MacDonald & Anor v Carnbroe Estates Ltd (Scotland) [2019] UKSC 57

Grampian, an insolvent company, sold its principal property to Carnbroe for £550,000, well below its open market value of £800,000+. The Supreme Court held this was not adequate consideration under section 242 of the Insolvency Act 1986 but remitted to consider a flexible remedy protecting the bona fide purchaser.

Facts

Grampian MacLennan’s Distribution Services Ltd owned a property in East Kilbride comprising a warehouse, workshop and yard, which was its principal asset and centre of operations. In March 2013, DM Hall valued the property at £1.2m on the open market, or £800,000 assuming a restricted 180-day marketing period. By 2014 Grampian was in financial difficulty. Earlier expressions of interest at £950,000 (from Carnbroe) and £900,000 (from Bullet Express Ltd) were not pursued. In June 2014, Mr Kevan Quinn became sole shareholder and director. After Grampian’s invoice factoring facility was withdrawn, its cash flow collapsed and it fell into arrears with NatWest, which held a standard security over the property.

Mr Quinn negotiated an off-market sale to Carnbroe (a family company of Mr James Gaffney, a long-standing business associate) for £550,000. The disposition was dated 24 July 2014. Carnbroe paid £473,604.68 to NatWest to discharge the standard security but did not pay the balance until June 2016, after the proof had concluded. Carnbroe funded the purchase through a £600,000 loan from the Bank of Scotland. HMRC, owed over £500,000, was left unpaid and petitioned for winding up. Liquidators were appointed and challenged the sale under section 242 of the Insolvency Act 1986.

Issues

The appeal raised three principal questions:

• The proper interpretation of ‘adequate consideration’ in section 242(4)(b) of the Insolvency Act 1986;
• Whether the Inner House was entitled to interfere with the Lord Ordinary’s evaluation that the consideration was adequate;
• Whether section 242(4) confers any discretion on the court as to the remedy it may give.

Arguments

Appellant (Carnbroe)

Lord Davidson of Glen Clova QC submitted that Grampian’s financial distress justified an urgent sale; the Lord Ordinary’s conclusion was open to him on the evidence; the First Division erred in applying a strict approach to ‘adequate consideration’ when the realistic alternatives were forced sales by NatWest or a liquidator; the law should facilitate commercial transactions and promote certainty; and the First Division’s approach lacked commercial practicability because purchasers cannot readily assess whether a distressed vendor has realistic prospects of continuing in business.

Respondents (Liquidators)

The liquidators argued that Grampian’s business was effectively at an end, so urgency could not justify the discount; the pre-1985 law and section 242 required strict scrutiny of adequacy to protect creditors; and that the remedy provisions did not confer a general equitable jurisdiction, relying on Short’s Trustee v Chung and Cay’s Trustee v Cay, reinforced by the re-enactment in the Bankruptcy (Scotland) Act 2016 (the Barras principle).

Judgment

Adequate consideration

Lord Hodge (with whom all other Justices agreed) held that ‘adequate consideration’ imposes an objective test. Approving Lord Cullen’s statement in Lafferty Construction Ltd v McCombe 1994 SLT 858, the consideration must be not less than would reasonably be expected assuming parties in the position of the parties acting in good faith and at arm’s length. The hypothetical purchaser would not know of the vendor’s financial distress unless that was known in the market. While a quick sale to preserve liquidity and maintain a going concern could justify accepting a lower price, where the insolvent company has ceased or is about to cease trading, the adequacy must be measured against the likely outcome of a formal insolvency sale or sale by the secured creditor.

Application to the facts

On the evidence, Grampian was conducting an informal winding up after selling its vehicles and could not continue trading. There was no objective justification for the urgent off-market sale at so significant a discount. Carnbroe led no evidence comparing the £550,000 price with the net likely outcome of a sale by NatWest or a liquidator. Therefore Carnbroe failed to discharge its burden of establishing adequate consideration, and the Inner House was entitled to interfere with the Lord Ordinary’s evaluation.

Remedies under section 242(4)

The Court considered authorities including Short’s Trustee v Chung 1991 SLT 472, Cay’s Trustee v Cay 1998 SC 780 and Baillie Marshall Ltd v Avian Communications Ltd 2002 SLT 189, which had held that section 242(4) did not confer a general equitable jurisdiction. Lord Hodge agreed that no general equitable discretion exists (as conferred elsewhere by section 35 of the Bankruptcy (Scotland) Act 1985). However, he held that the statutory words ‘or other redress as may be appropriate’ are broad enough to allow the court, where justice requires, to take into account the consideration paid by a bona fide purchaser when devising the remedy.

The Barras principle did not assist the liquidators because the 2016 Act was a consolidation statute. Pre-1985 law was a partial exception to the general principle that annulment requires restoration of the defender’s position; the 1985 reforms, by imposing the burden of proof on non-associate transferees, increased the risk of injustice to bona fide purchasers and could hamper the rescue culture. The Court reasoned that Short’s Trustee and Cay’s Trustee were wrongly decided insofar as they held the court had no power to give credit for consideration paid.

Lord Hodge quoted Lord Wright in Spence v Crawford 1939 SC (HL) 52, at p 77:

… restoration is essential to the idea of restitution. To take the simplest case, if a plaintiff who has been defrauded seeks to have the contract annulled and his money or property restored to him, it would be inequitable if he did not also restore what he had got under the contract from the defendant. Though the defendant has been fraudulent, he must not be robbed nor must the plaintiff be unjustly enriched, as he would be if he both got back what he had parted with and kept what he had received in return. The purpose of the relief is not punishment, but compensation.

The Court also quoted the First Division in Short’s Trustee v Chung as to the purpose of section 34(4), and Lord Drummond Young in MacMillan v T Leith Developments Ltd on the interpretation of consolidation statutes.

Implications

This decision clarifies two important aspects of Scots insolvency law. First, it confirms that ‘adequate consideration’ under section 242(4)(b) is assessed objectively by reference to hypothetical parties acting in good faith and at arm’s length. Where an insolvent company has ceased or is about to cease trading, urgency cannot be used to justify substantial undervalue; the appropriate comparators are the likely outcomes of a formal insolvency sale or sale by a secured creditor, having regard to the professional duties of liquidators and standard security holders to obtain the best reasonably obtainable price. The onus lies firmly on the transferee to adduce such comparative evidence.

Secondly, and significantly, the Court has overruled Short’s Trustee v Chung and Cay’s Trustee v Cay to the extent that they denied the court power to qualify the remedy by giving credit for consideration paid. While the court has no general equitable discretion akin to section 35 of the 1985 Act (now section 100 of the 2016 Act), it may, where justice requires, condition reduction upon repayment of part or all of the consideration paid by a bona fide purchaser, avoiding a windfall to creditors and disproportionate harm to innocent transferees. Where the transferee acted in bad faith or colluded to remove assets, the court retains the power to annul without such qualification.

The decision matters to insolvency practitioners, purchasers of distressed assets, secured lenders, and corporate directors. It supports the statutory rescue culture by protecting bona fide purchasers from disproportionate consequences while preserving the creditors’ core protection against dissipation of assets. The case was remitted to the First Division to determine the appropriate remedy in light of Carnbroe’s recent refinancing and the factual uncertainty as to the current security position over the property.

Verdict: The Supreme Court allowed the appeal only to the extent that the case was remitted to the First Division of the Inner House to consider what is the appropriate remedy under section 242(4) of the Insolvency Act 1986, in light of the court’s power to give appropriate redress (including potentially qualifying the reduction by requiring the liquidators to pay a specified sum to Carnbroe as a condition of reduction). The First Division’s conclusion that Carnbroe had failed to establish adequate consideration was upheld.

Source: MacDonald & Anor v Carnbroe Estates Ltd (Scotland) [2019] UKSC 57