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If your business cannot meet its financial obligations, it may be insolvent. When a business is insolvent or facing insolvency, the law can review the business’s transactions in the previous two years. Additionally, the directors may be liable if your company has undertaken a transaction at an undervalue. This article will define what a transaction at an undervalue entails and its consequences.
What is a Transaction at an Undervalue?
A transaction at an undervalue is any transaction an insolvent company undertakes where it sells a non-cash asset for significantly less than its market value. For instance, say a company owns a piece of machinery (a non-cash asset) valued at £100,000. The company then sells it for £10,000. This likely amounts to a transaction at an undervalue.
In some cases, a transaction at an undervalue might include instances where the insolvent company grants a creditor security for less than the security’s value. For instance, a mortgage over a piece of land valued at £1m for £10,000 may offend the rule against transactions at an undervalue.
What is Insolvency?
Insolvency is where a business either has:
- inadequate assets to meet its liabilities on the balance sheet; or
- insufficient cash to meet obligations as and when they come due.
For instance, if a company has £10,000 in liabilities and £5,000 in assets, it is insolvent on a balance sheet basis. On the other hand, if a company has £10,000 in current liabilities but £5,000 in cash with no prospect of raising any more cash, it is insolvent on a cash flow basis.
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Who Can Bring a Claim For a Transaction at an Undervalue?
Only a liquidator or administrator can bring a claim against the creditor. A liquidator is the insolvency practitioner the court appoints to oversee a company’s liquidation. On the other hand, an administrator is the insolvency practitioner overseeing an administration.
However, the transaction must have occurred within two years before the insolvency occurred. Specifically, this is at the point that either liquidation or administration commences.
Was the Transaction At an Undervalue with a Connected Person?
If the transaction involves a connected person or an associate, the law takes a stricter view of the transaction. A connected person refers to a shadow director. Whereas an associate is anyone whose relation to the insolvent company’s director includes:
- a spouse;
- a relative of the director or spouse of the director, which is widely defined;
- a business partner;
- an employer or employee;
- certain trustees to trusts; and
- a separate company to which the director is connected.
If the undervalued transaction was with a connected person, the law adapts the presumption that the company was insolvent at the time of the transaction. In this instance, the company (and its directors) must rebut this presumption.
Where the transaction is with an unconnected person, the liquidator or administrator must prove that the company was insolvent at the time of the transaction. Alternatively, the liquidator or administrator must demonstrate that the transaction contributed to the insolvency.
Use this checklist to ensure your supplier contracts contain all necessary terms.
What is the Effect of a Successful Application?
The court can set aside the transaction if a liquidator or administrator brings a successful claim. This is referred to as a voidable transaction. As a result, the court might order the company that benefited from the undervalued transaction to:
- return the asset; or
- pay its market value.
Are There Any Defences?
The court will refuse an application where it is satisfied that:
- the company entered into the transaction in good faith to carry on its business; and
- at the time of the transaction, there were reasonable grounds for believing that the transaction would benefit the company.
An example might be when a company sells property at a steep discount to raise cash. While the transaction may technically be undervalued, the directors may have authorised the transaction as a last-ditch effort to keep trading.
Key Takeaways
A transaction at an undervalue is where a company sells a non-cash asset for substantially less than its market value. If the company becomes insolvent within two years of the transaction, the insolvency practitioner who takes control of the company can apply to the court to reverse the transaction.
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Frequently Asked Questions
You should seek immediate advice the moment you realise your company may not be able to meet all of its liabilities. An expert can advise you on whether you can continue to trade.
A connected person refers to a shadow director.
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