Transaction At An Undervalue: Implications During Insolvency Investigations
Understanding what constitutes a transaction at an undervalue, as well as the associated implications, is crucial for businesses facing financial challenges and their directors.
Transactions at an undervalue can be a significant issue during insolvency proceedings – so, what is a transaction at undervalue?
A company might sell an asset for a nominal fee, or it could transfer an asset to another party without receiving any payment. Both scenarios involve the asset being exchanged below the value of its money’s worth on the open market without enough consideration provided of the consequences.
Such transactions are problematic if directors authorised them during a period of company insolvency, or if the transactions clearly contributed to the business’ poor financial state.
Transactions at undervalue can also undermine fairness by diverting valuable assets away from the pool that creditors are entitled when a company is insolvent. Insolvency practitioners will scrutinise these transactions closely.
They need to identify any asset transfers or sales that the company may have made at undervalue and evaluate their impact on the company’s financial state. If they discover an undervalued transaction, a court could reverse it, restoring the asset to the company’s estate.
However, under the Company Directors Disqualification Act 1986, directors held responsible could face penalties too.
Examples of transactions at undervalue in insolvency cases
These transactions can take various forms, all of which are closely scrutinised during insolvency proceedings.
Here are some common examples:
Gifts to connected individuals
One prominent example is when a business gives away assets to individuals who have a close relationship with the company, without receiving any form of payment. These include family members, friends, or fellow directors.
These gifts might include property, vehicles, or other valuable assets. Such transactions are considered at undervalue because they lack proper compensation in return.
During insolvency, this can deplete the company’s assets that should otherwise be available to creditors.
Sales below market value
Another example is selling assets at a price far below their market value. This can occur in various scenarios, such as liquidating company property in a hurry or selling valuable equipment at a steep discount.
Again during insolvency, such antecedent transactions can severely impact the financial recovery process. The reduced sale proceeds means there is less money available to satisfy creditor claims.
Unpaid transfers
Transferring assets without receiving any payment in return also qualifies as a transaction at undervalue. This situation is particularly problematic in insolvency cases.
Insolvency practitioners closely examine these transactions to ensure they are not unfairly protecting certain interests over others.
Investigating transactions at undervalue in insolvency cases
Should a director have authorised any transactions at undervalue, then they may have to take partial responsibility for the company’s insolvency – it may also be deemed that they attempted to keep assets out of a liquidation process – leading to a claim of misfeasance.
For more information, read this guide – what is misfeasance? Other examples include hiding assets, taking an excessive salary and preferential payments.
Therefore, insolvency practitioners play a vital role in identifying and investigating transactions at undervalue. Responsibilities include:
- Reviewing financial records: This involves examining the company’s financial statements, transaction histories, and asset registers. They look for patterns or transactions that deviate from normal business operations, particularly those that occurred before insolvency.
- Assessing transaction validity: They assess whether the terms of transactions were fair and reasonable under the circumstances. This involves comparing the transaction values with current market rates.
- Gathering evidence: Insolvency practitioners may interview directors and other involved parties to understand the rationale behind the transactions. They gather evidence to determine if there was any intent to defraud creditors.
- Reporting findings: After the investigation, they submit a detailed report, outlining their findings and recommending any necessary actions.
If a transaction at an undervalue is identified, several consequences can follow – including a reversal of transactions and director penalties.
Directors involved in transactions at undervalue could face penalties including:
- Disqualification: They may face a ban from serving in directorial roles for up to 15 years.
- Financial liabilities: They may face personal liability for the company’s debts in insolvency cases.
- Fines and prosecution: In severe cases, fines or criminal charges may apply, potentially leading to imprisonment.
An insolvency practitioner or office holder can seek a court order to reverse the transaction. This legal solution aims to restore the asset to the company’s estate, thereby ensuring that the asset is available to help repay creditors.
If the company can prove the transaction was in good faith and there were reasonable grounds to expect it would be beneficial to the business, the court may reject the application. Such a defence may lessen if a connected person received the transaction.
Avoiding transactions at undervalue
To prevent issues related to undervalue transactions, keep the fiduciary duties of directors in mind. Directors should follow several best practices:
- Obtain board approval: Ensure that the board of directors approves all significant asset transfers or sales. Documenting these decisions through formal minutes helps demonstrate proper procedure.
- Professional valuation: Before selling or transferring assets, obtain a professional valuation to ensure that the price reflects the market value. This helps avoid claims of undervaluation.
- Maintain records: Keep detailed records of all transactions, including valuations, agreements, and payment proofs. Retaining these documents provides transparency and supports the company’s position in case of scrutiny.
Directors must be aware of the implications of transactions at undervalue which are in breach of the Insolvency Act 1986. These transactions not only affect the financial health of the company but also have consequences for repaying a company’s creditors during insolvency proceedings.
Final thoughts
Understanding what constitutes an undervalue transaction, how these transactions are investigated, and the potential consequences for directors is crucial.
By adhering to best practices, obtaining proper approvals, and maintaining thorough records, directors can avoid the pitfalls associated with such a transaction. This helps ensure a fair resolution during insolvency proceedings.
If you have concerns about your company’s financial situation, with our vast expertise in business recovery, insolvency and turnaround, we can help.
Hudson Weir is a team of highly qualified chartered accountants and insolvency practitioners. For a no-obligation discussion about your company’s financial situation, please do not hesitate to contact us.
