Understanding transactions at undervalue

A transaction at undervalue is when business assets are sold lower than their true value or for a loss.

If transactions at undervalue are entered into by a company that later becomes insolvent, it can result in serious repercussions for company directors who may be viewed as deliberately diverting assets away from creditors.  

When a business enters administration or is liquidated, one of the duties of the appointed insolvency practitioner (IP) is to identify whether any transactions at undervalue have been carried out.

The IP may be able to go back two years or more from the date of insolvency in their search, and have the right to apply to the court for the transaction(s) to be reversed. So what would constitute a transaction at undervalue?

What is a transaction at undervalue?

A transaction at undervalue occurs when a business asset is transferred or sold to a third party, either for no payment at all, or for a price that is considerably lower than its true value.

Transactions at undervalue can include:

• Assets that are ‘gifted’ to someone connected to the business – perhaps a family member or another director – where no payment is made in return.
• Assets gifted/transferred to an independent third party, again with no consideration being received by the company.
• An asset that is sold for a vastly reduced sum – one that is considerably lower than its true market value.

How are transactions at undervalue identified by the IP?

The appointed insolvency practitioner analyses the company’s books, asset register, and other financial documentation, to identify whether any ambiguous or otherwise questionable transactions have taken place.

They will particularly look for instances where the transaction could have caused or contributed to the company’s financial decline. If this is found to be the case, or such transactions have taken place once the company had formally entered insolvency, the office-holder will investigate further.

What happens if transactions at undervalue are discovered?

Investigation into director actions

The director will be interviewed by the office-holder, who will expect an explanation of why the transaction took place, the reasoning behind it, and to establish whether it was a deliberate act to divert company assets away from creditors.

Specifically, they will be looking for any instances of unfit conduct or attempts to reduce the returns available to creditors, whether deliberate or otherwise. If this has occurred, it is a serious breach of the Insolvency Act, 1986.

Once the investigations are complete, the IP must submit a report to the Secretary of State, who decides whether or not to pursue an action against the director. The Insolvency Service act on behalf of the Secretary of State, and they have two years in which to decide whether to take action against a company director.

Reversal of the transaction

The administrator or liquidator also has the power to reverse these transactions. They can apply to the court for a reversal that returns the company’s finances to the position prior to the transaction.

What are the ramifications for company directors?

Company directors who have carried out transactions at undervalue face a number of potential penalties, both financially and professionally. These include:

• Disqualification as a director for 2-15 years
• Personal liability for some or all of the company’s debts
• Fines
• Criminal prosecution and a potential prison sentence if serious unlawful conduct is established

Being disqualified as a director has implications in other areas of life, including being banned from taking on certain roles and responsibilities, such as a pension trustee or school governor. 

Avoiding undertaking transactions at undervalue

Directors can avoid allegations of making transactions at undervalue by obtaining the consent and approval of the board prior to the transfer or sale of a business asset. The asset should also be professionally valued to ensure that the correct price is achieved.

The proceeds of sale should also be deposited into the company bank account as soon as practical following sale of the asset, and along with the sale documentation, these financial records should be retained for a prolonged period of time – preferably for some years after the statutory time period has elapsed.

Transactions at undervalue can be a complex area for company directors, but one that also has the potential for serious consequences if not handled correctly.

Begbies Traynor can provide more guidance on transactions at undervalue, to ensure you understand the nature of these transactions and the potential implications for you personally. We operate from nationwide offices across the UK and can arrange a free same-day consultation to discuss your needs.