Transactions at an Undervalue: Legal Action Explained

When a company in England and Wales goes into insolvency, one of the insolvency practitioner's key tasks is to review past transactions to identify conduct that unfairly reduced the company's estate. Among the antecedent transactions that can be challenged is a transaction at an undervalue. This legal mechanism allows a liquidator or administrator to ask the court to undo certain deals made shortly before insolvency, restoring value back to the company's estate for the benefit of creditors. These provisions are found mainly in Section 238 of the Insolvency Act 1986.

This article explains what a transaction at an undervalue is, when and how it can be challenged, the legal tests and defences involved, practical consequences, and common questions that arise in practice.

What Is a Transaction at an Undervalue?

A transaction at an undervalue occurs when a company disposes of an asset or enters into a transaction on terms that mean it receives significantly less than the asset's true value - or no value at all - in exchange. There is no requirement to show that it was done with the intention of defrauding creditors; the focus is whether the deal was actually undervalued.

Examples include:

• A company gifts valuable equipment to a related party without receiving any payment.
• A company sells a piece of property to a director or connected party for a fraction of its market price.
• A company pays for services at inflated prices that benefit a third party or enters a contract that gives it no significant benefit.

In each case, if the company received inadequate consideration in return - and the transaction took place in the period before insolvency - it may be open to challenge.

Legal Basis for Challenging Transactions at an Undervalue

Under Section 238 of the Insolvency Act 1986, where a company at a relevant time entered into a transaction at an undervalue with any person, an administrator or liquidator may apply to the court for an order to:

• Restore the company's position to what it would have been had the transaction not occurred;
• Order repayment of value to the company's insolvency estate;
• Make such other order as the court considers appropriate to remedy the loss.

This is a voidable transaction claim, meaning the court can set aside or reverse the transaction if the statutory criteria are satisfied.

When Can a Transaction Be Challenged?

Relevant Time Before Insolvency

To challenge a transaction at an undervalue, it must have occurred within a defined period before insolvency - often referred to as the “relevant time”. For corporate insolvency:

• The relevant period is generally two years before the onset of insolvency. This applies regardless of whether the recipient is connected or unconnected to the company.

In practical terms, this means that if a undervalued transaction took place more than two years before the company entered administration or liquidation, it will normally fall outside the scope of a Section 238 claim.

Insolvency Must Exist or Result

The office‑holder must also show that:

• The company was unable to pay its debts at the time of the transaction, or
• The transaction caused or contributed to insolvency.

This reflects the objective that voidable transaction provisions are designed to protect creditors when a company's financial position has deteriorated.

How the Court Decides the Claim

Evidence and Application

A challenge under Section 238 involves an application to the High Court (Chancery Division) or another appropriate insolvency court. The liquidator or administrator must present evidence about:

• The nature of the transaction and its timing;
• The consideration (and its value) received by the company;
• The company's financial position when the transaction was made.

Evidence may include contracts, valuations, finance records and witness statements.

Defences and Commercial Justification

The court will consider defences where the transaction was entered into:

• In good faith, and
• With the genuine intention of benefiting the company and enabling its ongoing business.

If the company directors could reasonably believe at the time that the transaction promoted the company's legitimate interests - for example, raising cash to keep operations going - the court may refuse to set it aside even if it was technically undervalued.

This “good faith and benefit” defence recognises that not every low‑value deal is improper in the context of commercial distress.

Connected Parties and Presumptions

Connected persons - such as directors, major shareholders or associated companies - are more likely to trigger scrutiny. While the look‑back period remains two years for undervalue transactions, insolvency can be presumed for transactions involving connected parties unless evidence establishes otherwise. This reduces the burden on the office‑holder to prove financial difficulty at the precise moment of the deal.

The provision reflects policy concerns that deals involving related parties are more likely to divert value away from creditors. It does not, however, automatically make every such deal voidable - the statutory tests and defences still apply.

Remedies and Practical Outcomes

If the court is satisfied that a transaction was at an undervalue and meets the statutory criteria, it has broad powers to make orders that:

• Void the transaction, treating it as if it had not occurred;
• Restore the asset or its value to the company's insolvency estate;
• Adjust the rights of the recipient so that they prove as a creditor in place of an asset received.

The purpose of such orders is to maximise returns to creditors in a fair and orderly distribution process.

Time Limits and Procedural Considerations

A Section 238 claim must be made within the statutory periods and typically before final dissolution of the company. Office‑holders must act promptly once suspect transactions are identified, as delay or failure to pursue claims within the insolvency process can foreclose remedies.

Parties facing a challenge should be aware that rights of action for undervalue transactions cannot be assigned outside the insolvency estate. This differs from some other avoidance actions where assignment is possible.

Examples to Illustrate

Example 1: A company transfers a machine worth £70,000 to a director's company for £10,000 two years before entering liquidation. A liquidator can apply to set aside this undervalued transaction and seek return of the machine or its value.

Example 2: A business struggling with cashflow sells unencumbered property at below market price in a last‑ditch attempt to raise funds, but the company later enters administration. Whether the deal is set aside depends on the company's position at the time and whether it reasonably appeared beneficial.

These examples show how courts balance objective value with commercial context.

Practical Risks and Advice

For directors and connected parties, transactions that reduce the corporate estate shortly before insolvency carry risk of being challenged. Good practice includes:

• Ensuring any disposal at less than market value is justified by clear business rationale;
• Documenting the decision‑making process and commercial reasons for the transaction;
• Seeking independent valuations and professional advice when financial distress looms.

For office‑holders, careful investigation and early identification of suspect transactions form a core part of recovering assets for creditors.

Key Takeaways

A transaction at an undervalue occurs where a company disposes of property or enters a deal in which it receives no consideration or value significantly less than what it gives. Under Section 238 of the Insolvency Act 1986, insolvency office‑holders can apply to set aside such transactions if they occurred within two years before insolvency and the company was insolvent or became insolvent as a result. Courts will assess the value exchanged, the company's financial position, and any commercial justification, applying defences where appropriate. If successful, orders can restore assets or value to the company's estate, aiding fair distribution among creditors.