When a company is wound up, any dispositions of its property after the presentation of the petition are void unless the Court validates them. Without a Court order, any funds paid by the company after the petition was presented have to be returned to the liquidator, to be distributed proportionately across the creditors of the company according to the size and ranking of their claim (the pari passu principle). A 1980 case that related to payments in and out of a company’s bank account has long been quoted as the authority to turn to when deciding whether or not a Court would be likely to validate the payment.
A recent Court of Appeal case has reassessed what principles apply to the Court’s decision.
A wholesaler regularly supplied a company (E) with electrical goods. E began to have difficulty making payments on time and the wholesaler suspended E’s credit.
E eventually paid £30,000 to the wholesaler, which actually put E in a credit balance (based on their commercial trading terms) for a short period of time. The wholesaler reinstated E’s credit and the two continued trading.
In the meantime, a different supplier had presented a winding-up petition against E. The petition was presented a week before the payment of £30,000 was made, but not advertised until around two months later. E was wound up shortly afterwards.
The liquidators of E then sought to recover the £30,000 payment from the wholesaler. The wholesaler applied for a validation order on the basis that it did not know about the petition and that it had accepted the money in good faith.
The Court of Appeal analysed Re Gray’s Inn and concluded that a validation order can only be made if there are “special circumstances”. There must be a clear benefit to the company’s creditors to justify overriding the pari passu principle. This could, for example, include dispositions to assist a prospective sale of the business.
The Court analysed, in depth, the common assumption derived from the Judge’s comments in Re Gray’s Inn that a disposition carried out in the ordinary course of business, at a time the parties are not aware of the presentation of a petition – ie in good faith – should normally be validated by the Court. Lord Justice Sales considered that these comments had been interpreted at odds with the remainder of the judgement, which strongly emphasised the necessity to maintain the pari passu principle; further, that the dicta was too ‘flimsy’ to amount to any clear direction that the Court should depart from the principle.
Whilst the Court was satisfied that, on the balance of probabilities, the wholesaler was unaware of the presentation of the petition and not therefore acting in bad faith, the Court found there was no evidence the payment provided any benefit to the creditors of E. On the facts, a validation order was not justified and the appeal was dismissed.
Much of this case hinged on the evidence presented – or rather not presented. There was no evidence of an intended benefit to the company or its creditors from the payment and no evidence of any intention to sell the business as a going concern. Given the goods had been supplied on credit and were already in the possession of the company, the payment did nothing more than put the wholesaler in a better position than other unsecured creditors.
However, the case serves to clarify the requirements for a validation order. The question of whether a payment was accepted in good faith and without knowledge of an extant petition – even if not advertised – is now largely irrelevant.
Instead, the focus is on the substantive test outlined in Re Gray’s Inn rather than the dicta: for a post-petition disposition of company assets to be validated by the Court, the applicant must be able to show a clear benefit to the general body of creditors of the Company as a result. The same principles will apply whether a validation order is sought on a prospective or retrospective basis. Following this decision, applications for validation orders are even more likely to turn on their specific facts.
 Section 127(1) Insolvency Act 1986 (IA 1986)
 Re Gray’s Inn Construction Co Limited  1 WLR 711
 Express Electrical Distributors Limited v Beavis and Others  EWCA Civ 765