Transactions At Undervalue (TUV): Your Complete Guide
For directors managing financially distressed companies, a comprehensive understanding of transactions at an undervalue (TUV) is not just beneficial, but crucial, especially when navigating insolvency.
In this guide, we delve into transactions at undervalue, emphasising its definition, examples, potential consequences, and the relevant legal framework, particularly within the context of the Insolvency Act 1986.
Directors' responsibilities during insolvency
When a company is in financial distress and on the brink of insolvency, directors are legally bound to act in its creditors’ best interests.
This is a significant departure from normal business operations, where directors primarily focus on benefiting the company and its shareholders.
Key responsibilities directors must be aware of during insolvency include:
- Avoiding wrongful trading: If directors allow the company to continue trading when it is clearly insolvent, they can be held personally liable for any increase in the company’s liabilities during this period.
- Avoiding fraudulent trading: Fraudulent trading involves knowingly taking actions that harm creditors, such as transferring assets out of the company to protect them from liquidation.
- Preventing preferential payments: Preferential payments occur when directors favour one creditor over others (such as paying off a personal debt or a loan from a family member).
A significant part of a director’s responsibility during insolvency is avoiding transactions at an undervalue.
Failure to uphold this obligation can result in personal liability and/or disqualification, underscoring the seriousness of the situation.
What is a Transaction at an Undervalue?
A transaction at undervalue happens when a company or director transfers assets (or makes a deal) where the amount received is far below the asset’s actual market value.
These transactions are carefully examined during insolvency cases because they can reduce the wealth available to pay off the company’s creditors. TUVs can potentially lead to serious legal and financial repercussions.
Legal definition under the Insolvency Act 1986
According to Section 238 of the Insolvency Act 1986, a transaction is considered at an undervalue if:
- Assets are sold for significantly less than their value
- Assets or money are given away without receiving any equivalent value in return.
Transactions at an undervalue are generally voidable if they occur during a specific time period before the company’s insolvency (known as the look-back period).
What is the look-back period?
The look-back period for transactions at an undervalue is typically two years prior to the onset of insolvency. This means any transactions made during these two years can be challenged and potentially reversed if they unfairly depleted company assets to the detriment of creditors.
Examples of transactions at an undervalue
As your company approaches insolvency, it’s critical to be mindful of the transactions it engages in – especially any that could be seen as undervaluing or transferring assets for less than their market value.
Understanding the different types of TUVs can help protect your business and you from legal and financial repercussions.
- Sale of assets below market value: A director sells valuable machinery, equipment, or property owned by the company for significantly less than its market value before insolvency proceedings formally commence. For example, selling an asset worth £100,000 for £20,000 could be challenged as a TUV.
- Excessive remuneration: Providing directors or employees with excessive salaries, bonuses, or other benefits during times of financial distress can be problematic and may be scrutinised.
- Gifts or donations: A company close to insolvency may donate large sums of money to a charity or a third party without any business justification. While such donations are legal in normal circumstances, they could be deemed a transaction at an undervalue when done during financial distress.
- Disposal of intellectual property (IP): If a director transfers the company’s valuable intellectual property, such as patents or trademarks, to another entity for little or no consideration, this might be considered a transaction at an undervalue. This is especially problematic if the transfer reduces the value of the company just before insolvency.
- Transfer of ownership to family members: A director transfers ownership of a company’s assets, such as property, land, or shares, to family members for a nominal fee or as a gift. If done immediately before insolvency, this kind of transaction is a common example of a transaction at an undervalue.
- Director’s loans: If a company writes off a director’s loan during a period of financial distress, it could be viewed as a TUV. Directors must exercise extreme caution when managing loans and repayments, especially if the company is nearing insolvency. If a director’s loan is judged to be a TUV the consequences can be severe.
- Writing-off debts: Forgiving a debtor’s obligations to your company without receiving something of equal value could be scrutinised, especially if the transaction involves connected parties. Likewise, assuming another party’s debts or obligations without receiving a proportionate benefit may be considered a TUV.
What is a connected party?
- Family members such as spouses, children, parents, or siblings
- Business partners or co-directors in the same company
- Other companies controlled by the same director
- Associates of the director, which can include relatives, employees, or entities where the director has a significant interest or influence.
Making a transaction at an undervalue claim
A transaction at undervalue claim can be made by a liquidator, administrator, or trustee (in personal bankruptcy).
The purpose of the claim is to reverse the transaction, recover the lost value, and ensure all creditors are treated fairly.
Legal requirements when making a TUV claim
For a TUV to be vulnerable to a claim, certain financial conditions must be met, specifically:
- The company must have been unable to pay its debts at the time the transaction occurred, meaning it was insolvent or close to insolvency. Or;
- The company must have become unable to pay its debts as a direct result of the transaction.
Transaction at an undervalue time limits
The time limit for challenging a transaction at an undervalue varies depending on whether the case involves corporate insolvency or personal bankruptcy. The look-back periods are crucial in determining whether a transaction can be challenged and reversed.
Corporate insolvency
A liquidator or administrator can challenge a transaction at undervalue if it occurred within two years before the company’s insolvency.
Personal bankruptcy
A trustee can challenge a TUV if it occurred within five years before the bankruptcy declaration. However, if the transaction took place between two and five years before the bankruptcy, the trustee can only challenge it if the other party involved knew the debtor was insolvent at the time of the transaction.
Avoiding transactions at an undervalue
Obtaining a fair market value
Ensure all sales of company assets are conducted at fair market value. If you need to sell assets, get professional valuations and keep records of the sale to demonstrate the transaction was above board.Seeking professional advice
Before making significant financial transactions during periods of financial distress, it’s essential to consult with legal and financial experts. Summit Law can provide valuable advice to help you navigate these complex situations and avoid potential pitfalls.Act in good faith
Directors must act in the best interests of creditors when a company is in financial difficulty. Avoid any transactions that could be seen as shifting assets away from the company in a way that harms creditors’ interests.Document everything
Always maintain detailed documentation of business transactions, including the rationale behind any transfers or sales. If the company’s financial situation is questioned, having thorough records can help demonstrate transactions were made in good faith.
Defending against allegations of transaction at an undervalue
If you are accused of engaging in a transaction at an undervalue, it’s essential to build a robust legal case. Possible defences against transactions at undervalue include:
Proving solvency at the time of the transaction
One of the most effective defences against a TUV claim is demonstrating the company was solvent at the time the transaction occurred and remained solvent afterwards.
If the business was able to meet its financial obligations as they fell due, it suggests the transaction did not undermine the interests of creditors.
To prove solvency, directors can provide:
- Up-to-date financial statements: Showing the company had sufficient assets and cash flow to cover its liabilities at the time of the transaction.
- Cash flow forecasts: Demonstrating the company had no immediate risk of insolvency based on projected income and outgoings.
- Balance sheets: Clearly showing that assets exceed liabilities.
Proving adequate consideration
Even if the value of a transaction is contested, providing documentation to show the price or terms were reasonable under the circumstances can help negate claims of undervaluation.
Examples of adequate consideration include:
- Market valuations: Obtaining an independent professional valuation of the asset before the sale can demonstrate the price aligned with market rates.
- Comparable transactions: Showing similar sales or deals made in comparable market conditions can help justify the fairness of the transaction.
- Economic pressures: Highlighting any financial pressures or market volatility that may have influenced the transaction can explain why the asset was sold for less than might typically be expected.
Demonstrating business rationale
Insolvency practitioners may be more lenient if a director can clearly show a transaction was made for legitimate business purposes and was aimed at restructuring, stabilising, or improving the company’s financial position.
Potential examples of legitimate business rationales include:
- Debt restructuring: If the transaction was part of a more significant effort to reduce debt or improve cash flow, this context can be valuable.
- Raising liquidity: Selling an asset below market value might be necessary in a cash-strapped business trying to remain operational. If the asset sale was crucial for paying employees or keeping the company afloat, you could argue the transaction was done in good faith.
- Asset disposal strategy: If the transaction was part of a broader strategy to focus on core business activities by disposing of non-essential assets, insolvency practitioners may view this as a legitimate business decision.
Date of transaction
The timing of the transaction is a critical factor in defending against TUV claims. Under the Insolvency Act 1986, transactions at an undervalue can only be challenged if they occurred within the statutory “look-back” period – two years before the company became insolvent.
If the transaction in question falls outside of this period, it cannot be legally challenged as a TUV. This defence is especially powerful when there is no evidence the company was facing financial distress at the time of the transaction.
This argument relies heavily on proper record-keeping and adherence to financial reporting requirements.
Contact our director defence lawyers today
If you are a director facing financial distress or are concerned about potential transactions at an undervalue, Summit Law can provide expert legal guidance to protect your interests.
With our 30 years’ experience, our specialist director defence solicitors have unrivalled experience assisting directors against liquidator claims. These include TUV alongside other claims such as misfeasance, wrongful trading, overdrawn director loan accounts, and preferential payments.
For your free consultation, contact our director defence solicitors today on 020 7467 3980 or complete the enquiry form on this page.