The Aveling Barford Case

An issue very closely related to the ability of a company to make a distribution is that of the propriety of transfers of assets between group companies (either between sister subsidiaries or affilates or directly to parent companies). Aveling Barford v Perion remains the seminal case on this area. Much has been written about the decision and, unfortunately, there are multiple interpretations of it. We have tried to distil the issues and set out some practical guidance for companies embarking on intra-group transfers and similar transactions which are likely to fall within the remit of this decidedly difficult area of law.

· If, immediately prior to the transfer, the transferor's net assets are equal to or less than the aggregate of the transferor's share capital and undistributable reserves (i.e. there is a zero balance or deficit on distributable reserves), the transfer must be in excess of the book value of the transferring asset by an amount to enable the zero balance to become positive or the shortfall to be eliminated UNLESS market value is less, in which case the transfer can take effect at market value.

· If, immediately prior to the transfer, net assets exceed the aggregate of share capital and undistributable reserves (i.e. there is a positive balance on distributable reserves) even by only a nominal amount (e.g. £1) then:

-	the transfer can take place at book value, as this would be balance sheet neutral
-	the transfer can take place at less than book value but only if, following the transfer, the net assets continue to exceed the aggregate of share capital and undistributable reserves (i.e. there continues to be a positive balance on distributable reserves)

However, there is a school of thought that, even where the transferor has a positive balance on its distributable reserves (i.e. where net assets exceed the aggregate of share capital and undistributable reserves), it must nevertheless have sufficient distributable reserves to cover the difference between the sale price and the market value or else the transfer will be an unlawful distribution as a matter of common law.

There is no judicial authority for this, but simply represents an interpretation of the Aveling Barford decision by certain leading Counsel.

Other leading Counsel do not share this view and take a more commercial approach, i.e. that there is no need for the transferor to have distributable reserves equal to the difference between book value and the higher market value; all that is needed is for the transferor post transfer to have a positive balance on distributable reserves (even if only £1).

Many practicioners align themselves with this approach. However, in the case of difficult or high value transactions or where a sale or listing is contemplated, the more conservative analysis referred to above should be considered.

· Transfers of assets at market value will never be an unlawful reduction of capital or an unlawful distribution, even where market value is less than book value. This is because directors cannot reasonably be expected to sell assets for more than their market value.

· An absolute gift up the corporate chain is a clear distribution and so must comply with Part VIII of the Companies Act. On the basis that the asset being distributed by way of gift is not cash, the distributing company's articles should be checked to ensure that the company has specific authority to make distributions in specie. If not, a special resolution will need to be passed. It is accepted that, in order to make distributions in specie, the distributing company only needs to have distributable reserves to cover the book value of the asset being distributed. It does not need reserves to cover the difference between book value and market value

There are a number of practical consequences of falling foul of these rules:

· The attempted transfer would be an unlawful reduction of capital, ultra vires and void and therefore not capable of shareholder ratification.

· It would also be constitute an unlawful distribution: As well as being ultra vires and void, there may possibly be an obligation on the recipient of the asset to repay the value of unlawful distribution.

· The directors of the transferor may be in breach of their fiduciary duties owed to the company.

Given the complexities of the Aveling Barford decision and the potentially severe consequences of contravening the unlawful distribution and return of capital rules, a number of practical steps should be taken and questions asked at the outset.

· Does the transferor have any creditors? Are they external creditors or other group companies? If the former, then maintenance of capital issues assume the utmost importance.

· Ensure that the accounts upon which the transferor is relying to effect the transfer (usually the last statutory accounts) are materially accurate; it may be that new interim accounts ought to be prepared in order to justify the transaction. This will be the case where the last accounts do not give a true and fair view of the assets and liabilities of the transferor. Have there been any significant developments in the business of the transferor since the last accounts date?

· Where the transferor receives non-cash consideration (e.g. the consideration is left outstanding on intercompany account), consider the following: (a) what is the value of the non-cash consideration?; (b) does it represent a realised profit?; and (c) does the transferor need to make a provision in its accounts, thereby affecting distributable reserves?

· If there is maintenance of capital concern (which will almost certainly be the case where the transferor has a deficit on distributable reserves and may be the case where the transfer takes place at less than market value), consider ways of restoring distributable reserves, e.g: a capital contribution being made from the parent or other group company to create a realised profit or taking advantage of the ability to treat an unrealised profit as a reaslised profit under Section 276 of the Companies Act.

· Ensure that the board minutes of the transferor document comprehensively the directors' reasoning.

· Check the objects clause of the transferor to ensure it can transfer at less than market value (assuming this is what is being proposed and it is acceptable on Aveling Barford principles).

· Consider securing ratification from the transferor's shareholder/s to protect the transferor's directors from possible claims for breach of fiduciary duty.

· It is not good enough to say "we always do intra-group transfers at book value". The consequences of falling foul of the return of capital and distribution rules are severe.

· Go to Counsel in respect of difficult or high-value transactions or where a listing or sale of the transferor company (or group of which it forms part) is in contemplation.

Finally, always remember that, even if the transfer in question does not fall foul of Aveling Barford principles, you should always consider whether the directors of the transferring company are acting in the best commercial interests of the company in effecting the transaction.

For more information about this, please contact Glafkos Tombolis on 020 7203 5219.