What is a transaction at an undervalue?

Why might someone sell an asset for less than it’s worth?

When a company cannot pay its debts and becomes insolvent, the legal duties of the company directors change. Rather than promoting the company’s success, they must take steps to maximise the interests of their creditors (the parties the business owes money to). In practice, that usually means ceasing trading immediately, protecting the company’s assets and treating all creditors equally.

When the company enters a formal insolvency procedure like liquidation or administration, its assets may be sold so the proceeds can be used to repay its debts. By selling or transferring an asset for less than its true worth, the directors are diverting assets that could be used to compensate their creditors.

Often, the recipient of a transaction at undervalue (TUV) will be another company controlled by the director or a connected party, such as a business partner or family member. And there can be serious financial and legal consequences if a transaction at an undervalue is discovered. 

Examples of transactions at undervalue (TUV)

If a company is in financial distress, its directors must be mindful of any transactions they enter into. Avoiding these common examples will help to protect you from repercussions.

• Selling assets for less than they’re worth - Selling business assets for less than their market value when the company is struggling.
• Giving gifts or donations - Donating or gifting assets or large sums of money to connected individuals or independent third parties without clear business justification.
• Transferring assets to family members - Transferring ownership of company assets to a family member for a nominal fee or as a gift when the business is in financial distress.  
• Writing off debts - Cancelling a debt to your company without receiving payment or something of equal value in return.
• Writing off a director’s loan - Writing off a loan from the company to a director when the business is in a period of financial distress.

Generally speaking, directors must be extremely cautious when managing loans and repayments and paying any creditors when the business is nearing insolvency.   

How are transactions at undervalue identified?

When a company becomes insolvent, it must contact a licensed Insolvency Practitioner. They will assess the business’s finances, explain the options available and offer advice on the best route forward. They may recommend administration if the company can be rescued or liquidation if it is no longer financially viable.

If the business enters either of these procedures, the appointed Insolvency Practitioner must investigate the directors’ conduct and determine whether any transactions at undervalue took place in the two years leading up to the insolvency. To qualify as a transaction at undervalue, the company must have been unable to pay its debts at the time of the transaction, or it must have contributed to the company’s financial decline. 

What are the penalties for transactions at an undervalue?

If the Insolvency Practitioner identifies any suspicious transactions during their investigation, they will examine company records and interview the directors to understand their reasoning for them.  

The Insolvency Practitioner can apply to the court to reverse the transaction if the directors entered into it to benefit themselves or a connected party at the expense of their creditors. If it’s not possible to transfer the property back to the company, one or more directors could be ordered to compensate the company to restore it to the financial position it was in before the transaction.  

The Insolvency Practitioner will also submit a report of their findings to the Insolvency Service, and it will decide whether to take further action against the directors. The potential penalties include:

• Fines
• Personal liability for some or all of the company’s debts
• Disqualification from acting as a director for up to 15 years
• A potential prison sentence in the most serious cases where the transaction was entered into with the deliberate intention to defraud creditors 

How to avoid transactions at undervalue

There are steps company directors can take to avoid the risks associated with transactions at an undervalue when the company is struggling financially. 

Seek board approval

Seek the board’s approval before entering into any transactions involving the sale or transfer of business assets when the company is struggling. You should act in good faith and avoid transactions that worsen the creditors’ positions. 

Get your assets professionally valued

If you are considering selling non-essential assets to boost cash flow or using an asset to access finance, you should always have them valued by professionals with experience in your sector.

Document everything

Keep detailed documentation of every transaction you enter into for at least six years. That should include the reasoning behind them, minutes of board meetings, evidence of independent valuations and the sales particulars.   

Get peace of mind with professional asset valuations

Transactions at undervalue can be a complex area for company directors, but obtaining an independent valuation will help you avoid accusations. At Eddisons, our RICS-registered experts perform professional asset valuations across many asset classes and work to the highest global standards. Please get in touch to discuss a professional valuation or for help with asset sales.