What is a 'gratuitous alienation'?
The Insolvency Act contains protection against attempts by companies and their directors to put assets beyond the reach of creditors in the event of a subsequent insolvency event. Transactions entered into by a company which is later the subject of liquidation or administration can be unwound by the court. These transactions are called 'gratuitous alienations'. It is usually fairly easy to identify whether a transaction is a gratuitous alienation -, the company has given something away (like a property) and received nothing, or not enough, in return. The intention of the company when making the transfer doesn't matter, it's the effect.
The effect of a successful challenge to a transaction as a gratuitous alienation is that the transfer is set aside, so that the transferred asset is returned to the company. However, if a third party has acquired the property in good faith, and for value, then the reduction of the transfer is probably pointless, and the restoration of the property to the company becomes impossible. The legislation therefore provides that “other redress” can be made by the transferee, typically paying the value of the property to the liquidator/administrator.
If the transaction is in favour of someone associated with the insolvent company, then transfers dating back 5 years from the date of insolvency can be undone. If the transfer is in favour of someone other than an associate then the relevant time period is 2 years.
The legislation provides defences which, if proven, mean that the transaction cannot be challenged. Those defences are:
- immediately, or at any other time, after the alienation the company’s assets were greater than its liabilities; or
- the alienation was made for adequate consideration; or
- the alienation was a conventional or charitable gift,
Adequate consideration: Brown & another v Stonegale Limited
One case to look at the defence of "adequate consideration" is Brown & another, the Joint Administrators of Oceancrown Limited v Stonegale Limited  UKSC30
In the case, administrators were appointed in August 2011 to 3 companies - Questway, Oceancrown and Loanwell - all of whom transferred properties in November 2010. At the time, Oceancrown had a £17.3m facility with Anglo Irish Bank which was guaranteed by Questway and Loanwell. Oceancrown sold a property at 278 Glasgow Road to Strathcroft for £762,000. Strathcroft was 99% owned by one of the directors of Oceancrown and Stonewell. On the same day, Strathcroft sold the same property for £2,467,500. The bank was told the sale price was £762,000 and was told the sale was part of a wider portfolio sale by the group that brought in £2.414m. The information given to the bank attributed sale prices to each of the 5 properties. The bank received £2.414m and discharged the securities they held over the 5 properties. In fact, the other properties that were transferred - to another associated company and to the director's son - were transferred for no consideration. They were not transferred until 2 weeks after the sale of 278 Glasgow Road. The market value of these other properties at the time of transfer was a combined £1.525m.
The dispositions of these other properties were challenged by the joint administrators as gratuitous alienations. Proceedings were raised at the Court of Session. The defence was that adequate consideration had been given because the bank debt owed by Oceanwell was reduced and therefore the potential guarantee liability of the other two companies was reduced. The Outer House was not impressed by this (and nor were they impressed by a purported loan agreement produced during the proceedings, describing it as a sham "concocted purely for the purpose of defending these proceedings".) The court duly ordered reduction of the dispositions. That decision was upheld on appeal to the Inner House. In reaching their decision the court found that there is scope for value being given that is something other than payment of cash but that did not happen here. The simple fact was that the company received nothing for transferring the other properties. The guarantee obligation was contingent and adequacy of the consideration was to be assessed as at the time of the transfer (at which point the guarantee had not been called on). The court was of the view that these transactions were simply "devices for the diversion of assets from creditors, facilitated by a misrepresentation to the banker of the companies which were involved".
A further appeal was then taken to the Supreme Court. The appeal was on the basis that the administrators had chosen the wrong remedy and that it was the transfer of 278 Glasgow Road for £762,000 which should have been challenged, or that the bank could have taken proceedings against (a) for breach of fiduciary duty against the director of the company or (b) for fraudulent misrepresentation in respect of the mis-information they'd been given about the sale prices of the 5 properties. The appellants argued that the wrong remedy - of reduction on the grounds of gratuitous alienation - had been sought and therefore the decision of the Inner House should be overturned. Unsurprisingly, the appeal was unsuccessful. Delivering the decision of the court, Lord Reed said
"The purpose and effect of those transactions was to divert assets away from the companies’ creditors: exactly what section 242 is intended to prevent. That they were gratuitous alienations is plain and obvious."
Most insolvency professionals expected this outcome. It was clear that assets had been diverted without any consideration - far less anything approaching adequate - being paid. As Lord Reed said, this is precisely what the legislation is intended to prevent.