Goodwill Sold For A Pound
Does company goodwill have value? If not, what is it doing sitting on balance sheets?
Accountants are the witch doctors of the modern world and willing to turn their hands to any kind of magic.
Was Lord Justice Harman thinking about company goodwill when he made that statement? How often do you look at a balance sheet with £20,000 goodwill in it and think, what is that?
On 31 December 2014 Dormco Sica Limited had company goodwill sitting pretty and in all its glory right at the top of its balance sheet at £2,955,000. The net shareholders funds was however running around 10% of that figure at £274,480 because it had around £4.5 million of creditors. Scroll forward 12 months and goodwill had taken a worrying turn, shown at £0 and shareholders funds had also dropped like a stone but right into the deep-sea zone deficit of (£2,585,724).
So how did … the giant squid … eat up close to £2.9 million inside of 12 months?
Enter the world of Dormo Sica Limited (“DSL”) which has been placed into Compulsory Liquidation. The litigation case that arose thereafter of Dormco Sica Ltd & Ors v SBL Carston Ltd  EWHC 3209 (Ch) was a Section 423 of the Insolvency Act 1986 matter, involving consideration of transactions defrauding creditors.
When Insolvency And Company Goodwill Collided
On 6 February 2015 DSL’s trade or business was sold to SBL Carston Ltd (“SBL”) for £141,201 and an accountancy group in Germany purchased 40% of the holding company (called Carston Holdings Ltd) from Mr and Mrs Munn and Mr Rees for around £2.3 million initial consideration with the prospect of a further c.£0.5 million based on performance. And yet the goodwill of DSL was sold by DSL to SBL for £1.
However, DSL was left with a substantial residual liability owing to a connected company Dormco Candco Limited (“Candoc”) in the sum of £1.8 million. The problem particularly appears to have sprouted when Cando went into Liquidation. Candco’s Statement of Affairs signed by a Liquidator shows £3,883,427.97 owing to HMRC.
Judge Jones said:
I accept as a fact that he controlled Candco before its liquidation, although as a director he would have had to act in the paramount interests of its creditors for any period whilst Candco was or was likely to be insolvent and that would have required recovery of the debts owed to it. It is also a fact that he has not provided SICA with funds to repay the debt owed to Candco. The reason given was that Candco’s liabilities increased significantly as a result of HMRC assessments made during its liquidation making payment in full by Candco to its major creditor impossible. The difficulty for that evidence as an explanation for the absence of repayment by SICA is that the £1.8 million liability of SICA to Candco had to be paid whether or not Candco’s liability to HMRC increased to a larger amount. These are all problems for his claimed belief to be addressed further when deciding whether there was a Prohibited Purpose.
The Judgment Summary
The Judge was concerned in this case that we might get lost meandering through the 180 paragraph judgment so he fleshed out a neat little summary and guess what it was called; “Judgment Summary“. Here’s what it said:
I cannot accept that the Goodwill was only worth £1.00. The defence seeking to justify that consideration by distinguishing between the Goodwill sold and the personal goodwill of or attributable to Mr Munn and Mr Rees has to be rejected. The reasons include the facts that: there is no reference to this distinction in the contemporaneous documents including the 6 February 2015 contracts; the accounts record that SICA had purchased goodwill from two businesses in 2013 for over £3 million; and the factual evidence does not support the existence of personal goodwill either in terms of ownership belonging to Mr Munn and Mr Rees or in terms which would produce the result that the value of the Goodwill sold should be reduced to £1.00 because of the consideration needed to be paid to ensure they remained with the Business.
That being so, the creditors of SICA have lost out because SICA did not receive the money it ought to have received for the purchase of its Goodwill. Instead, Mr and Mrs Munn have benefited by the amount of the consideration paid for their CHL shares which is attributable to the fact that SBL only paid £1.00 for the Goodwill. Whether viewed from the perspective of the contract for the sale of the business (including the Goodwill) between SICA and SBL only or from the perspective of the overall arrangement, the wide discretionary power conferred by ss.423-425 of the Insolvency Act 1986 enables the Court to order Mr and Mrs Munn to pay to SICA the amount of that benefit. It is right to make that order.
The Last Balance Sheet of Dormo Sica Ltd
The precise series of arrangements whereby DSL’s assets (including its company goodwill) were transferred to a connected company are neither here nor there, except for the net result they created. Zoom in on the last balance sheet of DSL for the year ended 31 December 2015 (“the 2015 Accounts”) and what sprouts before your very eyes is a balance sheet that looks a little blank in spots.
To the trained eye who has seen it time and again, it however sits right at home with a company whose assets have been sold. The lugubrious element however is the transformation from solvency into insolvency.
Normally, when you look at the bottom of a balance sheet and you see a positive-looking number you assume all must be shipshape. Not so here. Instead of the bottom number being the shareholder funds, in this case, it is something else. The net assets figure however in fact looks a touch worrying at c.(£2.5million).
DSL sold its assets to SBL as part of the sale of an accountancy business and Insolvency and Companies Court Judge Jones summarised matters as follows:
On 30 October 2017 the Court ordered that SICA should be compulsorily wound up. From the perspective of its joint liquidators the sale of the Business was a transaction at an undervalue designed for the purpose of putting assets beyond the reach of SICA’s creditors. In particular, SBL had paid a mere £1.00 for the goodwill purchased (“the Goodwill”) when it was worth substantially more than £2 million. That was because, they asserted, the true value of the Business had been included in the share purchase price paid to Mr and Mrs Munn and Mr Rees, an initial consideration of circa £2.3 million, potentially increasing to circa £2.8 million. In 2019 the liquidators started proceedings against SBL relying on section 423 of the Insolvency Act 1986 (“s.423”). That required them to prove that its purchase of the Goodwill was for a consideration significantly less than its value and for the purpose (“the Prohibited Purpose”) of placing that asset and value beyond the reach of a person who is making, or may at some time make, a claim against it or for the purpose of otherwise prejudicing the interests of such a person in relation to the claim which they are making or may make.
On 24 September 2021 SBL accepted SICA’s Part 36 offer made on 27 July 2021 whereby it would pay £2,650,000 in settlement of SICA’s claim. That left the Part 20 claim by SBL against Mr and Mrs Munn for this trial.
SBL said that it was entitled to claim against Mr and Mrs Munn.
The experts jointly agreed that goodwill was worth £2.75 million and as a result, the Court held there had been a transaction at an undervalue and it also found that there had been a breach of fiduciary duty by Mr Munn.
The Court rejected the suggestion from Mr Mumm that the goodwill was personal to him as opposed to DSL.
The Prohibited Purpose
For the purpose of Section 423 of the Insolvency Act 1986, a prohibited purpose has to be shown and the Court here found one. The effect of the agreements that were entered into culminated in creditors going unpaid in DSL because of the sale of goodwill for £1 goodwill, notwithstanding a sumptuous sum going to Mr and Mrs Munn:
A problem with that evidence and case is that if the purpose was only to ensure that ETL obtained a 40% stake in the Business, it would have been unnecessary to hive SICA’s assets across to SBL. ETL could have purchased CHL’s shares with CHL remaining the parent of SICA. It does not explain the purpose behind the hive across to SBL. In addition, there is the difficulty of the finding that the negotiations for and the terms of the Asset Sale Agreement together with the Share Purchase Agreement did not address and were not for the purpose of securing personal goodwill.
However, the fundamental problem for that evidence and defence is the finding that the Agreements effected the Arrangement, namely to achieve payment of ETL’s funds to Mr and Mrs Munn and Mr Rees and not to SICA (see paragraph 124 above). Mr Munn and Mr Rees and, therefore SICA, will have known that the more that was paid for their shares, the less would be available for SICA to pay its creditors. The fact that the sale of the Goodwill was at an undervalue leads to the inevitable conclusion that the or at least a purpose of the Arrangement and the valuation of the Goodwill at £1.00 in the Asset Sale Agreement was to achieve a higher price for the sale of CHL’s shares than would otherwise have been agreed if more was paid for the Goodwill. SICA through Mr Munn and Mr Rees knew that by agreeing to the consideration of £1.00 for the Goodwill, an undervalue, its true value was put beyond the reach of its creditors.
The findings of fact concerning financial knowledge lead to the conclusion that all parties appreciated that the Asset Sale Agreement left SICA not only without the Business to provide future income but also without the value of its intangible assets for the purpose of paying its creditors, in particular the long terms creditors. It being a subjective test for SICA, it does not matter what the purpose of ETL was. However, the findings of fact concerning its knowledge supports my conclusion (see paragraphs 71-74 above), namely, that SICA had a Prohibited Purpose. The purpose of putting the Goodwill and its realisable value out of the reach of persons who may at some time make a claim. I have to reject Mr Munn’s evidence of a belief that the £1.00 represented the value of the Goodwill without the personal goodwill of himself and Mr Rees when plainly it did not.
That leaves his evidence and case that he believed SICA’s creditors would be paid by SICA. He and SICA cannot have held that belief when the Arrangement and the Asset Sale Agreement resulted in the reduction in the value of goodwill/customer relations from circa £3-4 million in the balance sheet to £1.00 with its obvious impact upon SICA’s financial position in particular including its long term liabilities as established by the findings of fact. Nor can he claim that SICA did not have the Prohibited Purpose because he intended to provide funds to SICA in the future. Not only did he not do so but the only reason for considering doing so was because the Arrangement and the Agreements including the Asset Sale Agreement were designed to leave SICA’s creditors as victims by putting the true value of the Goodwill into SBL and beyond the reach of its creditors. That was one of their purposes even if he anticipated curing the position later.
In a document filed after the close of submissions, Mr Munn asserts that one of the dominant purposes of the structure of the Agreements was to achieve taxation benefits and that the tax saved was £1.339 million. This did not feature during the trial. An obvious response would have been that the test is not “dominant purpose” (see paragraph 116c(ii) above). In addition, it might have been observed that this case supports the submission that the Agreements should be considered as a whole and of the existence of the Arrangement. However, the issue here is whether SICA had a Prohibited Purpose and it is plain based upon the facts and for the reasons set out above that it did.
In those circumstances I do not consider it necessary to address the case and submission that SBL can rely upon a history of Mr Munn’s failing to disclose full facts and matters and leaving companies insolvent and, HMRC in particular unpaid. The case that there was a Prohibited Purpose for the Arrangement and the Asset Sale Agreement is established by the facts of this case.
Oliver Elliot Comment: How Did Company Goodwill Vanish From A Balance Sheet?
The Court here noted that a company’s most material asset had been hoovered up from its balance sheet and sold off for £1. However, assets that are fundamental to a business such as goodwill in the case of accountancy, cannot usually in isolation be sold off for such sums as £1, either from a tax point of view or from the vantage point of insolvency. One way to avoid this sort of potential problem is to obtain an independent valuation from a relevant expert when disposing of all material business assets. This might not only make your creditors happier that you had done things right but HMRC as well.
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