REUTERS | Vasily Fedosenko

Retrospective validation in insolvency context just got more difficult

Conferences on insolvency issues might seem rather dry but are often enlivened by discussions of how to tell when a company is on the brink of insolvency. Ostentatious headquarters and the quality of the directors’ limousines are often cited. However, there is a danger in dealing (even routinely) with companies in this position that is posed by section 127 of the Insolvency Act 1986 (IA 1986). This provides that in a winding up by the court, any disposition of the company’s property made after commencement of winding up is void.

Further, IA 1986 provides that once a winding up order is made, the winding up is taken to have commenced from the date of presentation of the petition. So, once the winding up petition is presented, then trading by the company and any payments received from it are at risk.

This was the issue in Express Electrical Distributors Ltd v Beavis and others, which was decided by the Court of Appeal on 19 July 2016.

Express Electrical Distributors Ltd v Beavis and others

This case concerned a payment received from a company after a winding up petition was presented by another creditor but before it was advertised and before a winding up order was subsequently made.

The payment’s recipient sought to validate this under section 127 and it was accepted that it did not know about the petition until it was advertised. However, the company’s liquidators sought repayment. The issue was whether validation of the payment should be ordered. (I commented on validation orders in my post last year on Wilson and Sharp Investments Ltd v Harbour View Developments Ltd.)

Validation orders can be sought either prospectively or retrospectively. Sometimes a company may dispute the debt that has led to the winding up petition and contend that it is solvent so as to enable it to continue to trade. In other cases (as here), the court may be asked to validate a past transaction. The court in Express v Beavis decided that the test for making an order was whether the transaction was one that could properly be regarded as being for the benefit of the general body of creditors. Making such an order would involve departing from the application of the pari passu principle, which requires that all unsecured creditors should be treated equally in any liquidation. In other words, the validated transaction is given precedence over the general body of creditors.

The criteria for an order

At first instance, the court found that the company had made the payment and received goods so as to carry on its business generally in the hope that its position might improve, rather than to sell the business as a going concern. On this basis, the court concluded that the purpose of the payment was to retain the possibility of future supplies for the company. This could not be said to be in the interest of the general body of creditors.

However, in Re Gray’s Inn Construction Company Ltd [1980] 1 WLR 711, the court had said that a disposition made in good faith when the parties were unaware that the petition had been presented may “normally” be validated by the court.

The Court of Appeal in Express v Beavis held that this was too wide a proposition and that a validation order should only be made where there were special circumstances to show that the disposition was for the benefit of the general body of unsecured creditors.

So where does this take us?

Obviously caution should always be exercised when dealing with a company where insolvency is suspected, whether by way of an irregular payment pattern or otherwise. Given that Express v Beavis indicates that routine transactions may not be validated, even where the recipient does not know that the petition has been presented, it is important to carry out regular searches into the solvency of such a company. For example:

  • A search of the companies register at Companies House will show whether the company is already the subject of some insolvency procedure, including whether a winding up order has been made against it. Checking for presented winding up petitions can be done by phone or in person at the Central Registry of Winding Up Petitions, though there will be a delay of three to four days if the winding up petition was issued other than at the High Court (so this information may not be completely up-to-date).
  • A presented winding up petition must be advertised in The London Gazette so it is worth doing a search of The Gazette online although, as Express v Beavis illustrates, there is a delay between presentation of the petition and publication of the advertisement.

To obtain a validation order the recipient will need to show that it was in the interest of the unsecured creditors generally for the company’s business to be carried on and that this can only be achieved by paying for goods already supplied. The sale of an asset at full market value after the presentation should not present a problem as to dissipation of the company’s assets as it does not reduce their value.

In Express v Beavis, payment had been made earlier than was usually the case and in advance of the contractual obligation. The court said that this could have indicated an attempt to prefer the recipient over other creditors. Contracting parties receiving payments in these circumstances can, at the very least, expect the details of any transactions to be closely scrutinised by a liquidator subsequently appointed.

Most construction contracts (such as the JCT contracts) permit termination only on the making of a winding up order. However, under clauses 8.5.2 and 8.10.2, the contractor must notify the employer (and vice versa) if either becomes the subject of any proceedings relating to insolvency procedures. Therefore, consideration may need to be given as to whether suspension of obligations upon presentation of a petition should be provided for.

Herbert Smith Freehills LLP Michael Mendelblat Julie Farley

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