Winding-up property dispositions—Wilson v SMC Properties

In what circumstances can a party obtain a validation order if a transaction is caught by the Insolvency Act 1986 (IA 1986), s 127? Marc Brown, a barrister at St Philips Chambers, advises that parties to transactions will want to be satisfied that there is no winding-up petition pending against a company before becoming bound.

Original news

Wilson and another v SMC Properties Ltd and others [2015] EWHC 870 (Ch), [2015] All ER (D) 115 (Apr)

The second claimant company, 375 Live, experienced financial difficulties and sold property that it owned to the first defendant company, SMC, at a time when a winding-up petition had been presented against 375 Live. Following a winding-up order having been made against 375 Live, a dispute arose between SMC and 375 Live's liquidator as to whether the sale had been entered into in good faith and for value, and whether the court should exercise its discretion to validate it. The Chancery Division held that, on the evidence, the sale had been entered into in good faith and for value, and that court would exercise its discretion to validate it.

What was the background to the application?

375 Live Limited (the company) was in business as a scrap gold and silver merchant. On 4 August 2011, it purchased property at 58G Hatton Garden, London for £1.2m. The company defaulted on its VAT which resulted in VAT assessments being raised. The company put the property on the market in November 2013 and a board minute recorded a decision on 5 November 2013 to sell the property for £1.1m.

At some point in November 2013, however, the company signed a contract for sale of the property for £1.3m. This sale did not proceed.

On 26 February 2014 HMRC presented a petition for the winding up of the company.

In the meantime, a creditor holding a fixed charge over the property was pressing for payment. The company then sold the property to SMC for £850,000.

On 14 April 2014, a winding-up order was made on HMRC’s petition.

What were the legal issues that the Registrar had to decide in this application?

The application before the Registrar was one made by SMC for the sale contract in respect of the property to be validated pursuant to IA 1986, s 127 as the contract had been entered into after the presentation of a winding-up petition against the company (26 February 2014) but before a winding-up order was ultimately made (14 April 2014).

Also before the court was a Part 8 claim brought by the liquidator of the company seeking a declaration that the contract was void pursuant to IA 1986, s 127 and relief against the sole de jure director of the company in relation to the contract.

The Registrar had to consider and assess IA 1986, s 127, its rationale and its purpose. As a result of those considerations, the Registrar could then consider the principles applicable to the making of a validation order that was being sought by the third-party in respect of the contract. Having identified those principles, the Registrar then had to consider the factual evidence as to the circumstance so the transaction and its effect upon the company and its creditors, in order to apply those principles to the facts as found.

Why did these issues arise?

IA 1986, s 127 provides that in a winding up by the court, any disposition of the company’s property, and any transfer of shares, or alteration in the status of the company’s members, made after the commencement of the winding up is, unless the court orders otherwise, void.

IA 1986, s 129(2) provides that the winding up of a company by the court is deemed to commence at the time of the presentation of the petition for winding up.

As a result, the transaction between the company and SMC had occurred between the time of the presentation of the petition and the winding-up order. As a result, when the winding-up order was made, the winding up was deemed to commence on the earlier date of the presentation of the petition. This in turn meant that the transaction for the purchase of the property had occurred after the commencement of the winding up for the purposes of IA 1986, s 127.

What were the main arguments put forward?

The dispute between the parties centred around two main areas, namely the issue of good faith at the time that SMC negotiated and entered into the contract with the company. The second concerned the value or price obtained by the company for the property.

The company, acting by its liquidator, argued that that the transaction was not entered into in good faith and that the value of the property was £1.3m—accordingly the sale to SMC was at a significant undervalue.

SMC argued that they entered into the transaction without knowledge of the petition and in good faith for value or near value.

What did the Registrar decide, and why?

The Registrar analysed the history of IA 1986, s 127 and the jurisdiction and guiding principles concerning an application for the grant of a validation order.

He decided that SMC entered into the transaction for the purchase of the property in good faith and the transaction was an arm’s length commercial transaction. He decided that the value of the property was in the region of £900,000.

The Registrar did not find it helpful to look at the position from the perspective of the general body of creditors and the innocent third-party—this was because if the fixed charge holder had gone into possession and sold the property, on the evidence, it would have achieved no more than the £850,000 paid by SMC and may have received less.

The Registrar held, based on the evidence as to valuation, the general body of creditors would not have suffered significantly or at all.

Accordingly, the transaction did not undermine the policy behind IA 1986, s 127 as it did not favour a pre-liquidation creditor and there had been no or no significant loss to creditors as a whole.

The Registrar therefore made a validation order in respect of the transaction.

The effect of this was to dispose of the Part 8 claim against the director.

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

The Registrar’s discussion of the principles governing the exercise of the discretion to grant a validation order will be a very useful starting point in any such application. The Registrar made clear that:

  • the court must exercise its discretion, being mindful of the policy behind the section and carrying out a balancing exercise, weighing the interests of the general body of creditors against the transaction under scrutiny
  • the discretion is at large and not confined by any express statutory requirements
  • the policy which underlies IA 1986, s 127 is the pari passu distribution of the assets of the company among the same class of creditors
  • in deciding whether to make a validation order, there will be some cases where it will be beneficial for dispositions to be made in the closing period so that the company can continue the business in its ordinary course
  • in considering whether to allow such dispositions, the court should endeavour to ensure that the interests of unsecured creditors are not prejudiced
  • whether it is desirable that the company should carry on its business involves some speculation and a balancing exercise
  • save in special circumstances, the court should not validate a transaction that might result in one or more pre-liquidation creditors being paid at the expense of other creditors
  • a disposition made in good faith in the ordinary course of business at a time when the parties were unaware of the petition will normally be validated unless there are grounds to believe that the payment was intended to prefer the recipient over other creditors
  • in considering whether an order will be beneficial to creditors, the court will have regard to the interests of all creditors and not just certain creditors supporting the winding up or consent to the application
  • while different sorts of cases may lead to different factors being relevant, the policy consideration remains constant
  • good faith both in relation to the knowledge of the petition and beyond is important—a transaction which depletes the assets of a company to the detriment to of the general body of creditors is unlikely to be made in good faith (however, where good faith exists, there needs to be a balance between the rights of the general body of creditors on the one hand and the innocent third party on the other)

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

Parties to transactions will want to be satisfied that there is no winding-up petition pending against a company before becoming bound, so as to keep them outside of the operation of IA 1986, s 127 altogether. However, if a transaction is caught by IA 1986, s 127, it is not the case that the transaction is necessarily void for all purposes—it may be that a validation order can be obtained.

As far as liquidators are concerned, the ability of a third-party to seek and potentially obtain a validation order will mean that a transaction is not necessarily a straightforward one of being void just because it was made within the relevant period—it may be that the third-party will seek a validation order. If granted, this may have the effect of defeating the company’s claim to the benefit for the liquidation, and may therefore result in the denial of any relief against a director of the company in question—just as it did in this case.

Marc Brown undertakes work across a broad spectrum of commercial work, but is a particular specialist in insolvency matters. He offers advice that is tailored towards the commercial outcomes sought by the client and is conscious of the business needs of clients, as well as the pure legal aspects of litigation.

Interviewed by Kate Beaumont.

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:

Restrictions on dispositions of property once a winding-up or bankruptcy petition has been presented

Validation orders

Witness statement in support of an application by a liquidator for a declaration that a transaction has breached the Insolvency Act 1986, section 127

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First published on LexisPSL Restructuring and Insolvency

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