Validation Orders, restructuring and COVID19

Authors – Simon Duncan, Senior Associate and Robert Paterson, Partner

When companies are under financial pressure or engaged in restructuring, until or unless a moratorium is in place there is always a risk that an unpaid creditor will present a winding-up petition to the Court.  If that happens, any disposition of the debtor company’s property from that date is void, pursuant to Section 127(1) of the Insolvency Act 1986.

As the hearing of winding up petitions has been adjourned until June 2020 because of the measures put in place to limit the spread of coronavirus, there will be many companies that may require a validation order to protect the recipients of payments whose services are vital for the continuity of their businesses. This is because the effect of Section 127 of the Insolvency Act 1986 has not been postponed and hundreds of winding up petitions have been presented and served before the hearings were adjourned until June 2020.

The company may not know of the petition until it is served.  Frequently, therefore, payments out of the company’s bank account may well have been made in the meantime.  These payments are dispositions and are prima facie void, unless the Court otherwise orders.

The application to Court is usually made by the company.  The principles upon which the Court will act are discussed in Express Electrical Distributors Ltd v Beavis [2016] 1 WLR 4783.  The facts are typical of what occurs when creditors are paid post presentation, but without any knowledge of the petition.

Edge paid £30,000 to Express Electrical in respect of goods supplied.  The payment was made on the 29^th May 2013, just a week after presentation of the winding-up petition on the 22^nd May. Note that the recipient of the payment brought the application for an order validating the payment, not the company. The application was lost at first instance and an appeal to the High Court was dismissed, hence this appeal to the Court of Appeal.

Whether the Court should exercise its discretion is determined in accordance with the following principles:

• The guiding principle of pari passu distribution among unsecured creditors should be respected.  If the effect of the proposed order is to give preference to one creditor at the expense of others, it will not be made, absent ‘special circumstances.’

• Payments required to key creditors/suppliers whose support is necessary to protect the business and therefore the wider interest of creditors, can be sanctioned.
• Transactions which will not diminish or dissipate the company’s asset position will usually be validated as will transactions that increase the value of those assets or preserve the value.
• Where the company and the creditors were unaware of the petition (as they often are before service and advertisement) and dispositions have been made in good faith in the ordinary course of business, this leans towards the grant of the order, but it must also be shown that the transactions benefited creditors generally.
• When deciding whether a payment made post-presentation to pay for goods purchased before presentation on terms that are cash on delivery, the Court looks at the benefit derived from that supply.  The Court also considers whether the payment will enable further supplies that allows the business to continue and earn revenue.
• The Court’s discretion can validate individual dispositions, or the general continuance of trading and the operation of the company bank account for this purpose.  This is more speculative and is likely to depend upon what the company’s plans are going forward.

Applying these principles, the Court of Appeal dismissed the appeal and the £30,000 was returned to the company, now in liquidation.  The applicant had not shown that the transaction was in the interests of the general body of creditors.

 

 

Typically, in the context of a restructuring or re-financing, the company will be unaware of the presentation of a petition.  If a winding up petition is presented, it will scupper the deal unless the directors of the company seek immediate advice about the prospects of getting a validation order.  This is because the company’s bank will see the advertisement and will inevitably freeze the account, which will render trading impossible without a validation order.