What are Validation Orders and why are they Required?
Section 127 of the Insolvency Act 1986 (IA 1986) provides that, in the case of a compulsory liquidation, any disposition of the company’s property made after the presentation of a winding up petition, unless the court otherwise orders, is void.
The court’s interpretation of ‘disposition’ provides for a wide definition including payments out of the company’s bank account, gifts, leases, charges, mortgages and sales (but not completion of specifically enforceable contracts for sale). Avoidance is automatic, meaning no court order, notice or declaration is required.
Accordingly, upon the appointment of liquidator, any such transaction could be (and often are) subject to challenge by the office holder. While there is no statutory remedy per se in respect of a void disposition, the claim will usually be restitutionary in nature ie a claim for monies had and received.
At face value, the effect of section 127 may seem severe. However, the principle underpinning it is one of equity. In practice, the prohibition on disposal has the effect of preserving assets for the benefit of all creditors which can then be distributed on a pari passu basis.
Who may want a validation order?
Generally speaking, validation orders are usually sought by either the company subject to the winding up petition, or a recipient / disponee of the company property.
Where the company makes an application, this is usually for one of two reasons:
- 1) to facilitate the unfreezing of the company’s bank account (which can occur automatically upon the presentation of a winding up petition), thereby enabling business as normal; or
- 2) to protect the directors of the company from any subsequent misfeasance / breach of duty claim that a liquidator may look to bring in respect of any void transactions.
Applications can be made in respect of one transaction only or, a series of transactions, both prospective and retrospective.
When will the court make a validation order?
Although the court benefits from extensive discretion, as a general rule, a validation order will only be made in one of two circumstances:
- the company in question can prove its solvency to the satisfaction of the court insofar as it is able to pay its debts as they fall due; or
- the company can evidence that the proposed transaction / s on which they seek validation will be beneficial to, or at the very least, will not prejudice the interest of creditors.
However, where the application is made retrospectively, applicants will be subject to a further hurdle, as the court attempts to balance the interests of the recipient with the interests of the company’s creditors. In that regard, the Court of Appeal has made it clear that the fact any disposition may have been in good faith and before either the company or the recipient became aware of the petition’s existence, will not be sufficiently persuasive to award validation. Indeed, the court must find special circumstances to justify overriding the pari passu principle.
In practice, this means it is not easier to ask for forgiveness as opposed to permission.
Summary
While obtaining a validation order is subject to a strict criterion, the key to a successful application is timing. Like most elements of insolvency and restructuring, taking stock at an early stage will provide the widest range of options and resolutions.
Our restructuring and insolvency team can advise on all aspects of validation orders and the wider issues that may arise in respect of the same. If you require advice or assistance in respect of a validation order, winding up petition or have any concerns about your director duties in such circumstances, please contact a member of our team.
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