James Lloyd: Supreme Court casts doubt on gratuitous alienations

James Lloyd

The law governing gratuitous alienations is less certain that it was following a decision of the Supreme Court, writes James Lloyd.

On 4 December, the Supreme Court handed down its judgement in the case of Macdonald & Another v Carnbroe Estates Limited. The judgment reframes the remedies available to the court when there has been a transfer of an asset at undervalue prior to an insolvency.

The background to the case was unremarkable. Shortly before going into liquidation, Grampian sold a warehouse to Carnbroe. The price agreed was £550,000 but, at settlement, only the sum of £470,000 was paid Natwest to settle Grampian’s debt. The final balance of the agreed purchase price was not actually paid until the proof in the Court of Session.

Parties were agreed that, had the property been the subject of a proper marketing process, a higher price would have been achieved. Carnbroe argued that Grampian did not have the luxury of time in which to carry out a proper marketing process because of its perilous financial position. A “quick sale” was therefore required to avoid action by the secured creditor. The consideration that it had given was “adequate” because that was the best price which could have been achieved “in the circumstances”.

The Supreme Court agreed that there had been a gratuitous alienation. The correct test to be applied to the transaction was, had Carnbroe proved that the price that it had paid was the equivalent to what would have been achieved if the property been sold by a liquidator or the secured creditor? The onus of proof lay with Carnbroe but it had not led any evidence to that effect. It had therefore failed this test.

The Supreme Court then moved on to consider what the remedy should be in circumstances where a substantial consideration has been paid for an asset but that consideration is found to be inadequate.

The prevailing and long standing authority was that the only remedy available to court was to order reduction of the transaction, restoring the asset to the insolvent estate. Although the legislation provided for “such other redress as appropriate” this was only available to the court if reduction was not possible. The court had no general equitable discretion to make an alternative order to meet the circumstances of the cases. Thus a purchaser who had paid an inadequate consideration could suffer the “double whammy” of having to return the asset but only be entitled to lodge an ordinary claim in the insolvency.

The Supreme Court held that existing authority was wrong. The legislation could be interpreted much more flexibly so as to allow the court to take account of the consideration which a bona fide purchaser has paid when determining what the appropriate remedy should be. Such an approach did not amount to exercising a general equitable jurisdiction.

This decision has far-reaching implications for both corporate and personal insolvencies. Until now, practitioners considered the law settled and that an alienated asset would be returned following a successful challenge. While the effect might seem to be “unfair” there were good policy reasons for that, specifically that it discouraged such transactions. This was a powerful weapon in the practitioner’s armoury which could be used as leverage in negotiations.

Matters are now more uncertain. The UKSC has remitted the case back to the Inner House to determine what the remedy should be. It is hoped that, when doing so, the Inner House will give guidance as to how this exercise should be approached.

On a positive note, the decision provides some comfort for the rescue/turnaround industry where would-be white knights can deal with distressed businesses in the knowledge that, if a seller goes bust, they will not lose everything to a liquidator. In this regard Scotland was at a disadvantage to England, where the remedies available are more flexible.

Also the fact that the court can fashion a remedy to suit the circumstances of a case may, in many cases, be more attractive to a liquidator.

Reduction is often too blunt a tool for liquidators, who rather than recovering an asset which has to then be marketed and sold, might simply prefer a big bag of cash.

James Lloyd is a partner at Harper Macleod. This article first appeared in The Scotsman.