Creditor Must Show Undervalue to Prove Claim

22 April 2010

When people are burdened with debt, they will sometimes resort to underhand tactics to relieve themselves of the consequences. One of the most common strategies is for the debtor to dispose of an asset, which would otherwise be used to pay his or her debts, for less than its market value. In consequence, there is legislation to protect the position of the creditors, who are, unusually, described as ‘victims’ in the legislation.

In a recent case, the court had to decide whether the sale of a couple’s house had been undertaken at less than its market value. The couple was indebted to others as a result of a company dispute and the creditors had obtained judgment against them, but the debt remained unpaid.

The couple entered into a transaction to sell their house to a third party and to then lease it back from him. The house was worth £275,000 with vacant possession on the open market. It was sold for £210,000 and leased back for £500 per month on a 21-year lease, with no upward rent reviews and the lease was not terminable by the landlord unless the usual tenant’s covenants were not met. The effect of this was that the mortgage on the property of £160,000 was repaid and the vendors retained the balance.

The creditors argued that the transaction was undertaken at an undervalue and was entered into for the purpose of putting the debtors’ assets beyond their reach.

The argument turned on the true value of the transaction. The difference between the open market value of the property with vacant possession and its selling price was £65,000. Was that merely an undervalue or did it reflect, in effect, the premium a tenant would pay for a 21-year lease on the property under the terms of the lease?

The court concluded that the deal reflected commercial reality and was not one which was undertaken at an undervalue. The principal debtor stated that he wished to secure the roof over his family’s head and his actions had not been intended to prejudice the position of his creditors. He had clearly succeeded as regards the former, although he had, as a result, in fact prejudiced the position of his creditors. However, the transaction could not be set aside, because they had failed to demonstrate that the transaction undertaken was at an undervalue.

In this case, the fact that a formal valuation of the property had been carried out and was not disputed was helpful. If you find yourself in similar circumstances, it would be sensible to take advice to ensure, as far as possible, that the evidence exists to make it unlikely that any challenge to the arrangements would succeed.

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