Undervalue transaction
Encyclopedia
An undervalue transaction is a transaction entered into by a company who subsequently goes into bankruptcy
which the court orders be set aside, usually upon the application of a liquidator
for the benefit of the debtor's creditors.
Under ordinary principles of contract law, the courts will not generally look into the adequacy of the consideration
provided by either side. However, if a company is in real peril of going into bankruptcy, many legal systems provide a mechanism that transactions which are seriously commercially disadvantageous to the company can be unwound, so as to prevent prejudice to the creditors of the company.
Normally, for a transaction to be set aside as an undervalue transaction, the liquidator or equivalent must demonstrate that:
The vulnerability period is the period of time immediately prior to the company going into bankruptcy. The length of the vulnerability period varies between countries, and some countries apply different vulnerability periods in different circumstances. For example, in the United Kingdom, the vulnerability period is either:
The period is calculated by reference to the period of time immediately preceding the company going into liquidation or administration.
The effect of a successful application to have a transaction declared as an undervalue transaction varies. Inevitably the other party to the transaction who received the benefit has to return the benefit (or account for it) it to the liquidator. In some countries the assets are treated in the normal way, and may be taken by any secured creditor
s who have a security interest
which catches the assets (characteristically, a floating charge
). However, some countries have "ring-fenced" recoveries of unfair preferences so that they are made available to the pool of assets for unsecured creditor
s.
Many jurisdictions which have prohibitions on undervalue transactions also provide for an exception in the case of transactions entered into in the ordinary course of business
where the directors
are of a view that it is for the benefit of the company, and such transactions are usually either validated or presumed to be validated.
Bankruptcy
Bankruptcy is a legal status of an insolvent person or an organisation, that is, one that cannot repay the debts owed to creditors. In most jurisdictions bankruptcy is imposed by a court order, often initiated by the debtor....
which the court orders be set aside, usually upon the application of a liquidator
Liquidator (law)
In law, a liquidator is the officer appointed when a company goes into winding-up or liquidation who has responsibility for collecting in all of the assets of the company and settling all claims against the company before putting the company into dissolution....
for the benefit of the debtor's creditors.
Under ordinary principles of contract law, the courts will not generally look into the adequacy of the consideration
Consideration
Consideration is the central concept in the common law of contracts and is required, in most cases, for a contract to be enforceable. Consideration is the price one pays for another's promise. It can take a number of forms: money, property, a promise, the doing of an act, or even refraining from...
provided by either side. However, if a company is in real peril of going into bankruptcy, many legal systems provide a mechanism that transactions which are seriously commercially disadvantageous to the company can be unwound, so as to prevent prejudice to the creditors of the company.
Normally, for a transaction to be set aside as an undervalue transaction, the liquidator or equivalent must demonstrate that:
- the consideration received by the company in the transaction, in money or money's worth is significantly less than the value, in money or money's worth, provided by the company;
- the transaction was entered into during the "vulnerability period"; and
- at the time of the transaction, the company was unable to pay its debts as they fell due, or became unable to pay its debts as they fell due as a result of the transaction.
The vulnerability period is the period of time immediately prior to the company going into bankruptcy. The length of the vulnerability period varies between countries, and some countries apply different vulnerability periods in different circumstances. For example, in the United Kingdom, the vulnerability period is either:
- two years, if the person with whom the company entered into the transaction with is a "connected person", or
- 6 months, in all other cases.
The period is calculated by reference to the period of time immediately preceding the company going into liquidation or administration.
The effect of a successful application to have a transaction declared as an undervalue transaction varies. Inevitably the other party to the transaction who received the benefit has to return the benefit (or account for it) it to the liquidator. In some countries the assets are treated in the normal way, and may be taken by any secured creditor
Secured creditor
A secured creditor is a creditor with the benefit of a security interest over some or all of the assets of the debtor.In the event of the bankruptcy of the debtor, the secured creditor can enforce security against the assets of the debtor and avoid competing for a distribution on liquidation with...
s who have a security interest
Security interest
A security interest is a property interest created by agreement or by operation of law over assets to secure the performance of an obligation, usually the payment of a debt. It gives the beneficiary of the security interest certain preferential rights in the disposition of secured assets...
which catches the assets (characteristically, a floating charge
Floating charge
A floating charge is a security interest over a fund of changing assets of a company or a limited liability partnership , which 'floats' or 'hovers' until conversion into a fixed charge, at which point the charge attaches to specific assets...
). However, some countries have "ring-fenced" recoveries of unfair preferences so that they are made available to the pool of assets for unsecured creditor
Unsecured creditor
An unsecured creditor is a creditor other than a preferential creditor that does not have the benefit of any security interests in the assets of the debtor....
s.
Many jurisdictions which have prohibitions on undervalue transactions also provide for an exception in the case of transactions entered into in the ordinary course of business
Ordinary course of business
In law, the ordinary course of business covers the usual transactions, customs and practices of a certain business and of a certain firm. This term is used particularly to judge the validity of certain transactions...
where the directors
Board of directors
A board of directors is a body of elected or appointed members who jointly oversee the activities of a company or organization. Other names include board of governors, board of managers, board of regents, board of trustees, and board of visitors...
are of a view that it is for the benefit of the company, and such transactions are usually either validated or presumed to be validated.