When will a sale of assets at undervalue be regarded as ultra vires?

01/07/2009

The Court of Appeal recently had to determine in what circumstances a sale of assets at an undervalue by a company at the request of a shareholder should be held ultra vires on the ground that the sale was an unlawful distribution.

The facts were that Progress Property ("Progress") had entered a sale and purchase agreement with Moorgarth Group ("Moorgarth") for the sale of shares in one of Progress' subsidiaries, YMS Properties (no 1) Limited ("Y"). The purchase price had been calculated on the basis of an open market value of Y, from which was deducted, amongst other things, a sum for a repairing liability. This deduction was made in the belief that Progress had given an indemnity under which liability would ultimately fall on Progress. As part of the transaction that liability was to be released. In fact there was no indemnity, and hence no justification for the deduction from the sale price. Progress sought the return of the shares or compensation. At the time of the sale both Progress and Moorgarth were under the control of the same holding company, and the sale was negotiated by a Mr Moore, who was a director of both Progress and Moorgarth, and a close colleague of the Chairman of that holding company. There was no dispute that Mr Moore genuinely believed the share price was their market value. Nor was there any intention to commit a fraud on the creditors of Progress.

The claim was not based on what are standard ground of ultra vires, namely that the transaction was outside the powers set out in Progress' Memorandum of Association, but was based on Common Law. The Court of Appeal restated the general rule at Common Law for the protection of creditors, namely that a distribution of a company's assets to a shareholder, except in accordance with specific statutory procedures (such as winding up) is a return of capital and is unlawful and ultra vires that company.

However the Court of Appeal held that this rule did not apply in this case simply because, through Mr Moore's connection to the holding company, the shares were sold at an undervalue. Nor was it unlawful because Mr Moore should have appreciated that the sale of the shares was at an undervalue. To found a cause of action on this ground the sale must not have been genuine on the basis that it was known and intended to be a sale at an undervalue. This was not the case here. Progress accepted that the sale was entered into in the belief by Mr Moore that the agreed price was the market value. There was therefore no knowledge or intention for the shares to be disposed of at an undervalue, and no reason to doubt the genuineness of the transaction despite a misunderstanding on the calculation of the basis of the valuation of the properties. The Court held that the sale was an intra vires sale of shares for a proper purpose, even if at an undervalue (this was assumed in the Court below).

Back to news archive