Timing is everything in gratuitous alienations

The subject of gratuitous alienations is a problematic area for the property practitioner.

31 January 2008

The subject of gratuitous alienations is a problematic area for the property practitioner. Timing is all-important, and often it only becomes an issue for insolvency reasons retrospectively.  Put simply of course, in lay terms a gratuitous alienation is no more than a gift, and there is nothing to prevent an owner of property gifting it to someone if he chooses.  However, where the donor was insolvent at the time of the gift, or within a period following the gift, the expression "gratuitous alienation" has a specific meaning, and a transfer of property which constitutes a gratuitous alienation is challengeable by a creditor or the trustee in sequestration in the case of individuals, or the liquidator or administrator in the case of companies, and may be reduced. The asset does not need to have been transferred for nothing.  A transfer where a price is paid, but is under the true value of the property, can also be caught by the rules.

Timing of the gift
If a person is technically insolvent at the time of the transfer – in other words his liabilities exceed the amount of his assets – then gifting any of his property is open to challenge. In the recent case of Thompson (Accountant in Bankruptcy) v Sneddon and The Keeper of the Registers of Scotland, the Outer House had to consider whether the granter of a disposition of a property was insolvent at the time of the gift and whether sums in respect of a claim and a corresponding counter-claim had to be taken into account.

Figures in the balance sheet
Ms Thompson was the permanent trustee on the sequestrated estate of Matthew Sneddon. The first defender, Mrs Sneddon, was his mother, to whom Mr Sneddon had disponed his half-share of his home in Glenrothes for no consideration in June 2005. The permanent trustee sought to challenge the alienation, and reduce the transfer.

For the mother to have a defence, it would be necessary to show that Mr Sneddon's assets exceeded his liabilities immediately, or at any other time, after the transfer (in terms of Section 34(4)(a) of the Bankruptcy (Scotland) Act 1985).  At the time of the transfer, Mr Sneddon and his father had been partners in a firm which was suing a third party for fees worth £20,000.  The third party had counter-claimed for £30,000. In August 2005 decree was granted for the sum counter-claimed. Ms Thompson claimed that this sum should figure in the alleged insolvency in June.

The Lord Ordinary (following the decision in Miller v McIntosh (1884) 11 R 729) held that in a balance sheet test for the time of the transfer, the claim and counter-claim should be displayed as assets and debts which had to be included. These claims simply needed to be quantified. In August 2005, when decree was granted, the asset became nil and the debt became a sum greater than any other assets held by Mr Sneddon at the relevant time. Accordingly, the court upheld Ms Thompson's claim and allowed a proof before answer in relation to the property.
Challenging gratuitous alienations
A challenge to a gratuitous alienation may be made either at common law or under the relevant statutory provisions.  The rules relating to gratuitous alienations by companies are very similar to those for individuals.  Actions at common law are not subject to the statutory time limits, but may be more difficult to raise because the onus of proof lies with the challenger.  At common law, it is for the challenger to establish both that the alienation was gratuitous and that the granter was absolutely insolvent at the time.  He must also show that the transaction was to the prejudice of the challenging creditor.

Such a challenge will be defeated if it can be shown that onerous consideration was paid.  This can take the form of value given in money or money's worth or may be in implement of a prior obligation, for example, the payment of a debt.

The common law remedies are also available to a trustee in sequestration, and the liquidator or administrator of an insolvent company.

Statutory challenge
There are statutory provisions dealing with gratuitous alienations in both personal and corporate insolvency situations.  Section 34 of the Bankruptcy (Scotland) Act deals with gratuitous alienations in personal insolvency situations, whereas section 242 of the Insolvency Act 1986 is the equivalent statutory provision relevant to corporate insolvency.
A statutory challenge only requires the challenger to show that there has been an alienation within the relevant time limit and it is then up to the defender, if he wishes to resist the challenge to establish that the transaction is not challengeable. To do this he would have to show that the transaction falls within one of the specified defences, such as that adequate consideration had been paid or that immediately, or at any other time after the alienation the debtor's assets were greater than his liabilities.

In both personal and corporate cases there are time limits imposed during which a gratuitous alienation may be challenged by a creditor, trustee or liquidator or administrator, and this will depend on the relationship between the debtor and the recipient. The periods are:

  • five years when the recipient is an associate of the debtor, or
  • two years for any other recipient.

In both cases the period is counted from the date of sequestration or granting of a trust deed, or the date on which the winding up of the company commences, or the date it enters administration.

An associate of the debtor is someone who is debtor's spouse or civil partner, or a relative, or the spouse or civil partner of a relative of the debtor or of the debtor's spouse or civil partner.  It also includes any person with whom the debtor is in partnership and any person who is an associate of any such partner.  A firm is an associate of any person who is a member of the firm, and a person is an associate of any person employed by him or who employs him. A director or other officer of a company is regarded as being employed by that company and is therefore an associate of it. Related companies of a company are associates.

Effect on a purchaser
Any one acquiring the property from or through the recipient in the alienation is protected from any challenge, provided that they acquired in good faith and for value. It will however be likely that the circumstances in which the recipient received the property, and whether the fact that the transfer was gratuitous or under value was apparent may be subject to close scrutiny in the event of a challenge.

What constitutes good faith in these circumstances, is not, unfortunately, something that has ever been clearly judicially defined.  In situations where full value has been given, a third party ought to be able to rely on the statutory protection.  However if it is apparent from the titles that there has previously been a transfer of the property for no consideration or for a payment obviously at under the value, then the prudent course of action is to try to establish the solvency status of the granter of the previous transaction to ensure that the statutory protection is not undermined. That is often easier said than done, as obtaining a certificate of solvency from an accountant or a company's auditor may be difficult to obtain.  Where the title to a property is registered in the Land Register, it will not usually be possible to establish the previous considerations paid for the property, and therefore there will be nothing to alert the purchaser to the circumstances of previous transfers, in which case the good faith of the purchaser would not be tainted by any indications from the title. 

For the full text of the decision in Thompson (Accountant in Bankruptcy) v Sneddon and The Keeper of the Registers of Scotland please click here