampian’s other principal creditor, HMRC, unpaid. 

The Lord Ordinary held that the sale of the property was for adequate consideration. The Inner House reversed this and and ordered Carnbroe to transfer the property to the Respondents. Carnbroe appealed to the Supreme Court.

Lord Hodge, with whom Lord Reed, Lord Wilson, Lord Briggs and Lord Sales agreed, said the meaning of “adequate consideration” was to be determined according to an objective test, having regard to the commercial justification of the transaction in all the circumstances and assuming that the parties would be acting in good faith and at arm’s length. Unless the insolvent party’s financial embarrassment was known in the relevant market, the hypothetical purchaser would not be assumed to have knowledge of it, and it was not relevant that Mr Quinn advised Mr Gaffney of Grampian’s financial difficulties. 

However, the fact of Grampian’s insolvency was, itself, a relevant circumstance, in that an insolvent vendor would be expected to manage its assets in such a way as to protect the interests of its creditors. The objective purpose of the sale was also a relevant circumstance. The court recognised that a quick sale might sometimes be in the interest of the creditors, such as when the sale would enable the insolvent party to trade out of insolvency. Where there was no prospect of this, the adequacy of the consideration would depend on whether there was prejudice to the insolvent company’s creditors, which involved comparing the outcomes which would have been available in the circumstances of the insolvency.

In the present case, the sale of the property was part of an informal winding up of Grampian. As such, the court considered that there could be no justification for an off-market sale at a price so far below market value on the ground of urgency. There was no evidence to support the view that a sale by the secured creditor, or by the liquidators, would have been likely to achieve a comparable or lower net price than that which Grampian accepted. As such, the Inner House was entitled to interfere with the Lord Ordinary’s assessment of the adequacy of the consideration. 

As to the appropriate remedy, the liquidators argued that s 242(4) of the 1986 Act required the courts to annul any transaction with an insolvent company for less than adequate consideration, save where such annulment was impossible. However, the court considered that such a rule could produce harsh and disproportionate effects, since s 242(b) would capture sales to good faith, arm’s length purchasers for substantial (if not adequate) consideration. If such a transaction were reversed, the good faith purchaser would be forced to compete as an unsecured creditor to recover the consideration it had paid. In a departure from previous decisions of the Inner House, the court concluded that s 242(4) was broad enough to allow the courts, in appropriate cases, to devise a remedy to protect the good faith purchaser. In the absence of agreed facts as to the impact of reversing the present transaction, the case would be remitted to the Inner House to determine whether it was appropriate to qualify the remedy it had given to take account of all or part of the consideration paid.

Click here to access the judgment.