The Insolvency and Companies Court of the High Court has held the payment of money from a Bolton-based company to a selling shareholder was an undervalued transaction and a breach of the director’s duties.
ICC Judge Prentis handed down judgment in the case of Manolete Partners Plc v David Howard Smith this week (06 May).
Neil Kelly and Ruby Klarzynska of Sheffield’s MD Law acted for Manolete which had purchased claims from the administrators of David Smith’s firm Bolton-based A&D Joinery Ltd.
The 30-year-old window and door producer and fitter A&D Joinery Ltd had traded solidly and built up cash reserves and in late 2020 / early 2021, David Smith was approached to sell the company. It was seen by Smith as a good opportunity to exit the business and receive a return on his investment as the potential buyer had similar businesses and plans to increase sales and profit.
A sale price was agreed and a special purpose vehicle holding company called A&D Ventures Ltd (Ventures) was incorporated by the purchaser to buy Mr Smith’s shares. On or shortly after completion, £748,720 was paid to Mr Smith with the payment coming almost entirely from the Company’s own money and £100,000 of ‘new money’ being provided by Ventures.
The payment of the purchase price (or most of it) to Mr Smith was treated as a loan by A&D Joinery to Ventures, although no written loan agreement was found.
Only 8 weeks after paying Mr Smith, it had run out of cash and had to cease trading. A month later it was in administration and Ventures went into liquidation too.
ICCJ Prentis held ‘on any analysis’ the loan debt owed by Ventures was worth significantly less than the monies paid to Mr Smith as the loan could not have been repaid in the demand or even in the foreseeable future and there was no provision for interest on the loan.
The Court found the payments to Mr Smith had caused A&D Joinery to become insolvent on both a cashflow and balance sheet basis. In doing so ICCJ Prentis expressly rejected the proposition that the transaction was balance sheet neutral – the loan to Ventures could not be included at its full face value: “it was never an asset which could be converted into cash; it was also always severely compromised”.
Having found the payments to Mr Smith were worth less than the value of the loan to Ventures and they had caused the company to become insolvent, the Court determined that they were transactions at an undervalue in breach of section 238 Insolvency Act 1986 and would have to be repaid by Mr Smith.
Mr Smith was also found to have breached his duties as a director with the Court finding no evidence he had considered whether, and how, the company would be able to keep trading after it had paid him or that he had paid any regard to the company’s creditors and how they would be paid.
Neil Kelly, partner at MD Law, said: “Using a company’s own money to fund the purchase of its own shares is not unusual. Prior to the Companies Act 2006 such transactions were prohibited as being unlawful financial assistance, unless the ‘whitewash’ procedure was followed. The 2006 Act ended the prohibition on financial assistance and whitewashing, which was seen as an unnecessarily burdensome and restrictive regulatory hurdle.
“In many or most cases, the target company will continue successfully under its new ownership but the decision serves as a warning to parties selling shares and their advisors, that they need to look beyond the immediate future and take professional advice before entering transactions where some or all of the purchase price is being funded by the company they are selling.
“Particular care will be required to ensure both that the company is not going to become insolvent because of the transaction (taking into account that the transaction will probably not be balance sheet neutral) and that the company is going to have sufficient cash left to fund its operations for the foreseeable future. Decisions should be documented and supported by detailed evidence.”
The specialist and experienced corporate and insolvency transactional teams at MD Law can assist with the legal complexities associated with such funding structures.
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