The allure of a "leveraged buyout"—where a buyer uses the target company’s own assets to pay the seller—has long been a staple of corporate finance. However, a recent judgement from the High Court serves as a stark warning to business owners: if the company’s own cash is used to fund your exit and the business subsequently collapses, then you may be forced to pay back every penny. This case clarifies that directors cannot hide behind professional advice or "goodwill" valuations when the financial realities of a transaction strip a company of the very liquidity it needs to survive.
Background:
A & D Joinery Ltd. was incorporated by Mr. Lowe and his brother-in-law, Mr. Smith, on 17 June 1993, as a continuation of their business, which was originally established in 1978 when Mr. Smith was eighteen. Mr. Lowe subsequently retired through ill-health and, from 14 August 2012 until 27 July 2021, Mr. Smith was the sole director and held all four of the £1 A ordinary shares issued, and two of the £1 B ordinary shares, with his wife, Anne, holding the other two.
In July 2021, Mr. Smith, as sole director and majority shareholder, agreed to sell the company to a venture vehicle for approximately £748,270. However, although the business was consistently profitable and "cash-rich" at the point of sale, the structure of the deal became its undoing. The buyer, a shell company with no assets of its own, utilised a "Letter of Direction" to ensure that the purchase price was paid entirely from the joinery company’s cash reserves.
Crucially, this cash included a £250,000 government-backed CBILS loan from the pandemic era, which was legally restricted to "supporting business activity" and not intended to fund shareholder exits. To balance the books, the buyer entered into an interest-free loan agreement promising to repay the company for the cash it had extracted. The seller received the bulk of the funds in late July and August 2024. Within two weeks of the new ownership taking over, the company—depleted of the very cash reserves which had enabled it to pay suppliers and staff—was unable to trade. By November, it was in administration with massive debts, leading the administrators to assign the legal claim to a litigation funder.
Decision:
The Judge Prentis ruled that the payments made to the seller constituted a "Transaction at an Undervalue" under Section 238 of the Insolvency Act 1986. The Court found that the company had provided a massive amount of cash and received a near "worthless" consideration in return. While the seller argued that the buyer’s promise to repay the loan was a valid asset, the Judge applied the "reality principle" established in Phillips v Brewin Dolphin. This principle dictates that courts should not be blind to empty shells that became insolvent almost immediately after acquiring an asset. In other words, its promise to repay was effectively worthless at the time of the transaction.
The Court also addressed the "Insolvency Test" under Sections 123 and 240. Because the seller was a "connected person" (a director), the law presumed the company to be insolvent unless he could prove otherwise. He failed to do so. The Judge noted that extracting over £700,000 in four days was so catastrophic that the company became "cashflow insolvent" instantly, losing its ability to pay trade creditors. Furthermore, the Judge found the seller had breached his fiduciary duties under Sections 171-175 of the Companies Act 2006. Even though the seller relied on solicitors who assured him the deal was "fine," the Court held that the risk to the company was so obvious that he could not be excused from liability.
Implications:
For business owners planning an exit, the implications of this judgement are profound and emphasise that a successful sale is not merely a matter of price, but also about the source of the funds. If you are selling your shares and the buyer suggests using the company’s own balance sheet to pay you, then you are stepping into a legal minefield. If the company fails within two years of that payment, a liquidator can "claw back" the purchase price from you personally to satisfy creditors, effectively leaving you without a business or money.
Parties must understand that "goodwill" is not a substitute for cash. In this case, the defence argued that the company was solvent because its brand remained valuable. However, the Judge was clear: brand value cannot pay a VAT bill or a supplier on "stop" credit. Moreover, professional indemnity does not provide an impenetrable shield. If a transaction is "extraordinary" from a commercial standpoint—such as taking the equivalent of 19 years' worth of dividends out of a business in a single week—then the Court expects a director to apply their own common sense. Relying on a lawyer's ‘say-so’ will not protect you if the transaction serves your private interests at the expense of the company’s survival. Before signing off on a leveraged exit, a director should ensure a rigorous, independent solvency analysis is conducted to protect their retirement funds from future litigation.
