When a company faces financial distress, directors often find themselves walking a tightrope. Decisions made in an attempt to keep the business afloat can, in the event of liquidation, come back to haunt not only the directors but also those who received payments or assets from the company. This is particularly true due to the powerful – and often unforgiving – provisions of Section 127 of the Insolvency Act 1986.
As Licensed Insolvency Practitioners, we frequently encounter situations where otherwise innocent creditors or recipients of payments are caught out by this section. It’s a fundamental principle of insolvency law designed to protect the collective body of creditors, but its impact can be severe.
The Core Principle: “Void Unless the Court Otherwise Orders”
Section 127 of the Insolvency Act 1986 states that any disposition of a company’s property made after the commencement of a winding-up by the court is, unless the court otherwise orders, void. This means that once a winding-up petition has been presented to the court, any payments made or assets transferred by the company can be unwound by a liquidator, regardless of whether the recipient acted in good faith or was aware of the petition. The purpose of Section 127 is to preserve the pari passu principle in a liquidation, ensuring fair and equal distribution among unsecured creditors.
The Issues for Recipients: Giving it Back or Facing Court Action
For a recipient of such a payment or asset, the implications of Section 127 are stark: you may be required to repay the sums received or return the assets, even if you provided genuine goods or services in exchange. Liquidators have a duty to recover void dispositions to benefit the general body of creditors. If you refuse to repay, the liquidator will likely apply to the court for an order, which could result in you incurring significant adverse costs in addition to having to return the funds.
“Tough Luck” Unless There Are Exceptional Circumstances
The law, in essence, operates on a “tough luck” principle for recipients. The onus is on the recipient to satisfy the court, on a balance of probabilities, that the disposition was in the overall interests of the general body of unsecured creditors to obtain a validation order. This is a high bar to meet, as highlighted in the case of Re Changtel Solutions UK Ltd [2022] EWHC 694 (Ch). A validation order should only be made if there is a special circumstance which shows that the disposition has been for the benefit of the general body of unsecured creditors, such that it is correct to disapply the pari passu principle.
What Won’t Be Considered Exceptional Circumstances
Case law, particularly Re Changtel Solutions UK Ltd and Express Electrical Distributors Limited v Beavis and Ors [2016] EWCA Civ 765, provides valuable insight into what circumstances will not be considered exceptional enough to validate a void disposition:
- Lack of Advertisement of the Petition: The fact that a winding-up petition was not advertised, and therefore the recipient was unaware of its existence, is not an exceptional circumstance. There is no “carve-out” to cover the period between the presentation of the petition and its advertisement. This means ignorance of the petition’s existence will not assist a recipient in defending a claim.
- Significant Time Between Petition and Winding-Up Order: A significant length of time between the petition being presented and the winding-up order being made was not considered an exceptional circumstance to justify validation in Changtel.
- Perceived Benefit to the Company (But Not Creditors Generally): Arguments that a disposition preserved value for the company, such as G4S providing security to Changtel’s property, are generally rejected if they fail to demonstrate that unsecured creditors as a whole were better off. The focus is squarely on the benefit to the general body of unsecured creditors, not just an individual transaction’s perceived benefit to the company. The special circumstances must be those of the insolvent debtor rather than those of the creditor.
- No Significant Loss to Creditors or Liquidator Delay: Arguments that there was no significant loss to creditors from the payments or that the liquidators delayed in issuing the claim were not deemed exceptional circumstances in Changtel. Limitation for a Section 127 claim runs from the date of the winding-up order, not the date of payment.
- Payments Not in the Ordinary Course of Business: Even if a recipient was unaware of the petition, a payment may not be validated if it was not in the ordinary course of the company’s business. For instance, settling invoices earlier than usual or when sums were not yet due can indicate that the payment was not in the ordinary course of business.
The Limited Scope of “Change of Position” Defence
The defence of “change of position,” which might ordinarily be available in other restitutionary claims, is severely limited in Section 127 cases. The court in Re MKG Convenience Ltd [2019] EWHC 1383 (Ch) held that this defence is constrained in the same way as the court’s discretion to validate a transaction. If a defendant could not obtain a validation order, they will not be entitled to rely on a change of position defence. This effectively removes any defence to a claim for repayment in circumstances where the court will not validate a transaction under Section 127.
The Critical Message for Creditors and Recipients
The message from the courts is clear: Section 127 is a powerful tool designed to uphold the pari passu principle and ensure equitable treatment of creditors in a liquidation. While the outcome can be unfortunate for individual creditors who received payments in good faith, this was the policy decision behind the drafting of the section.
If you are a creditor or have received payments from a company that subsequently enters liquidation, and you receive a request from liquidators for repayment under Section 127, it is crucial to seek immediate professional advice. Attempting to defend such a claim without understanding the stringent legal requirements and the limited scope for exceptions can lead to adverse court orders and significant cost liabilities. The court will not depart from the pari passu principle except in special circumstances.
For more information or if you have concerns about a payment you have received from a company now in liquidation, please contact us.
