When a company enters liquidation in the United Kingdom, the liquidator has a legal duty to investigate the company’s financial affairs and review transactions that took place before insolvency. One important part of this process involves examining whether directors or the company transferred money or assets in a way that unfairly benefited certain parties before liquidation.
Under the Insolvency Act 1986, two key provisions often arise during these investigations:
- Section 238: Transactions at Undervalue
- Section 239: Preferences
These provisions are designed to protect creditors and prevent directors or businesses from moving assets improperly before insolvency. Liquidators frequently review repayments to directors, transfers to connected parties, and disposal of company assets made shortly before liquidation.
Understanding how these rules work is important for directors, shareholders, creditors, accountants, and businesses experiencing financial distress.
What Is a Transaction at Undervalue?
A transaction at undervalue occurs when a company transfers an asset or enters into a transaction for significantly less than its true value.
This is covered under Section 238 of the Insolvency Act 1986.
A company may enter into a transaction at undervalue if it:
- Gifts an asset for no consideration
- Sells assets for substantially less than market value
- Transfers property without proper payment
- Waives debts owed to the company
The law exists to prevent directors from reducing the value of company assets before insolvency in a way that disadvantages creditors.
Common Examples
Examples of transactions at undervalue may include:
- Selling company vehicles cheaply to family members
- Transferring equipment to another company owned by the director
- Writing off loans owed to the business
- Selling stock below market value shortly before liquidation
- Transferring intellectual property for nominal sums
In insolvency investigations, liquidators will usually compare the value received against the actual market value of the asset or transaction.
What Is a Preference?
A preference arises under Section 239 of the Insolvency Act 1986 when a company puts one creditor, guarantor, or connected party in a better position than other creditors before insolvency.
This often occurs when directors repay certain debts while knowing the company is financially distressed.
The key issue is whether the transaction unfairly improved the position of one creditor compared to the outcome they would otherwise receive during liquidation.
Examples of Preferences
Common examples include:
- Repaying a director’s loan shortly before liquidation
- Paying a family member ahead of trade creditors
- Settling debts owed to connected companies
- Granting security for existing debts
- Prioritising one supplier while others remain unpaid
Preferences are particularly relevant where directors personally benefit from repayments or where connected parties receive preferential treatment.
Connected Parties and Insolvency Investigations
Connected party transactions receive especially close scrutiny during liquidation investigations.
Under insolvency legislation, connected parties may include:
- Directors
- Shadow directors
- Associates
- Family members
- Spouses
- Parent companies
- Subsidiaries
- Businesses under common control
Transactions involving connected parties are viewed more critically because there is a greater risk that directors may have influenced decisions for personal benefit rather than acting in the interests of creditors.
For example:
- Repaying money owed to a director while trade suppliers remain unpaid
- Selling company assets to relatives below market value
- Transferring contracts to another company owned by the same director
These situations may trigger liquidator investigations under Sections 238 or 239.
Lookback Periods Under the Insolvency Act
One important aspect of preferences and transactions at undervalue is the statutory “lookback period.”
The lookback period determines how far back a liquidator can investigate transactions before insolvency.
Transactions at Undervalue – Section 238
For transactions at undervalue:
- The transaction must usually have occurred within two years before insolvency
The liquidator must also show that:
- The company was insolvent at the time, or
- Became insolvent because of the transaction
Preferences – Section 239
For preferences:
- Connected parties: up to two years before insolvency
- Unconnected parties: up to six months before insolvency
In preference claims, the liquidator generally needs to establish that the company was influenced by a “desire to prefer” the creditor or connected party.
Where connected parties are involved, the court may presume this desire existed unless evidence suggests otherwise.
Director Loan Repayments Before Liquidation
One of the most common areas of investigation involves repayments made to directors before liquidation.
Directors sometimes repay overdrawn director loan accounts or withdraw company funds when financial pressure increases. In other cases, directors repay loans owed by the company to themselves shortly before insolvency.
Liquidators frequently review:
- Director loan account movements
- Dividend payments
- Expense reimbursements
- Salary increases
- Cash withdrawals
- Transfers between related businesses
If repayments are considered preferential or excessive, the liquidator may seek recovery action.
For example, if a director repaid themselves £30,000 while PAYE, VAT, and supplier debts remained unpaid, the transaction could potentially be challenged as a preference.
Similarly, if directors transferred assets from a struggling company into a newly formed business for below market value, this may trigger a transaction at undervalue claim.
Asset Transfers Before Liquidation
Asset transfers shortly before liquidation are another major focus during insolvency investigations.
Liquidators may examine:
- Vehicle sales
- Machinery transfers
- Intellectual property assignments
- Stock disposals
- Property transactions
- Transfers between connected companies
The key concern is whether assets were removed from the company improperly before creditors had an opportunity to recover debts.
Even where directors believe a transfer was reasonable, the transaction may still face scrutiny if:
- The value was inadequate
- No independent valuation was obtained
- The buyer was connected to the company
- The business was already insolvent
Proper documentation and professional valuations are therefore extremely important when disposing of company assets during financial distress.
Liquidator Powers and Court Action
If a liquidator believes a preference or transaction at undervalue occurred, they may:
- Request repayment
- Seek return of transferred assets
- Negotiate settlements
- Apply to court for recovery orders
The court has broad powers under the Insolvency Act to reverse transactions where appropriate.
Potential outcomes may include:
- Returning assets to the company
- Repayment of funds
- Compensation orders
- Restoration of creditor positions
In some cases, investigations may also contribute to director disqualification proceedings or allegations of misfeasance.
Defences and Commercial Justification
Not all transactions before insolvency are automatically unlawful.
Directors may defend claims where transactions were:
- Made in good faith
- Supported by proper market valuations
- Part of ordinary commercial activity
- Intended to improve the company’s survival prospects
For example, asset sales conducted at independently verified market value may not amount to transactions at undervalue even if the buyer was connected to the company.
Courts generally assess the surrounding circumstances carefully before making findings against directors.
Conclusion
Sections 238 and 239 of the Insolvency Act 1986 play an important role in protecting creditors during company liquidation. Transactions at undervalue and preferences are closely examined to ensure directors did not improperly transfer assets or favour certain parties before insolvency.
Repayments to directors, connected party transactions, and asset transfers shortly before liquidation often attract significant scrutiny from liquidators. Understanding the relevant lookback periods and legal tests is therefore essential for directors managing financially distressed businesses.
Simple Liquidation and other insolvency practitioners regularly investigate these transactions as part of the formal liquidation process, particularly where creditors may have suffered financial loss due to pre-insolvency actions.
FAQs
1. What is a transaction at undervalue under the Insolvency Act 1986?
A transaction at undervalue occurs when a company transfers assets or enters into a transaction for significantly less than market value before insolvency. This is governed by Section 238 of the Insolvency Act 1986.
2. What is a preference in company liquidation?
A preference happens when a company unfairly places one creditor or connected party in a better financial position than other creditors before insolvency. This falls under Section 239 of the Insolvency Act 1986.
3. How far back can a liquidator investigate transactions?
Lookback periods vary:
- Transactions at undervalue: up to two years
- Preferences involving connected parties: up to two years
- Preferences involving unconnected parties: up to six months
4. Can a liquidator recover money repaid to directors before liquidation?
Yes. If repayments to directors are considered preferential or improper, the liquidator may seek recovery through negotiation or court proceedings.
5. What are connected party transactions in insolvency?
Connected party transactions involve directors, family members, associated businesses, or companies under common ownership. These transactions are subject to increased scrutiny during liquidation investigations.