Transactions at an Undervalue Insolvency Case Law

The following case illustrates the law relating to transactions at an undervalue in action.


House of Lords

18 January 2001

Section 238(4)(b) of the Insolvency Act 1986 directed attention to the consideration for which a company had entered into a transaction and did not stipulate the person or persons by whom the consideration was to be provided. The consideration could include the value of a collateral agreement entered into by the company with a third party.

In assessing the value of the agreement, the court was entitled to give precedence to reality over speculation and to have regard to events which occurred after the agreement had been entered into.

The House of Lords so held, dismissing an appeal by the defendants, Brewin Dolphin Bell Lawrie Ltd, formerly Brewin Dolphin and Co Ltd, and Private Capital Group Ltd, from a decision of the Cort of Appeal (Lord Woolf, Master of the Rolls, Lord Justice Morrit and Lord Justice Laws) (The Times March 30, 1999;[1999] 1 WLR 2052) affirming a decision of Mr Justice Evans-Lombe ([1998] BCLC 700) who ordered the defendants to pay the first plaintiff, Ian Peter Phillips, the liquidator of the second plaintiff, A. J. Bekhor and Co, the sum of £1,005,534 following the sale of part of the second plaintiff's business and some of its assets to the defendants at an undervalue.

Mr Gregory Mitchell QC, Mr Ewan McQuater and Mr Christopher Hare for the company; Mr Michael Briggs QC and Mr Richard Slade for Mr Phillips.

LORD SCOTT said that section 238 of the 1986 Act provided a remedy where a company went into liquidation within two years after entering into a transaction at an undervalue.

Where the section applied, the liquidator could apply to the court for an order and the court "shall, on such an application, make such order as it thinks fit for restoring the position to what it would have been if the company had not entered into that transaction".

By section 238(4)(b): "A company enters into a transaction with a person at an undervalue if [the transaction is entered into] for a consideration the value of which, in money or money's worth , is significantly less than the value, in money or money's worth, of the consideration provided by the company".

The company in the present case was A. J. Bekhor and Co ("AJB") which on November 10, 1989 entered into agreements with Brewin Dolphin and Co Ltd and with Private Capital Group Ltd ("PCG"), Brewin Dolphin's parent company. Those agreements were linked, their purpose being the sale of AJB's stockbroking business to Brewin Dolphin.

On October 17, 1989, in order to facilitate and set the stage for the sale, AJB sold its stockbrokering business and business assets to Bekhor Securities Ltd ("BSL"), a wholly owned subsidiary , for a consideration of £1. The transfer of the business to Brewin Dolphin was to be brought about by a transfer of the BSL shares.

Accordingly, under one of the agreements of November 10, 1989 with Brewin Dolphin, AJB transferred to Brewin Dolphin its shares in BSL.

Brewin Dolphin thus acquired AJB's business, AJB received in return (i) from Brewin Dolphin, the assumption by Brewin Dolphin of AJB's obligations to its employees, including, in particular, the obligation to make redundancy payments; and (ii) from PCG, under one of the November 10 agreements between AJB and PCG, a covenant by PCG to pay AJB £312,500 per annum for four years, the first payment to be made on November 10, 1990.

That agreement was expressed to be a computer equipment leasing agreement and the payments were expressed to be rent payable for the right to use the computer equipment.

The total "rent" to be paid over the four years was £1.25 million. It was by no means a coincidence that £1.25 million was the sum that had been agreed would be paid for the stockbrokring business.

The computer equipment in question was not owned by AJB but had been leased from two lessors, Wirral Equipment Ltd and Asterrose Ltd.

Each of the leases required the consent of the lessors to any subletting by AJB. Consent to the subletting of the equipment by AJB to PCG had been neither sought not given.

On account of default by AJB in paying rent due under those head leases, the head leases were terminated in early 1990 and the computer equipment was recovered by the lessors.

That took place before November 10, 1990 on which the first payment of £312,500 was due to be paid to AJB under the sublease to PCG. So PCG treated the sublease as having been brought to an end by the termination of the head leases and consequently had made none of the £312,500 payments.

In the negotiations between AJB and Brewin Dolphin that had led to the November 1989 agreements, the value of AJB's stockbroking business and the sum to be paid for it had been agreed at £2.5 million but later negotiated down to £1.25 million.

There were two reasons why under the form the transaction finally took, the £1.25 million was to be paid to AJB not by Brewin Dolphin, the purchaser of the business, but by PCG as rent for the computer equipment spread over four years.

One reason was that PCG hoped to be able to deduct the "rent" from its taxable profits. The other reason was that the payment of £1.25 million for the goodwill of the stockbroking business would have prompted requirements by the regulatory authority for additional capital funding for that business.

AJB was at the time of the agreements in deep financial trouble. A winding-up order was made against AJB on April 25, 1990 on the petition of Wirral Equipment Ltd and Asterrose Ltd.

On May 4, 1990 an administrative receiver was appointed by AJB's debenture holder. AJB was, and was when the winding-up order was made, hopelessly insolvent.

On June 24, 1994 Mr Phillips, the liquidator and administrator of AJB, commenced proceedings against Brewin Dolphin and PCG contending that the transaction under which AJB had transferred its shares in BSL to Brewin Dolphin, thereby, in effect, transferring its stockbroking business to Brewin Dolphin, was a sale at an undervalue. An order against Brewin Dolphin under section 238 was sought.

As against PCG, payment of the four annual sums of £312,500 was claimed as part of the value of the share capital of BSL due to be paid to AJB.

His Lordship said that one had to start with the share sale agreement under which AJB agreed to divest itself of its allegedly valuable asset, namely the shares in BSL.

Section 238(4)(b) of the 1986 Act did not stipulate by what person or persons the consideration was to be provided. It simply directed attention to the consideration for which the company had entered onto the transaction.

The identification of that consideration was, in his Lordship's opinion, a question of fact. It might also involve an issue of law, for example, as to the construction of some document.

But if a company agreed to sell an asset to A on terms that B agreed to enter into some collateral agreement with the company, the consideration for the asset would, in his Lordship's opinion, be the combination of the consideration, if any, expressed in the agreement with A and the value of the agreement with B.

n short, the issue in the present case was not to identify the section 238(4) transaction. The issue was to identify the section 238(4) consideration.

On the facts, it was plain that the consideration for the BSL shares was, apart from obligations assumed by Brewin Dolphin under the share sale agreement itself, the entry by PCG into the sublease agreement under which it covenanted to pay £312,500 per annum for four years.

The purchase price of £1.25 million was to be paid under the sublease in four annual payments of £312,500 each. No other conclusion was, in his Lordship's opinion, possible but that on those facts the consideration for the BSL shares included the benefit of the covenant given by PCG under the sublease.

What was the value, in money or money's worth, of PCG's covenant under the sublease?

Mr Mitchell contended that the value of the covenant was its face value, and pointed out that there was not, and never had been any question as to PCG's ability to pay.

His Lordship agreed that there was no doubt as to PCG's ability to pay but the value of the covenant needed to be investigated a little more deeply.

According to the sublease, the covenant was given in exchange for the right to use the computer equipment. But it appeared that, by the end of September 1989, Brewin Dolphin had decided not to use the equipment in order to run the business it was negotiating to acquire but, instead, to update its own existing computer system. That decision did not, of course, affect PCG's willingness to pay the £312,500 per annum for four years.

The amount of those payments was attributable to the purchase, via the BSL shares, of AJB's business and was not attributable in the least to any value placed on the right to use the computer equipment.

That equipment, as Brewin Dolphin and PCG knew, was held by AJB under head leases which barred AJB from assigning of subletting any of the equipment. The bar was expressed as an absolute one.

The sublease under which the four annual payments were to be made constituted ipso facto a breach by AJB of a term of the head leases. So the head leases became terminable at any time by the head lessors and the equipment comprised in the sublease could at any time have been repossessed by them.

The repossession of the equipment would, and did, bring to an end the sublease and the payment obligations of PCG.

So, what was the value in money or money's worth, of a covenant by PCG that was so precarious?

PCG's covenant which had been precarious at the outset had become worthless by February 1990 the latest. AJB went into compulsory winding-up in April 1990 and an administrative receiver was appointed in May 1990.

Those events would inevitably have led the head lessors to terminate the head leases and recover their equipment, if they had not done so previously, thereby bringing the subleases to an end.

Mr Mitchell submitted that those ex post facto events ought not to be taken into account in valuing PCG's sublease covenant as at November 10, 1989. His Lordship did not agree.

In valuing the covenant as at that date, the critical uncertainty was whether the sublease would survive for the four years necessary to enable all the four £312,500 payments to fall due, or to survive long enough to enable some of them to fall due, or would come to an end before any had fallen due.

Where the events, or some of them, on which the uncertainties depended had actually happened, it seemed unsatisfactory and unnecessary for the court to wear blinkers and pretend that it did not know what had happened.

Problems of a comparable sort might arise for judicial determination in many different areas of the law. Answers might not be uniform but might depend upon the particular context in which the problem arose.

For the purposes of section 238(4) however, and the valuation of the consideration for which a company had entered into a transaction, reality should be given precedence over speculation.

His Lordship would hold, taking into account the events which took place in the early months of 1990, that the value of PCG's covenant in the sublease was nil.

After all, if following the signing of the sublease, AJB had taken the sublease to a bank or finance house and had tried to raise money on the security of the covenant, it was unlikely that the bank or finance house, with knowledge of the circumstances surrounding the sublease, would have attributed any value at all to the sublease covenant.

Where the value of the consideration for which a company entered into a section 238 transaction was as speculative, as was the case here, it was for the party who relied on that consideration to establish its value. PCG and Brewin Dolphin were unable to do so.

Therefore, his Lordship would treat the value of the consideration for which AJB entered into the share sale agreement as being confined to the value of the consideration under that agreement. The sublease covenant added nothing.

Mr Mitchell submitted that AJB's business as at November 10, 1989 was worthless and that the BSL shares were therefore valueless.

That submission was based on the fact that AJB appeared to have been hopelessly insolvent and by November 1989 was trading at a substantial loss of around £13,000 a day.

The judge's findings were that AJB's business assets were an attractive package to buyers such as Brewin Dolphin, that it could not be inferred that Brewin Dolphin was the only potential purchaser, and that Brewin Dolphin, a reasonably well informed potential purchaser from the class of typical purchasers, had been prepared to pay about £1,050,000 for the BSL shares.

His Lordship agreed with that approach. The value of an asset that was being offered for sale was, prima facie, not less than the amount that a reasonably well informed purchaser was prepared, in arm's length negotiations, to pay for it.

On that issue, the judge reached his figure of £1,050,000 after hearing and assessing the evidence, including expert evidence. It had not been demonstrated that in doing so he misdirected himself. The Court of Appeal upheld him.

Lord Steyn, Lord Hutton, Lord Hobhouse and Lord Millett agreed.

Solicitors: Goodman Derrick; CMS Cameron McKenna

Source or File Reference : Times Law Report January 23rd 2001
Additional Pages in Library : 0 
Copyright : Times Law Report January 23rd 2001

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