Where a company enters into compulsory liquidation an insolvency practitioner will review any disposals of company property (including cash) which took place between the date of the presentation of the petition to the Court and the date that the winding up order is made (Post Petition Period). During the Post Petition Period, any disposal of property is void unless the Court rules otherwise by issuing a validation order. A Court validation order can be obtained before or after the disposal in question.
In a case heard earlier this month the High Court attempted to clarify the approach to be taken when considering applications for a validation order:
- The Court has unlimited discretion for the Court to validate the transaction;
- Was there good faith? (at the time of the transaction(s) in question did the parties know about the existence of the petition? Note – there may be wider factors which the Court will also take into account as part of good faith); and
- Has the disposal (or will it) significantly deplete the assets of the company to the detriment of the general body of creditors?
The general position since a leading Court of Appeal decision in 1992 has been that a disposal during the Post Petition Period which was made in good faith (without knowledge of the petition) in the ordinary course of business will normally be validated. The Court however has to be mindful of the policy behind Section 127 and the extent to which any validation would contradict the pari passu principle (the idea that equal ranking creditors will share any available assets of the company in proportion to the debts due to each of them).
In the case mentioned at the beginning of this blog post the company’s mortgage provider threatened to wind it up due to a failure to keep up with mortgage repayments. The company entered into a sale contract for the disposal of the charged property to pay off the lending but completion took place during the Post Petition Period making the transaction void.
The Court concluded that the legislative policy behind section 127 (avoiding creditor prejudice by championing the pari passu principle) should be of utmost importance when considering whether to validate a transaction. The Court would be reluctant to validate a transaction where there was a significant reduction in the company’s assets available to the general body of creditors as a result. The Court had to assess the value of the realisable assets available to creditors before and after the transaction. In this case the general body of creditors would not have suffered significantly or at all given the valuation evidence produced to the Court. The assets available for pari passu distribution were virtually the same before and after the mortgage had been discharged. As the transaction had also been made at arm’s length and in good faith (when the company was facing genuine pressure from a secured creditor) the Court concluded that the transaction should be validated.
The Court still retains its discretion to consider each application on its own facts but the above case does offer another decision from which advisers can gauge how the Court may do so. If you have a s127 disposal to consider – start with the checklist!
 Section 127 of the Insolvency Act 1986
 Wilson v SMC Properties Limited  EWHC 870 (Ch)
 Denney v John Hudson & Co Ltd  BCLC 901