Section 127 of the Insolvency Act 1986 (“IA 1986”) applies where a company is wound up by the court and has disposed of any of its property in the period between the time of presentation of the winding up petition and the date of the order (the “Relevant Period”). In that case, the recipient is at risk of having to restore to the company what it has received, unless the court orders otherwise. This provision also voids any transfer of shares or alteration of the company’s members made in the Relevant Period.
These transfers are known as void dispositions and can result in what may seem a harsh outcome as payments received honestly and in the ordinary course of business may still be void dispositions that the court will not validate. Re Changtel Solutions UK Ltd [2022] EWHC 694 (Ch) confirms that an absence of knowledge of the petition does not impact the operation of section 127, therefore, arguments of good faith and lack of knowledge of the petition are not relevant considerations by the court when deciding whether or not to validate a transaction. Re Changtel also considered the availability of a ‘change of position’ defence and ultimately found that the defence is subject to the same restrictions that apply when the Court considers the validation of transactions (see ‘Validating Dispositions’ below).
Why?
The reason for this rule is to preserve the company’s assets so that they can be distributed by the liquidator amongst the company’s creditors in accordance with the statutory insolvency regime. This may seem unjust as an innocent party could have to remit money that was paid in exchange for legitimate services or goods, but in reality, this law is in place to reflect the ‘pari passu’ principle of insolvency law. A creditor who is unsuccessful in obtaining validation for the payment received can claim in the liquidation for their debt.
Validating Dispositions
Recipients of void dispositions can apply for a court order known as a validation order for the court to approve the disposition of the company’s property. An application can be made before the disposition is made, or after it, although retrospective validation will usually only be granted where ‘exceptional circumstances’ exist.
In Express Electrical Distributors Limited v Beavis and Ors[2016] EWCA Civ 765 the court considered what ‘exceptional circumstances’ might be. The court found that only where a transaction was in the best interests of the creditors as a whole should dispositions be validated and departing from the pari passu principle can be justified. For example, where the disposition was made to fulfil a contract which will allow the company to continue its business and increase the return for creditors or where the disposition was paying for litigation to be conducted in pursuit of a claim to recover assets for the benefit of the company.
In Express Electrical the court noted that if the insolvent company had wilfully concealed the fact that a petition had been presented this may be an exceptional circumstance, however, this was not relevant in this case.
How we Can Help
Section 127 does not give rise to a claim against a company director, but if it can be shown that the director caused a loss by knowingly making the dispositions there may be grounds for a misfeasance claim brought under section 212 IA 1986.
If you are concerned about a payment you have received from a company that has gone into liquidation or your company is facing a winding-up petition and you are concerned about payments that have been made, it is important to seek advice as soon as possible.
If you would like more information, please reach out to our team [email protected].
This article was co-written by Andrew Knox, Partner, team and Rachel Western, Paralegal in our Restructuring and Insolvency team.