What are Transactions at an Undervalue?

December 5, 2022 / FAQs

Liquidating an insolvent company can be rather volatile for the uninformed. It’s easy to trip over one of the many legal pitfalls, especially when lacking a solid understanding of the practice and what to avoid. Acting haphazardly and underestimating the sensitivity of such a practice can easily result in unforeseen consequences, many of which carry legal implications. It is for this reason that professional assistance is invaluable.

One such facet of liquidation that can cause future problems is the disposal of assets, namely transactions at undervalue. This term refers to when an insolvent company sells off its assets at a price significantly lower than fair market value. This is often interpreted as directors purposefully transferring assets out of the reach of creditors, and it can have serious legal consequences.

In this article, Clarke Bell will discuss transactions at undervalue, summarising what they are, the consequences of making one, and how you can avoid them.

What is a transaction at an undervalue?

Transactions at undervalue (referred to as s238 of The Insolvency Act 1986) are when an insolvent company disposes of assets either at an unusually low value, or in the case of asset transferral to another company, for free. Transactions at undervalue also refer to assets gifted to a third-party company or individual. Furthermore, transactions at undervalue can also refer to deals made by companies that were not insolvent at the time of disposing of an asset below fair market value, but quickly became so.

When can a transaction at undervalue be discovered?

During liquidation, the insolvency practitioner acting as the liquidator must open an investigation into the company and director conduct. During this investigation, the insolvency practitioner will examine the company’s financial documents and accounts, with a view to confirming the absence or presence of suspicious activity. If anything looks out of place, it will be flagged for further investigation.

Suspicion will typically be cast upon unusual activity that was detrimental to the company and creditor interests. Additionally, any transactions that occurred just before or after a company entered insolvency will be scrutinised. Anything that looks to be a transaction at undervalue will be thoroughly examined, with results being passed on to the Insolvency Service.

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What are the implications of making a transaction at undervalue?

If your liquidator discovers any transactions at undervalue during their investigation of your company, they will first confront you before taking further action. Your liquidator will want to know why such a transaction happened, who was involved, and what reasoning went into the decision-making process. This information will be used to help the liquidator make a conclusion; whether the transaction at undervalue was made on purpose or not. If it was purposeful, it would likely be seen as an attempt to keep company assets away from outstanding creditors. In turn, this will be seen as director misconduct and a breach of the Insolvency Act 1986.

Once your insolvency practitioner has identified whether or not you have made a transaction at undervalue, they will send the results of their investigation to the Insolvency Service. It is up to them to determine whether your actions warrant legal action, and their responsibility to take action if deemed necessary. This action could take various forms; fines, the disqualification of your directors’ license, and personal liability for company debt are commonplace consequences. This disqualification of your directors’ license can last anywhere from 2 to 15 years, and also bars you from management positions in other companies, including ones you do not own. However, a prison sentence is also an option in more egregious cases of director misconduct.

If a transaction at undervalue is currently pending when a liquidator discovers it, they can cancel the transaction unilaterally. Furthermore, liquidators have the power to reverse a transaction at undervalue, even if it has already been completed. They can bring their findings to a court, petitioning for the transaction at undervalue to be annulled. Your company will then be obligated to buy back the asset, which could be disastrous for a struggling company.

How you can avoid making a transaction at undervalue

As the consequences for making a transaction at undervalue can be quite dire, it is best to avoid making one, even if done erroneously or by accident. There are a number of ways you can avoid making a transaction at undervalue, allowing you to make transactions without fear of falling on the wrong side of the law.

If your company is insolvent, but you need to sell off an asset or assets outside of a liquidation process, you should first communicate your intent to your company’s board. You will need to obtain their approval before you can make any transactions, and once approval is obtained, you must keep thorough records of the proceedings. Next, you should call in a professional valuer to assess the assets you intend to sell. They will appraise these assets, informing you of their true price. Provided you sell the asset at this price, you should avoid accusations of a transaction at undervalue.

If you sell off any of your company’s assets, you must immediately deposit the money into your company’s accounts once it becomes available. In addition to this, you should keep any records related to the sold assets, including the professional appraisal of the asset and bills of sale. The longer these documents are kept, the better; while you must keep them for the statutory time period, it will make your life easier if you have them close at hand in case an inquiry is made. Assuming you obtain consent and a professional valuation, along with keeping thorough documentation of your transactions, you will greatly reduce the risk of accidentally performing a transaction at undervalue.

Let Clarke Bell help

If your company is insolvent and you are struggling to keep a handle on its finances, don’t go it alone; let Clarke Bell help. We have more than 28 years of experience in helping companies find the best paths forward, whether that be a Creditors’ Voluntary Liquidation, or the implementation of a Business Rescue plan. Don’t hesitate to contact us today for a free, no-obligation consultation to find out exactly what we can do for you.