A gratuitous alienation?

A gratuitous alienation?

Stephanie Carr, insolvency partner at Harper Macleod, unpicks the Supreme Court’s decision on whether a sale of property by a company prior to it being put into liquidation constituted a gratuitous alienation.

Original news

Henderson v Foxworth Investments Ltd and another [2014] UKSC 41, [2014] All ER (D) 19 (Jul)

This appeal relates to the purchase of a country club, Letham Grange, by a Mr Liu under the company name LGDC. In 2001, LGDC was experiencing financial difficulties and Letham Grange was sold to a company called NSL. Later, a standard security granted by NSL over Letham Grange in favour of Foxworth Investments Limited (a company linked to Mr Liu) was registered in the Land Register of Scotland. The appointed liquidator for LGDC, Mr Henderson, brought an action for a decree of reduction, arguing that the sale of the Grange was a fraudulent and gratuitous alienation to remove the Grange from the liquidation with a view to putting the asset out of the reach of creditors and that:

the disposition from LGDC to NSL was not made for consideration, and

that the rights acquired by Foxworth were not acquired in good faith

What were the key features of the case?

The key features of the appeal to the Supreme Court included consideration, and application in the current circumstances, of an appeal court’s role where the appeal point involves a challenge to a judge’s assessment of the evidence and subsequent findings of fact. The Supreme Court, with reference to judicial precedent, set out established principles being that an appellate court should only interfere with the decision of a judge who had had the benefit of hearing witnesses giving evidence and of balancing up all of the evidence heard, when a finding can be made by the appellate court that the judge whose decision is being challenged issued a decision that ‘no reasonable judge’ could have come to having assessed the evidence and making his findings in fact based upon that evidence—a decision such that it could not be ‘reasonably explained or justified’ or where a decision made was ‘plainly wrong’.

The Supreme Court considered whether the judges of the Extra Division of the Inner House had no proper basis for concluding that the Lord Ordinary had failed to give satisfactory reasons for the factual conclusions which he reached on the evidence or for concluding he had plainly gone wrong. The Supreme Court assessed the Extra Division’s decision and did not agree with the decision reached. It set out that the test above requires to be met when allowing an appeal and not where the appellate court considers it would have reached a different conclusion. The Supreme Court assessed whether the findings in fact made had been based upon evidence heard and were such that they entitled the Lord Ordinary to reach the decision made in law.

The Supreme Court decision also looks at the issue of whether the Inner House had erred in finding that the Lord Ordinary had made no findings that there was when LGDC was sold to NSL, an enforceable obligation on NSL to repay certain debts. The Supreme Court held that the Lord Ordinary was correct to focus on evidence of whether, not when, any obligation was taken by NSL to assume debts of LGDC, and that he was aware that this obligation would only form part of the consideration for sale if it was undertaken as a counterpart of the obligations. Such considerations are often looked at and argued in gratuitous alienation cases. The case therefore assists in providing guidance as to the application of the Insolvency Act 1986, s 242 (IA 1986) and of the provisos regarding ‘good faith’ in the set of circumstances involved.

Under what circumstances will the court grant a decree of reduction?

The court will grant a decree for reduction where the ground of claim is in terms of IA 1986, s 242—ie a gratuitous alienation, which applies in Scotland, where the person seeking to uphold the alienation is able to prove to the satisfaction of the court one of the statutory defences which are:

that immediately, or at any other time, after the alienation the company’s assets were greater that its liabilities (the ‘solvency defence’)

that the alienation was made for ‘adequate consideration’

that the alienation was a birthday, Christmas or conventional gift or was a gift made, for a charitable purpose, to a person who is not an associate of the company, which having regard to all the circumstances, it was reasonable for the company to make

This section, however, also sets out a proviso that the subsection relative to statutory defences is ‘without prejudice to any right or interest acquired in good faith and for value from or through the transferee in the alienation’.

Actions based on this ground of claim can be raised by a creditor or a liquidator/administrator. There are time limits imposed for challenging a gratuitous alienation and the relationship between the transferor and transferee will determine which time limit applies.

In the current case, the Lord Ordinary held that there was adequate consideration as the price paid by NSL,who purchased the Grange from LGDC, included both the price paid plus the assumption of debts. Therefore, he held that the disposition had not been susceptible to reduction and that it consequently followed that Foxworth had obtained its rights under the security in good faith.

How did the court approach the arguments that the sale of the Grange was a fraudulent and gratuitous alienation to remove the Grange from the liquidation?

The Lord Ordinary approached the arguments by an assessment of all of the evidence. The Lord Ordinary, while concluding that there were some parts of Mr Lui’s evidence which he did not believe to be true, did consider him to be credible and reliable in relation to his evidence regarding the essential facts of the case. He also considered the unchallenged evidence that there had been loans made and considered whether loans were made, which he held they were, rather than when they were made or whether particular vouching of the loans was ‘all it bore up to be’ and whether the documentation regarding the assumption of loans invalidated the actual assumption of loans, which he held it did not.

The Supreme Court considered whether the Extra Division of the Inner House had erred in finding that the Lord Ordinary had made no finding that there was an enforceable obligation to repay certain debts and whether it had erred in interfering with the Lord Ordinary’s findings in fact—the Supreme Court held that it had erred in both respects.

What are the practical implications of the court’s decision?

In the current case the practical implications are that as the security is not to be reduced, it is likely that there is little, if any, equity in the property. Accordingly, it is not expected the liquidator will seek to sell the property—there being no benefit to creditors in doing so. The decision may also impact upon liquidator’s raising proceedings for reduction when there is some evidence of ‘adequate consideration’ being paid albeit perhaps at first sight appearing in the circumstances to be consideration established by methods which might not at first glance appear to be such as to amount to such and/or in circumstances where it appears given, amongst other things, the relationships and knowledge or individuals involved, to be a transaction entered into with the intent of putting property out of the reach of creditors.

What should lawyers take from this case?

The Supreme Court’s decision is of assistance to lawyers in re-stating the law as regards the role of an appellate court and lawyers should consider matters fully prior to seeking to proceed with an appeal based largely upon asking an appellate court to overturn a decision regarding findings in fact based upon assessment of evidence unless there is a very strong view that the judge was ‘plainly wrong’.

Further, the case assists in providing guidance as to what a court might consider as being sufficient evidence when dealing with actions for reduction and with the relevant statutory provisions.

Interviewed by Neasa MacErlean. The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

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About the author:
Kathy specialises in restructuring and cross-border insolvency. She qualified as a solicitor in 1995 and has since worked for Weil Gotshal & Manges and Freshfields. Kathy has worked on some of the largest restructuring cases in the last decade, including Worldcom, Parmalat, Enron and Eurotunnel.