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How secure is your security?

How secure is your security?

Charges can be set aside as transactions at an undervalue, but this can be avoided, say Eamonn Mcnamara and Michael Twomey

Consider the following situation: your client is owed a sum of money by Borrower Ltd. In order to provide comfort, Borrower Ltd subsequently grants security to your client. How secure is this security? In particular, can it be challenged as a 'transaction at an undervalue' under provisions of the Insolvency Act 1986 (IA)?

This important question was examined by the Court of Appeal in Hill v Spread Trustee Company Ltd [2006] EWCA Civ 542.

Transactions at an undervalue

If a company enters into a transaction at an undervalue up to two years prior to the onset of insolvency, then s 238 IA is applicable. This section enables an administrator or liquidator to challenge the transaction by applying to the court for an order under s 241. At the time of the transaction, the company must have been insolvent or became insolvent in consequence of the transaction (s 240(2)). Such insolvency is presumed if the transaction is with a connected person.

Transactions defrauding creditors

Section 423 IA is very widely drafted. In practice, this section is rarely resorted to, due to the problems of proving that the transaction was entered into for the purpose of putting the assets beyond the reach of a person who is making or at some time may make a claim against him, or otherwise prejudicing the interests of such a person (s 423(3)).

In order for this section to apply, the transaction must have been entered into at an undervalue. Significantly, there is no requirement that the company go into insolvency before an action can be maintained. A claim under the section can be brought not just by an official receiver, trustee in bankruptcy or liquidator and administrator, but also, by leave of the court, by a 'victim' of the transaction. Section 432(5) defines a victim widely as a person who is or is capable of being prejudiced by a transaction. In Hill, the majority considered that the limitation period for this section commenced with the appointment of trustee in bankruptcy. It is therefore possible for a transaction to be challenged under s 423 many years after its completion.

Grant of security

It can be seen from the above that the grant of a security may be open to challenge under s 238 IA and s 423 IA only if the grant amounts to a transaction at an undervalue.

For the purposes of s 423 IA, a person enters into a transaction at an undervalue with another person if '“

(a) he makes a gift to the other person or he otherwise enters into a transaction with the other on terms that provide for him to receive no consideration;

(b); or

(c) he enters into a transaction with the other for a consideration the value of which, in money or money's worth, is significantly less than the value, in money or money's worth, of the consideration provided by himself (s 423(1)).

The definition of a 'transaction at an undervalue' in s 423(1) is in all relevant respects the same as the definition in s 238(4) of the same Act.

Facts of Hill

An individual, N, bought land for a relatively small sum of money. This land had planning potential and N was offered a sum of £700,000 for it. He later transferred the land into a trust fund and informed the Inland Revenue that the value of the land at the time of the transfer was £35,000. N omitted to mention to the valuer of the land that he had already received the offer of £700,000. A district valuer subsequently challenged this valuation and the Inland Revenue and N reached a compromise for £160,000 for the tax due.

Later, the trust fund sold the land and made several loans to N of the proceeds. N, for his part, granted security and an assignment to the trustees to secure the amounts outstanding.

N subsequently went into bankruptcy and the trustee in bankruptcy challenged these securities under s 423 IA. The court found that N had entered upon the transactions for the purposes of putting assets beyond the reach of the Inland Revenue and that the Inland Revenue was a victim of the transactions in that it was prejudiced thereby. Section 423(2) enables a court to take whatever steps are necessary to protect the interests of such victims.

The trustees appealed to the Court of Appeal, arguing, inter alia, that the grant of security could not amount to a transaction falling within s 423(1) IA.

Section 423(1)(a) and 238(4)(a): no consideration

Counsel for the trustees argued that dicta of Millet J in MC Bacon Ltd 1990] BCLC 324 was authority for the proposition that the grant of security cannot be given for no consideration because a charge does not deplete a debtor's assets. The Court of Appeal had little difficulty in dismissing this argument, observing that MC Bacon was not a situation where there had been an absence of consideration. In MC Bacon, the security was granted for the forebearance to sue.

The Court of Appeal in Hill found on the facts that the security provided by N was granted for no consideration. MC Bacon therefore had no specific relevance to this point. Arden LJ, who gave the leading judgment in Hill, held that it is possible for a charge to be granted for no consideration within the meaning of s 423(1)(a). This is a significant and important decision and one with which the rest of the Court of Appeal agreed. It is now clear law that a grant of security for no consideration can fall within the definition of a transaction at an undervalue for the purposes of s 423 and s 238.

This finding was sufficient to deal with the matter before the court in Hill. However, Arden LJ also considered the situation where some consideration is given for the grant of the security. And it is this obiter dicta that is likely to cause a great deal of debate.

Section 423(1)(c) and 238(4)(b): consideration that is significantly less

Section 423(1)(c) applies to a transaction by a person for a consideration, the value of which is significantly less than the value of the consideration provided by himself. It requires a comparison to be made between the value obtained by the person for the transaction and the value of consideration provided by the person.

In MC Bacon, Millet J considered this point and held that the grant of security by a company could not be for a consideration less than that provided to it because, as a matter of law, the grant of security involved no diminution in the value of the company's assets. He stated: 'By granting the debenture the company parted with nothing of value.' Therefore, the fact that the consideration provided to the company may be negligible did not bring the transaction within s 238(4)(b) and, by analogy, s 423(1)(c).

However, Arden LJ was not persuaded that a grant of security involves parting with nothing of value. She observed that s 423(1)(c) did not refer to a diminution in assets and does not depend on the grant of proprietary rights. Indeed, she felt that the grant of other rights can constitute consideration. This approach seems to be supported by s 425, which refers to 'obligations' and 'benefits', as well as to property. If it had been necessary to find the grant of a proprietary right, Arden LJ would provisionally not have accepted the argument that the grant of the security in Hill did not involve the disposition of any property right in favour of the trustees. Arden LJ referred to dicta by Lord Hoffmann and Lord Millett in Buchler v Talbot [2004] 2 AC 298, at [29] and [51] respectively, to the effect that the grant of security amounts to the granting of something of value.

While there is no change in the physical assets of the debtor when the security is given, Arden LJ considered there to be no reason why the value of the right to have recourse to the security and to take priority over other creditors, which the debtor creates by granting the security, should be left out of account.

Arden LJ doubted whether the contrary holding in MC Bacon could be relied upon. However, MC Bacon was applied by the Court of Appeal in National Bank of Kuwait v Menzies [1994] 2 BCLC 306, where a further assignment was made of a debt that had already been assigned by way of charge. Arden LJ stated that if this point had to be decided, then it would be necessary to consider whether that case was distinguishable or was now binding, particularly in light of the observations by Lord Hoffmann in Buchler.

Consequences of Hill

The Court of Appeal has held that the grant of security for no consideration is capable of amounting to a transaction at an undervalue.

But what if some consideration were provided for the security? Prior to Hill, the position seemed clear. Quite simply, if MC Bacon were followed, the grant of security could not amount to a transaction at an undervalue within the meaning of s 423(1)(c) and 238(4)(b). In Hill, the Court of Appeal did not have to provide a final view on this point. The dicta of Arden LJ is therefore obiter. However, despite this, the debate has now been reopened. It is arguable that the grant of security for some consideration could indeed amount to a transaction at an undervalue if the consideration received for the charge is significantly less than the value of the charge.

Practical steps?

To prevent the grant of security amounting to a transaction at an undervalue, it is advisable for some consideration to be given for the security and to seek to ensure that such consideration is not significantly less than the value of the charge. This may be difficult to quantify in practice. Arden LJ spoke of the value of the right to have recourse to the security. How is this 'value' to be assessed?

Following Hill, clients should be informed that there is a risk of a charge being set aside as a transaction at an undervalue. However, s 238 will only apply if a company grants a charge within two years of the onset of insolvency and, at the time of the charge, the company is insolvent or becomes insolvent as a result. Care should therefore be taken to ensure that the company is in fact not insolvent when the charge is taken.

As for s 423, it has already been stated that this section is unlikely to apply due to the difficulty in establishing that the transaction was entered into for the necessary purpose. But if this purpose can be shown, then the section is extremely wide-ranging.


It should not be forgotten that it is possible for the grant of security to be challenged under other provisions of the Insolvency Act 1986, namely, s 239 (preferences) and s 245 (avoidance of certain floating charges). However, these provisions were not relevant to Hill and a discussion of them has not been included in this article.

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