How to Challenge a Transaction at an Undervalue

What a Transaction at an Undervalue Means

In insolvency law in England and Wales, a transaction at an undervalue is a transaction in which a company transfers value - for example, assets or services - for less than the true market value or for no consideration at all in the period leading up to insolvency. These transactions can unfairly diminish the assets available to creditors when a company enters administration or liquidation. Insolvency law gives office‑holders such as liquidators and administrators the power to challenge and unwind such transactions through the courts under section 238 of the Insolvency Act 1986.

This article explains what a transaction at an undervalue is, when it can be challenged, the legal requirements to prove such a claim, how the court process works, available defences and practical considerations for practitioners and stakeholders.

What Is a Transaction at an Undervalue?

Under Insolvency Act 1986, section 238, a transaction at an undervalue arises where a company:

• Transfers property for no consideration (such as a gift) or;
• Enters into a transaction where the value it receives is significantly less than the value it gives.

Examples include selling an asset at a price far below market value, gifting company property to a related party, or engaging in arrangements where the company receives minimal benefit relative to the value given up. The test focuses on value exchanged rather than any intention to prejudice creditors, making it different from the related but distinct rule under section 423 for transactions defrauding creditors.

Why Undervalue Transactions Are Challenged

The legal policy behind challenging transactions at an undervalue is to protect the collective interests of creditors. When a company disposes of assets for less than their value shortly before insolvency, the pool available to satisfy creditor claims can be depleted, undermining the principle that unsecured creditors should share equally in available assets. By allowing office‑holders to unwind such transactions, the law seeks to restore the company's asset position as if the undervalue transaction had not occurred.

Who Can Bring a Claim

Only certain people can challenge a transaction at an undervalue:

• A liquidator in compulsory or creditors' voluntary liquidation;
• An administrator in administration proceedings.

These office‑holders must decide whether there are grounds for challenge based on records, financial data and the company's conduct prior to insolvency.

Time‑frames: When Challenges Can Be Made

The legislation sets out a “relevant time” for assessing whether a transaction can be challenged:

• For companies, the look‑back period is generally two years before the onset of insolvency; the transaction must have occurred within this period to be challenged.

Unlike preferences under section 239, where shorter and longer look‑back periods may apply depending on connection, undervalue transactions use a fixed two‑year period for companies. In individual bankruptcies (not covered here), longer periods apply.

To succeed, the office‑holder must also show that the company was insolvent at the time of the transaction or became insolvent as a result of it; insolvency may be presumed if the beneficiary is a connected person, such as a director or group company.

Legal Requirements to Challenge a Transaction at an Undervalue

To persuade the court to set aside an undervalue transaction, the office‑holder must establish several key elements:

1. There Was a Transaction

A transaction involves an agreement, arrangement or dealing between the company and a recipient. This must be more than a unilateral act; there must be some interaction or exchange between the parties.

2. The Consideration Was Significantly Less Than Value Given

The transfer must involve either no consideration (a gift) or consideration significantly less than the value of what the company gave up. For example, selling business assets far below market value could qualify.

3. The Transaction Occurred Within Two Years Before Insolvency

The transaction must fall within the relevant period immediately before the onset of insolvency - typically two years for companies. This window allows scrutiny of recent transactions that may have eroded the asset base.

4. Insolvency at the Time or Because of the Transaction

The office‑holder must show the company could not pay its debts when the transaction was entered into, or that the transaction caused or worsened the company's insolvency. Evidence includes financial statements and creditor demands around the time of the transaction. Insolvency can be assumed for connected persons, shifting the burden of proof.

The Court Application Process

1. Investigation by the Office‑Holder

After formal insolvency begins (e.g., liquidation or administration), the appointed office‑holder examines the company's transactions during the relevant period. This includes reviewing board minutes, asset dispositions, invoices and valuations to identify potential undervalue transfers.

2. Preparing the Court Application

If a suspect transaction is identified, the office‑holder prepares an application under section 238 IA 1986, including:

• Evidence of the transaction and its terms;
• Valuation information showing the discrepancy between value given and received;
• Proof of the company's insolvency around the time of the transaction; and
• Details of any connections between the company and the recipient.

The application is filed with the High Court or Companies Court, depending on the circumstances.

3. Court Hearing and Decision

At the hearing, the court examines submitted evidence and hears arguments from the office‑holder and any respondents. The respondent may include the recipient of the transaction or directors who authorised it.

Defences to an Undervalue Claim

A respondent can defend against a challenge by showing that:

• The transaction was entered into in good faith;
• It was part of carrying on the company's ordinary business; and
• At the time, there were reasonable grounds to believe the transaction would benefit the company.

This defence aims to protect legitimate commercial transactions that, although undervalued by hindsight, were made for sound business reasons, not to prejudice creditors.

Court Remedies and Outcomes

If the court finds that a transaction at an undervalue occurred and should be set aside, it has broad powers to ensure fairness:

• It may order that the transaction never took place in law, restoring assets to the insolvency estate;
• It can order repayment or restitution of the value given; or
• It may tailor other relief to restore the asset base for equitable distribution among creditors.

The exact remedy depends on the nature of the transaction and the identities of the parties involved.

Practical Considerations for Directors and Third Parties

Valuation Evidence

Because disputes often hinge on relative value, credible and contemporary valuations are critical. Expert reports or market evidence may be needed to show that a transaction was significantly below value.

Connected Persons

Transactions involving directors, shareholders or group companies attract stricter scrutiny: insolvency can be presumed, making it easier for the office‑holder to meet part of the statutory test.

Timing of Action

An application under section 238 must be made within six years of the onset of insolvency (the commencement of liquidator/administrator's powers) even though the relevant transaction window is two years; failure to issue proceedings in time can prevent recovery.

Indirect Involvement and Series of Transactions

Cases such as Phillips v Brewin Dolphin Bell Lawrie show that courts may treat a complex set of linked dealings as a single transaction at an undervalue if they operate together to transfer significant value for less consideration.

Common Questions About Challenging Transactions at Undervalue

Can any creditor challenge an undervalue transaction?
Generally, only the appointed liquidator or administrator can bring a claim; unsecured or secured creditors do not bring these challenges themselves but benefit from any recovery.

Does the transaction need to be intentional?
No - unlike fraud‑based claims (s423), a transaction at an undervalue claim does not require proof of intent to defeat creditors; it is enough that the value given was significantly less than value received by the company.

What sort of transfers qualify?
Gifts, underpriced sales, below‑market rentals and certain guarantees can all be challenged if they meet the statutory definition of undervalue.

Key Takeaways

A transaction at an undervalue can significantly reduce the assets available to satisfy creditor claims when a company becomes insolvent. Under section 238 of the Insolvency Act 1986, liquidators and administrators can apply to the court to set aside such transactions if they occurred within two years before insolvency and the company received less than reasonable value, was insolvent at the time, or became so because of it. Claims require evidence of valuation, timing and insolvency, and the court may restore value to the estate if a challenge succeeds. Defendants can avoid an order by showing the transaction was undertaken in good faith for the company's business with reasonable belief it would benefit the company. Understanding these rules helps practitioners identify suspect transactions and pursue appropriate remedies in insolvency cases.