Solvency confirmations and transactions at undervalue: key considerations for companies and lenders in respect of connected party transactions

Connected party transactions - transactions entered into between a company and persons or entities with a close relationship to it (such as directors, shareholders or group companies) - attract heightened scrutiny under the Insolvency Act 1986 (the Act). This is because connected parties are not independent of the transferring company and are often in a position to influence its decision‑making, giving rise to an increased risk that assets are transferred on non‑arm’s‑length terms.

The remedies available to the court in respect of a transaction at an undervalue (TUV) – meaning a transaction in which the transferor receives consideration of significantly less value than the consideration it provides – are restorative and include the power to reverse the transfer. This is a particular risk for a lender who has financed the transferee on the basis of its continued ownership of the asset. For that reason, lenders are particularly concerned about transactions which involve asset transfers between connected parties.

In this context solvency statements made by the directors of the transferring company at the time of entry into the transaction have two purposes: (1) to minimise the risk of a transaction being characterised as a TUV, or, where that cannot be avoided, (2) to support reliance on the statutory defence under section 238 of the Act.

This article highlights the key legal and practical issues to consider when preparing solvency confirmations in such circumstances. It examines the distinction between cash flow and balance sheet solvency, the treatment of contingent liabilities, and how to establish a documentary trail to support any future claim that the statutory defence under section 238(5) of the Act has arisen.

Cash flow vs balance sheet solvency

Section 123 of the Act contains two independent tests that establish that a company is unable to pay its debts (despite its name, the Act avoids using the term “insolvency”):

Cash‑flow test – i.e. whether the company can pay its debts as they fall due.
Balance‑sheet test – i.e. whether the company’s assets exceed its liabilities, taking account of its contingent and prospective liabilities.

A statement of solvency given by the directors in most cases will need to consider both cash-flow and balance-sheet solvency.

In practice, cash‑flow solvency is often more straightforward to assess. Many trading companies have stable revenue streams and no immediate threat to meeting their obligations. However, cash flow insolvency can be problematic for seasonal businesses (such as retail) which are broadly able to meet their liabilities over the course of a year but rely on busy peaks (e.g. around Black Friday, Christmas and January sales) to sustain the business through quieter periods.

Assessing balance‑sheet solvency, however, can be difficult where a company has significant contingent liabilities, such as guarantees given in respect of group banking facilities. These contingent liabilities must be factored into the solvency assessment, even where the company is comfortable it can meet its liabilities (because the guaranteed debt is being serviced, the risk of crystallisation is low and there is no evidence of imminent covenant breach or default).

Practical approach

When assessing balance‑sheet solvency, contingent liabilities must be included but their impact will depend on the likelihood of crystallisation. If there is no reasonable prospect of a demand under the guarantee, the liability may be weighted less heavily.

Directors should examine the anticipated net asset position of each relevant group entity post‑completion to determine whether a balance‑sheet solvency confirmation can be given. This analysis should be undertaken carefully (with the assistance of the company’s accountants), and the results clearly recorded in corporate authorisations. These assessments play a central role in determining whether a connected party transaction can later be challenged as a TUV under section 238 of the Act.

TUV and section 238 of the Act

Section 238 of the Act allows an insolvency officeholder to challenge a transaction entered into for no consideration or significantly less than market value, if the company later enters administration or liquidation within two years of the transaction.

For unconnected parties, the company must have been unable to pay its debts at the time of the transaction or as a result. In connected party transactions, there is a presumption of insolvency, unless the contrary can be shown. For this reason, contemporaneous evidence of the company’s solvency - assessed by reference to both the cash-flow and balance-sheet tests - is critical to fending off any potential challenge if the company were to later enter an insolvency process.

Additionally, evidence as to the value of the asset being transferred will be key to the assessment as to whether there has been any undervalue in the first place. Evidence should be produced (with input from third party advisers, where appropriate) and the rationale for attributing the relevant value should be documented in the corporate authorisations.

Statutory defence under section 238(5)

Where a transaction is entered into for no or insufficient consideration, and the transferring company has entered liquidation or administration within a relevant period following that transfer, it may still be possible to rely on the statutory defence to liability in section 238(5) of the Act. The defence will apply where the company:

Entered the transaction in good faith
For the purpose of carrying on its business
Believed the transaction would benefit the company

If these conditions are met, section 238(5) operates as a complete defence to liability. However, it is important to establish a clear benefit to the transferor entity itself, not merely the wider group. Where the benefit accrues only at group level, the defence will not apply (Health and Home Ltd v Elite Property Holdings Ltd [2025] EWHC 839 (Ch)).

Practical approach

Wherever possible, to minimise the risk of challenge, corporate approvals should explicitly articulate:

That the transferor is solvent and will remain so as a result of the transaction (as relevant)
The value attributed to the relevant asset, supported by valuation evidence to demonstrate that market value has been paid (if appropriate)
The commercial rationale for the transaction
The specific benefit to the transferor of entering into the transaction

This will assist in demonstrating that either (a) the transaction is not a TUV or (b) that the company was acting in good faith and may support an asserted defence to liability under section 238(5) of the Act.

Conclusion

Connected‑party transactions require clear evidence of commercial rationale, value and solvency at the time of the transaction. The key principles emerging from recent case law and market practice include:

Differentiate clearly between cash‑flow and balance‑sheet solvency and address how contingent liabilities should be assessed in context.
Identify at an early stage whether a transaction is capable of challenge under section 238, by reference to solvency and the value given or received.
Document the specific benefit to the transferor entity, not just to the wider group.
Where there is a risk that a transaction is likely to be treated as a TUV, ensure board minutes, transactional documents and authorisations articulate the business purpose, good faith, and anticipated benefit sufficiently to support a future defence under section 238(5).

By addressing in advance both the threshold question of whether section 238 is engaged and, if it is, the availability of the statutory defence, directors can significantly reduce the risk of any future challenge.