Gratuitous alienations before the Supreme Court—Stonegale Ltd v Brown

The Supreme Court's finding in Stonegale Ltd v Brown that transfers of properties by Scottish companies which later went into administration were gratuitous alienations is explained by advocate Susan Ower, of Axiom Advocates.

Original news

Stonegale Ltd v Brown and another, the joint administrators of Loanwell Ltd [2016] UKSC 30, [2016] All ER (D) 133 (Jun)

The Supreme Court held that the purpose and effect of transfers of property by Scottish companies which subsequently entered administration had been to divert assets away from the companies’ creditors, contrary to section 242 of the Insolvency Act 1986 (IA 1986). That they were gratuitous alienations was plain and obvious.

What was the background to the case?

Oceancrown, Loanwell and Questway were three companies controlled by Ralph Pelosi, who was the father of the second appellant. The companies owned five properties, over which the Anglo-Irish Bank held standard securities. The bank was informed that all five properties were to be sold for a total of £2,414,000. However, nine months before the companies entered administration, one of the properties was sold for £2,467,500. The sale was not direct. First, the property was transferred for a sum recorded as £762,000 to another company, Strathcroft, which was also owned by Ralph Pelosi, before being sold on the same day to the ultimate purchaser in a back-to-back transfer. The bank was sent the £2,414,000 from the proceeds of the sale, and believing it to be from the sale of the five properties, discharged the securities over all of those properties.

Three of the remaining four properties were transferred to the first appellant, Stonegale, whose sole shareholder was the second appellant, Ralph’s son Norman, while the fourth property was transferred to Norman himself and was later sold by him for £125,000.

After the three companies entered administration, the respondent joint administrators sought to have the transfers of the three properties to Stonegale set aside as gratuitous alienations, within the meaning of IA 1986, s 242. They also sought repayment by Norman of the £125,000 he had received for the fourth property.

The Lord Ordinary found in favour of the respondents. Reclaiming motions were marked by the appellants. In the Opinion of an Extra Division of the Inner House, the court held that the question for it was whether the Lord Ordinary had been entitled to hold, as he did, that the appellants had failed to establish that the alienations constituted by the conveyances of the four properties by the companies in administration in favour of the appellants were made for adequate consideration. The Inner House refused the reclaiming motions, holding that the whole motivation for the transaction was the diversion of assets away from the companies’ creditors, which was exactly what IA 1986, s 242 was designed to prevent, and had been facilitated by a misrepresentation to the bank. An appeal was marked to the Supreme Court.

What was the issue the court had to decide?

The issue for the Supreme Court was, essentially, whether the Lord Ordinary had been entitled to hold that the appellants had failed to establish the statutory defence provided for in terms of IA 1986, s 242.

What were the main legal arguments put forward?

The appellants argued that, by pursuing the actions in terms of IA 1986, s 242, the respondents had pursued the wrong remedy. The respondents could have pursued a number of alternative remedies. They could have challenged the alienation of the first property to Strathcroft by Oceancrown. They could have proceeded against Ralph Pelosi, as director of Oceancrown, for breach of his fiduciary duty, and recovered the proceeds of his breach from the ultimate beneficiaries. If the bank was the victim of a fraudulent misrepresentation, it could have recovered damages in respect of its loss. The wrong remedy, it was argued, had been selected. The failure to challenge the transfer by Oceancrown to Strathcroft meant that the transfer by Strathcroft to the ultimate purchaser could not be impeached. In any event, the £762,000 paid by Strathcroft reflected a professional valuation of the property, and therefore constituted the property’s market value.

What did the court decide, and why?

The court dismissed the appeals, holding in a very short judgment that the fact that the transfers of the four properties in question were gratuitous alienations was plain and obvious. The issue for the Supreme Court was not the variety of remedies which the administrators might have pursued—it was whether they were entitled to the remedy which they sought.

The judgment was delivered by Lord Reed, who stated:

The gratuitous nature of the alienations was clearly explained by the Lord Ordinary...Before the various conveyances, the companies owned five properties. A bargain was in place for the sale of one of those properties...for the sum of £2.4m. After the sale was completed, £2.4m was transferred to the bank in reduction of borrowings, and the companies retained the other four properties, valued at £1.525m. Those properties were then conveyed to the appellants. The companies received nothing whatsoever in return. There was no reciprocity between those disposals and the earlier payment made to the bank. 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.

To what extent will the English courts be bound by the decision when considering cases concerning transactions at an undervalue under IA 1986, s 238?

Not at all, although the case may be of interest to a court considering such an issue.

What practical lessons can those advising take away from the case?

In respect of an action at the instance of insolvency practitioners, in terms of IA 1986, s 242, or the equivalent section of the Bankruptcy (Scotland) Act 1985 in a personal insolvency, the onus lies on the transferee, being the recipient of an asset formerly owned by the insolvent entity, to establish one of the statutory defences. In order to establish the defence of ‘adequate consideration’, the transferee will be required to establish that some consideration was paid. There must be reciprocity between the transfer of the property and the making of the sum said to constitute the consideration.

It is unlikely that an appeal in similar circumstances would be permitted, given the requirement for leave to appeal to be granted by the Supreme Court.

Susan Ower appeared with Kenneth McBrearty QC for the respondents in this case.

Interviewed by Robert Matthews.

The views expressed by our legal analysis interviewees are not necessarily those of the proprietor.

Further Reading

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Can a liquidator or an administrator challenge or unwind transactions entered into by the company before it was wound up or entered into administration?

A summary checklist and timeline for a company's insolvency office-holder to bring a claim for transactions at an undervalue, preferences, and transactions to defraud creditors

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First published on LexisPSL Restructuring and Insolvency

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