The case was based on a challenge under section 242 of the Insolvency Act 1986 to a purported gratuitous alienation of property by Grampian MacLennan's Distribution Services Ltd (the company in liquidation) to Carnbroe. Carnbroe defended the action on the basis that "adequate consideration" had been paid for the property. It had been successful in arguing that defence at first instance but the First Division of the Inner House had allowed the liquidator's appeal and Carnbroe, therefore, appealed again to the Supreme Court.
The background was straightforward. In around August 2005 Grampian bought the property in question for £630,000. In March 2013 the property was valued at £1.2million on the open market with the valuation falling to £800,000 assuming a restricted marketing period of 180 days. In around May 2014, Carnbroe intimated an interest in purchasing the property for £950,000. In around June 2014, ownership of Grampian changed and it was bought by Kevan Quinn. It had substantial liabilities at the time. Mr Quinn realised shortly thereafter that he would be unable to keep Grampian going and he entered into further discussions with Carnbroe (conducted by Mr Gaffney on Carnbroe's behalf, who Mr Quinn had known for over 30 years). Mr Gaffney was aware of Grampian's financial distress and mentioned that he could buy the property after it had been repossessed.
Mr Gaffney's evidence was that Mr Quinn was looking for a quick sale because of mortgage arrears and the risk that the property would be repossessed. These issues were reflected in the price of £550,000. Importantly, no evidence was led by the pursuers at to the likely price which the secured lender could have obtained if it had called up its security nor what the liquidator would have likely obtained on a sale in the context of the winding up.
The transfer of property itself raised some questions at first instance as the purchase price of £473,604.68 was paid from Carnbroe directly to the secured lender rather than the agreed consideration of £550,000 being paid to Grampian. Accordingly, the actual purchase price that was initially paid was sufficient only to pay the secured creditor and no-one else. It was only after proof before Lord Woolman (who concluded that £473,604.68 would not have been adequate consideration) that Carnbroe paid the balance of the purchase price to the company which was, by that time, in liquidation.
At proof, the expert surveyors had given evidence to the effect that the consideration of £550,000 was appropriate in the context of an immediate off-market sale by a financially distressed seller. So, the issue which became centrally important in the Inner House and Supreme Court was whether there was an objective justification for an urgent off-market sale which caused such a radical reduction in the value of the property in comparison with its open market value.
The leading Scottish authority on adequate consideration, which was relied upon in all courts, is Lafferty Construction Ltd v McCombe 1994 SLT 858 in which Lord Cullen stated the principle as follows:
"In considering whether alienation was made for adequate consideration, I do not take the view that it is necessary for the defender to establish that the consideration for the alienation was the best which could have been obtained in the circumstances. On the other hand, the expression "adequate" implies the application of an objective standpoint. The consideration should be not less than would reasonably be expected in the circumstances assuming that persons in the position of the parties were acting in good faith and at arm's length from each other".
Lord Hodge (giving the unanimous judgment of the Supreme Court) held (at para 32) that this means that a hypothetical purchaser would not have knowledge of the seller's financial distress unless the insolvent's financial embarrassment was known in the relevant market. It would not, therefore, be a relevant consideration that the seller had actually disclosed its financial distress to the purchaser and that the purchaser had exploited that disclosure in its negotiation of the purchase price.
So what are the relevant circumstances which the court has to take into account? First, the mere fact of the company's insolvency. Secondly, the objective purpose of the sale. The court expands on this to say that where the property is not exposed to the market, there is clearly a risk that an inadequate price will be paid. But there will be cases in which "it may be objectively reasonable for the insolvent to accept the lower price from a quick sale of an asset in order to gain the chance of saving the business, as that outcome is likely to be in the interests of its creditors" (para 34).
Where there is no question of a sale to preserve liquidity or to remain in business and where the insolvent company has ceased trading and is winding up its business informally, what is adequate consideration? The answer, according to the court, depends on the circumstances of the particular insolvency. Accordingly, where an insolvent company is not able to support a proper marketing exercise the adequacy of the consideration achieved must be measured by comparing the consideration which the insolvent company has accepted against the likely outcomes which the formal insolvency would achieve through the sale or other disposal of the asset by the liquidator, taking into account any fees levied by the insolvency practitioner.
In that context, the court explained that the duties incumbent on the liquidator are relevant (as indeed are the duties to obtain the best possible price incumbent on a secured lender). The liquidator must take reasonable care in choosing the time at which to sell the property and must also take reasonable care to obtain the best price that the circumstances of the case, as he reasonably perceives them, permit. The sale by the company must, therefore, be measured against that standard.
For all of these reasons the court held that there was no justification for the price paid. There was no evidence to support the view that the secured lender or liquidator would have been likely to achieve a price that was comparable or less than the price Grampian accepted. Absent evidence that the £550,000 which Carnbroe eventually paid for the property was the equivalent to such a price, Carnbroe failed to establish that it had been sold for adequate consideration.
While that decision was not particularly surprising (albeit that it was based on slightly different grounds to those in the Inner House) the Supreme Court went on to discuss the statutory remedies available to the court as these had been addressed by parties at the hearing.
The normal remedy for gratuitous alienations is reduction or annulment of the transaction in question. However, reduction can provide for disproportionate and unfair consequences in the context of insolvency proceedings. Indeed, commentators have questioned whether the remedy of reduction in this regard is compliant with Article 1, Protocol 1 of the ECHR because the effect is that the alienated property is returned to the company in liquidation but the transferee is left with an unsecured claim for unjustified enrichment in the liquidation. It is simply left to prove in competition with other creditors for the price it paid which is hard on the transferee and, as the Supreme Court explains at para 51 of its judgment, provides an unjustified windfall for the company which would not have received the price but for the impugned sale.
The Supreme Court did not consider, however, that it was restrained to interpret the 1986 Act so as to lead to such a harsh result. It held that the words of section 242(4) are broad enough to allow the court to take account of the consideration which a purchaser in good faith has paid to the insolvent when considering what the appropriate remedy is in these circumstances. As the court points out at para 58 of its decision, the general principle in actions of reduction is that they ought only to be successful where restitutio in integrum is possible - i.e. the parties can be restored to the pre-contractual position. However, where the insolvent had sold at an undervalue the law doesn't provide for that but it should do so.
Accordingly, while section 242(4) does not mandate restitutio in every case it also does not exclude it as an appropriate part of the remedy chosen by the court. The court considered that there may be cases in which it would be "wholly disproportionate and unfair to annul the property transfer without giving the bona fide purchaser credit for the consideration which it has paid" (para 65). The court has sufficient power to devise an "appropriate remedy". Consequently, the Supreme Court allowed the appeal but only to the extent that it remitted the case to the Inner House to consider what that appropriate remedy might be. We will await with interest how the Inner House deals with its new found discretion.