Lifecycle of a Business – When insolvency beckons: a company’s perspective – reviewable transactions
Setting up and running your own business is an amazing achievement. It requires vision, creativity, motivation and stamina. On occasion, it can even bring you fame, riches and fortune. But it can also result in reams of paperwork and cause sleepless nights. And as someone once said to me about children “It doesn’t get easier, it just changes”, so the same can be said for your business throughout its lifecycle. From setting up to exit, it will force you to consider issues that you might not previously have known anything about and it will need you to make many decisions, sometimes very quickly. What it certainly is not is mundane.
With this in mind, the corporate team at Forsters, together with some of our specialist colleagues, has written a series of articles about the various issues and some of the key points that it may help you to know about at each stage of a business’s life. Not all of these will be relevant to you or your business endeavours, but we hope that you will find at least some of these guides interesting and useful, whether you just have the glimmer of an idea, are a start-up, a well-established enterprise or are considering your exit options. Do feel free to drop us a line or pick up the phone if you would like to discuss any of the issues raised further.
We’ve already discussed various topics, including funding, employment and commercial contracts, but it’s now time to discuss when things go wrong…
When insolvency beckons: a company’s perspective – reviewable transactions
We’ve recently discussed a director’s position when a company is facing financial difficulties. In this article, we consider transactions which might be reviewed if a company becomes insolvent.
Once a company enters formal insolvency, it is possible for historic transactions to be reviewed and challenged in certain situations, including where there has been a:
- Preference;
- Transaction at an undervalue; and/or
- Transaction which defrauded creditors.
Preferences
Preference transactions occur when, prior to insolvency, a company unfairly favours one creditor over others by making payments or transferring assets that would place the favoured creditor in a better position if the company becomes insolvent, than they would have been otherwise.
For there to be a preference, the transaction must involve a company creditor or a guarantor of the company’s debts or liabilities.
Secondly, there must be a clear improvement in the creditor’s position as a result of the company’s actions. The company must have done something or allowed something to happen that placed the creditor in a more favourable position than they would have been in if the transaction had not occurred.
The third element relates to the intention behind the transaction. There must be evidence that the company actively intended to place the creditor in a better position. It is important to note that this intention is presumed if the transaction benefits a connected party, such as a director, family member, or associated business.
The transaction must also have occurred within a specific period before the company’s insolvency. For non-connected parties, this period is six months, while for connected parties, it extends to two years.
Lastly, the company must have been unable to pay its debts when the transaction occurred or have become unable to pay its debts as a direct result of the transaction.
Transactions at an undervalue
A transaction at an undervalue occurs when a company transfers assets or enters into agreements for significantly less than their true market value and the company was either unable to pay its debts at the time of the transaction or became insolvent as a direct result.
Timing is crucial; the transaction must have taken place within the two-year period prior to the onset of insolvency.
Intent also plays a significant role in determining whether a transaction is at an undervalue. If the transaction was entered into with the purpose of putting assets out of reach of creditors or prejudicing their interests, it is more likely to be considered a transaction at an undervalue. Courts often assess whether the transaction was made in good faith or if there were reasonable grounds to believe it would benefit the company or individual involved.
Transactions defrauding creditors
A transaction defrauding creditors occurs when a company transfers assets for less than their market value, with the aim of moving the assets beyond the reach of its creditors or otherwise harming their interests. While there must be an intention to place assets beyond the reach of creditors or adversely affect their interests, this intention does not need to be the primary reason for entering into the transaction.
Unlike other voidable transactions, there is no specific time limit for challenging a transaction defrauding creditors (although the Limitation Act 1980 will apply), and the company does not need to be insolvent at the time of the transaction or become insolvent as a result of it.
Additionally, it is not necessary to prove fraud in a technical sense, but there must be evidence of intent to harm creditors’ interests, as stated above. Claims can be brought by any affected party, not just insolvency practitioners, and can be initiated at any time.
Remedies
When a successful claim is made in relation to a reviewable transaction, the courts have a range of remedial measures at their disposal.
The court may order the return of property or sale proceeds to the company, release or discharge security provided by the company, or require new security to be given. Obligations that were previously released or discharged can also be reinstated, and new obligations may also be imposed.
In cases involving transactions at an undervalue or those defrauding creditors, the court may void the transaction entirely. This typically involves restoring assets to their original state or ordering payment equivalent to the value of the assets transferred.
Directors and other involved parties may face personal liability for these transactions, which can include financial penalties, such as fines or obligations to repay amounts to the company or its creditors. They might also be banned from serving as directors for periods ranging from two to 15 years, and in severe cases, they could face imprisonment.
Such offences can also lead to broader consequences, including damage to the company’s reputation and costly legal proceedings, ultimately impacting its financial stability.
Practical considerations
To reduce the risk of a successful claim in relation to a reviewable transaction, companies should implement a comprehensive set of practices, such as:
1. Fair Market Value and Professional Valuations:
Ensure all transactions are conducted at fair market value. Obtain professional valuations for assets being sold or transferred, particularly for substantial transactions.
2. Financial Transparency and Documentation:
Maintain financial statements, cash flow forecasts, and balance sheets to demonstrate the company’s solvency at the time of transactions. Keep thorough records of all transactions, including contracts and correspondence.
3. Corporate Governance and Board Approval:
Establish clear and consistent payment policies. Obtain consent and approval from the board of directors before transferring or selling business assets and consider including the justification / rationale for the transaction in the board minutes.
4. Equal Treatment of Creditors:
Ensure all creditors are treated fairly and avoid preferential treatment. Be particularly cautious about transferring assets to connected parties such as directors, family members, or associated businesses at prices below true value, as these transactions are more likely to be scrutinised.
5. Seek Professional Advice:
Consult with legal advisors and financial experts before entering into major transactions, especially if the company is experiencing financial challenges. Seek professional advice as soon as financial distress becomes evident. This can help evaluate the merits of a transaction.
6. Declaration of Solvency:
Third parties to transactions shouldconsider requesting a declaration of solvency from the company transferring the assets. This will provide some comfort that the company is solvent at the time of the transaction.
Disclaimer
This note reflects the law as at 14 March 2025. The circumstances of each case vary and this note should not be relied upon in place of specific legal advice.
