Making the case for validation orders

Does the Court of Appeal’s recent decision in Express Electrical Distributors v Beavis clarify the issue of validation orders under the Insolvency Act 1986 (IA 1986)? James Davies, a barrister at 3PB who specialises in commercial and insolvency matters, considers the implications of the judgment.

Original news

Express Electrical Distributors Ltd v Beavis and others [2016] EWCA Civ 765, [2016] All ER (D) 118 (Jul)

The Court of Appeal, Civil Division, held that a validation order in respect of a payment made to a creditor after a winding-up petition had been made should only be made in relation to dispositions occurring after presentation of winding-up petition if there was some special circumstances that showed that the disposition in question would be, in a prospective application case, or had been, in a retrospective application case, for the benefit of the general body of unsecured creditors, such that it was appropriate to disapply the usual pari passu principle.

What was the background to the appeal?

The appellant (Express) was a wholesaler of electrical goods. Its customers included Edge Electrical Limited (Edge) from 2011. The relevant time line was as follows:

  • April 2013—Edge was not paying according to the Express’s standard terms
  • 17 May 2013—Express put Edge’s account on hold
  • 22 May 2013—another creditor of Edge presented a winding-up petition
  • 29 May 2013—Edge paid £30,000 to Express, representing all the invoices which had fallen due and something towards invoices falling due in June (the hold on Edge’s account allowing further goods to be supplied)
  • 17 June 2013—Express became aware of the winding-up petition
  • 15 July 2013—commencement of the winding-up, ie winding-up order made

The liquidators demanded repayment of the £30,000, relying on IA 1986, s 127. This provides any disposition of company property after presentation of the petition is void unless the court orders otherwise. Express made an application for a validation order under IA 1986, s 127 to displace that default position. The application was refused by the district judge at first instance and on appeal to the High Court. Express appealed to the Court of Appeal.

What were the legal issues the Court of Appeal had to decide, and what legal arguments were put forward?

The principles governing the exercise of the court’s discretion were examined in Re Gray’s Inn Construction Co Ltd [1980] 1 All ER 814. In that case it had been held that in considering whether or not to make a validation order the court always had to do its best to ensure the interests of the unsecured creditors were not prejudiced. It is a basic principle of insolvency law that the assets of an insolvent company at the commencement of a liquidation should be distributed pari passu among the unsecured creditors. A court should not validate a transaction which might result in a pre-liquidation creditor being paid in full at the expense of other unsecured creditors in the absence of special circumstances which made that particular transaction one which was in the interests of the creditors as a whole (for example to enable the business to continue trading with a view to its sale as a going concern or to complete a particularly profitable contract).

The question for the Court of Appeal was whether it was in the interest of the general body of creditors for there to be a validation order for the payment of the £30,000 on the basis that such payment was necessary in order to secure the continued supply of goods to Edge. Express also sought to rely on a passage in Re Gray’s Inn Construction Co Ltd (718F–G) which stated that a disposition in good faith should usually be validated.

What did the Court of Appeal decide, and why?

Lord Justice Sales held that Buckley LJ’s comments in Re Gray’s Inn Construction Co Ltd in relation to good faith were not intended to lay down any binding rule that such a disposition should be validated. Such a rule would be inconsistent with the emphasis given elsewhere in his judgment on the importance of the pari passu principle.

On the question of whether the payment had been in the interests of the general body of creditors it was noted that there was an absence of evidence from Express as to the purpose of the payment or exactly what benefit Edge had anticipated receiving for it. It was not suggested that Edge was continuing to trade with a view to being sold as a going concern. The stock to which the £30,000 related had already been supplied. There was no evidence that the supplies made after the payment had been made were to enable to completion of particularly lucrative contracts or that the general body of creditors was benefitted by the payment. This was a payment to an unsecured pre-liquidation creditor. There were no special circumstances justifying its validation and it was not in the ordinary course of business.

To what extent is the judgment helpful in clarifying the law in this area?

The decision of the Court of Appeal provides clarification that Re Gray’s Inn Construction Co Ltd that there is no principle that a payment made and received in good faith should be validated. It also clarified the Court of Appeal case of Denney v John Hudson & Co Ltd [1992] BCLC 901—the affirmed decision of a first instance judge to validate payments was explained as a judge who had correctly directed himself as to the law and arrived at a conclusion, considering the case in the round, he was entitled to arrive at. The desirability of the company continuing to trade was often speculative and in each case the court had to carry out a balancing exercise. To the extent that Denney sought to set out any general proposition that a payment that a payment in good faith in the ordinary course of business would usually be validated, this was disapproved.

What practical lessons can those advising take away from this case?

Those seeking validation orders to permit continued trading or for specific creditors to be paid will need to justify their application—clear credible evidence that the payment will or did produce a benefit for the general body of creditors. If this is on the basis that business will be sold as a going concern the evidence will need to be demonstrate that the sale as a going concern will be more beneficial than a break-up realisation. This case re-emphasises the collective nature of winding up, and the equal ranking of unsecured creditors within that.

James Davies has a commercial practice covering a range of areas. He has a specialised insolvency and bankruptcy practice building on his experience as a chartered accountant before coming to the Bar. His experience extends to factoring agreements, guarantees, the Commercial Agent Regulations and franchising.

Interviewed by Janine Isenegger.

The views expressed by our Legal Analysis interviewees are not necessarily those of the proprietor.

Further Reading

If you are a LexisPSL subscriber, click the links below for further information:

Validation orders—dispositions of property after commencement of winding up

Application for a validation order for a company—checklist

Not a subscriber? Find out more about how LexisPSL can help you and click here for a free trial of LexisPSL Restructuring and Insolvency.

First published on LexisPSL Restructuring and Insolvency

Relevant Articles
Area of Interest