Allyson Colby assesses the court’s balancing exercise when deciding applications for validation orders
Key points
- Transactions entered into by companies that have a winding up petition hanging over them, and are then wound up, are void
- Counterparties can ask the court for a validating order before or after completing a transaction
- Buyers would be well-advised to check a company’s status before parting with cash
Section 127 of the Insolvency Act 1986 was enacted to prevent directors of a company that is about to go into liquidation from dissipating its assets, so that they can be distributed rateably among its creditors. It provides that, in a winding up by the court, any disposition of the company’s property after the commencement of the winding up is void, unless the court otherwise orders. The commencement of the winding up is the date on which a petition to wind up the company is presented to the court.
The parties to a transaction may be aware of a winding up petition, but may be unable to make an application for a validation order before completion if time is of the essence. In other cases, the beneficial character of the transaction may be so obvious that there is no real prospect of a liquidator seeking to set it aside. However, a disponee who enters into a transaction in the vulnerable period between a winding up petition and order without first obtaining a validating order runs the risk that the court could subsequently decline to validate it.
Retrospective application
In Wilson (as liquidator of 375 Live Ltd) and another v SMC Properties Ltd and others [2015] EWHC 870 (Ch); [2015] PLSCS 119, the court was asked to validate a sale by a company that had sold a property to a buyer who agreed to pay £850,000 for it and was prepared to complete quickly. Previous offers for the property, in the sums of £1.3m and £1.1m respectively, had come to nothing and the seller was under pressure from a creditor holding a fixed charge over the property. The loan expired in April 2014 and the creditor was threatening to sell the property as mortgagee in possession to repay the debt.
The company exchanged contracts to sell the property to the buyer on 6 March 2014, completed the sale on 4 April 2014, and went into liquidation soon afterwards. However, because the disposition was made after the presentation of a winding up petition on 26 February 2014, the transfer was void. The buyer first realised that there was a problem when a member of the liquidator’s team visited the property a couple of months later and found it occupied by builders, who explained that there had been a change of ownership. Shortly afterwards, the liquidator informed the buyer that the seller had gone into liquidation and that the sale was void.
Balancing exercise
The judge explained that the court must carry out a balancing exercise when considering applications for validation orders, weighing the interests of all the creditors against the transaction under scrutiny. Each case will be decided on its own facts and the authorities to date suggest that, where a disponee applies for a validating order retrospectively, the court is more likely to validate the disposition if it was made in the ordinary course of business, in good faith, in ignorance of the fact that a winding up petition has been presented.
If an asset is sold at a significant undervalue, the court is unlikely to find that the transaction was made in good faith. Furthermore, good faith alone is not enough; it must be weighed against the consequences of validating the transaction and the extent to which validation would prefer one or more unsecured creditors above others. So a disponee is unlikely to escape the effects of section 127 if either an asset was sold at a substantial undervalue and every creditor receives an equal share of the proceeds, or if full value was paid for the asset but one or more creditors are preferred.
The judge noted that the winding up petition was not advertised until 3 April 2014 and accepted that the buyer did not know about it before completion of the transaction on 4 April. The transaction was made in good faith, at arm’s length, and did not favour a pre-liquidation creditor. In addition, it took place in the context of a tight timeframe imposed by a concerned and pressing secured creditor. The company believed that the price was the best that was obtainable in the circumstances and the buyer believed that the purchase price reflected the full, or near full, value of the property.
Undervalue
However, the liquidator claimed that the property was worth £1.3m and was sold at a significant undervalue. The judge disagreed. He noted that the property required considerable work and that the company’s previous attempts to sell the property were unsuccessful. The judge decided that the buyer had paid no more than 5-6% less than the open-market value of the property and this took no account of the fact that the property had had to be sold quickly. If the fixed charge holder had sold the property as mortgagee in possession, the evidence suggested that it would not have realised more than £850,000. In fact, it may have had to sell for less. Consequently, the judge concluded that the general body of creditors had not suffered significantly, or at all.
Furthermore, if the matter had come before the court before the transaction had been completed, and the court had been appraised of all the facts, the judge considered that the court would have made a validation order. Therefore, having weighed the interests of the creditors in general against the transaction under scrutiny, the judge decided to exercise his discretion in the buyer’s favour.
Allyson Colby is a property law consultant
