Section 238 Insolvency Act 1986: What Directors Need to Know

As a company approaches financial distress, directors step into a far more scrutinised environment. Section 238 of the Insolvency Act 1986 is one of the key statutory provisions that directors must keep firmly in mind. It allows an administrator or liquidator to challenge transactions at an undervalue, and in doing so, it can expose directors to significant risk if not properly managed.

This article sets out what Section 238 means from a director’s perspective, what triggers it, some ways to stay compliant, and what practical steps you should take to protect yourself and the company.

What Is a Transaction at an Undervalue? (Director’s Lens)

Under s238, a company is considered to have entered a transaction at an undervalue if it:

• Gives away assets, receiving no consideration at all, or
• Sells assets for significantly less than their true market value.

Any disposal of assets below market value in the lead‑up to insolvency exposes the transaction,  and potentially the director, to challenge.

From your perspective as a director, this means you must assume that every transaction during financial distress will be examined closely.

When Does Section 238 Apply?

Section 238 only becomes relevant once the company has entered Administration or Liquidation, however, transactions entered into long before insolvency occurs may still be caught if they fall within the “relevant time." The relevant time is:

• Two years before insolvency for connected parties
• Six months for unconnected parties

For directors, this means decisions made months, even years, before insolvency may later be scrutinised.

Why Section 238 Matters to Directors

s238 exists to protect creditors from losses caused by directors disposing of assets improperly during periods of doubtful solvency.

From a director’s standpoint, the risks include:

• Transactions being unwound
• Claims for repayment of benefits
• Adverse findings regarding your conduct
• Potential personal liability through related provisions (e.g., wrongful trading)

Courts and insolvency practitioners will closely examine your decision making, your documentation, and your rationale.

What Powers Does the Court Have Under Section 238?

If a liquidator or administrator establishes that a transaction was at an undervalue, the court may order:

• Return of property to the company,
• Repayment by recipients of any benefit,
• Restoration of the company’s position as though the transaction never happened,
• Imposition of obligations on guarantors, release of security, or re‑creation of obligations.

This can have major implications if you have already committed the company to new arrangements, transferred assets, or reorganised operations.

The Good Faith Defence and Directors' Responsibilities

A critical protection for directors is the statutory defence and the court will not make an order if satisfied that the company:

1. Acted in good faith,
2. Entered into the transaction for the purpose of carrying on its business, and
3. Had reasonable grounds to believe that the transaction would benefit the company.

For directors, this means two things are essential:

1. Clear commercial justification
2. Evidence

Be able to explain why the transaction made sense at the time is a critical component, as such, keeping robust records, board minutes, valuation reports, advice from professionals is key.

Lessons from Case Law (What Can Catch Directors Out)

In Re Fastfit Station, payments due to the insolvent company were diverted to a newco. Even though the company itself did not directly transact, the court treated the diversion as a company transaction because the directors facilitated it.
For directors, the key takeaway is that, if you direct or cause the company’s assets to be applied improperly, you may be treated as having caused the company to enter a transaction, even if formally it didn’t.

Practical Guidance for Directors

Internal materials provide consistent recommendations for directors operating in periods of financial uncertainty:

• Always Obtain Independent Valuations - Ideally RICS approved valuations before disposing of any asset.
• Preserve Cash and Assets When Solvency Is Doubtful
• Do not make selective payments or dispose of assets unless there is a clear creditor wide benefit
• Seek Advice Early
• Consult insolvency practitioners or legal advisors if liquidity is tightening, this not only strengthens decision‑making but evidences responsible conduct.
• Record Your Reasoning - this is often decisive in demonstrating “good faith.”
  Board minutes should document:

1. Why the transaction was necessary
2. How it benefits the company
3. What alternatives were considered

What Directors Should Avoid

Directors should be wary of:

• Transferring assets to connected parties without a formal valuation
• Selling assets below market value to raise quick cash
• “Phoenix-style” restructures without professional oversight
• Diverting income streams away from the company (as in Fastfit)
• Relying on informal or verbal agreements

Paying favoured creditors (may also trigger s239 preference claims)

Conclusion: Director Mindset and Best Practice

Section 238 is not designed to punish directors acting responsibly, it protects creditors against asset depletion and improper transactions when a company is sliding toward insolvency.

As a director, your protection lies in:

• Acting transparently,
• Making decisions for proper commercial reasons,
• Taking advice early,
• Documenting everything,
• Ensuring transactions reflect market value.

By following these principles, you significantly reduce your exposure to challenge under s238 and demonstrate that you have acted in the best interests of creditors as the company’s financial position deteriorated.