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Void payments under the Insolvency Act and change of position defence

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Posted by Caroline Benfield on 30 September 2019

Caroline Benfield - Insolvency Lawyer
Caroline Benfield Partner

Section 127 of the Insolvency Act 1986 (“IA86”) says:

(1)   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 otherwise orders, void.

The commencement of the winding up in a compulsory liquidation is the date on which the winding-up petition is presented at court. Therefore, from the date of presentation to the date on which the company is wound up by the court, any disposition of the company’s property is void unless the disposition is validated by the court.

The rule is there to preserve the assets of the company for the benefit of the company’s creditors and to protect the pari passu principle of asset distribution.

Apply for a validation order prior to the transaction

The disposition will not be void if the court grants a validation order thereby validating the transaction. The application for a validation order can be made before the winding-up order is made, but it is good practice to apply for such an order before the transaction takes place.

If a validation order not been obtained prior to the liquidation, then it is very likely that the Liquidator will look to recover property that was subject to a void disposition under Section 127 IA86.

A recipient in respect of a void disposition can apply for retrospective validation and in those circumstances the court will attempt to balance the interests of the recipient with the interests of the company’s creditors. There is no presumption that dispositions should be validated where they were made in good faith and before either the company or the recipient became aware of the winding-up petition’s existence (Express Electrical Distributors Ltd v Beavis [2016] EWCA Civ 765). The court needs to find some special circumstance that justifies overriding the pari passu principle.

Nisa - 'change of position’ defence

The recipient of a void payment may also be able to rely on the defence of “change of position”. This is because a liquidator’s remedy in that case is a restitutionary one which gives rise to an equitable defence whereby a Respondent could prove that their circumstances have changed detrimentally such that it would be unjust to require them to, for example, repay money that they received after the winding-up petition was presented.

In the recent decision of Mustafa Hassanali Abdulali, Neil James Dingley (Joint Liquidators of MKG Convenience Ltd, MKG Convenience Ltd v Nisa Retail Ltd [2019] EWHC 1383 (Ch) the court considered whether to grant a validation order in respect of direct debits taken by a retail organisation from one of its members. It also considered whether the change of position defence was available.

Nisa is a members’ organisation which supports small independent traders operating grocery and convenience stores operating under the Nisa brand. MKG Convenience Ltd (In Liquidation) (“MKG”) was a member of Nisa and it supplied goods to MKG and central services such as marketing and the use of its brand name.

MKG ran three stores and had a number of bank accounts. It paid a cash deposit to Nisa which it held as security for any money that was owed to it and MKG also gave a direct debit authority in respect of three accounts for the purpose of taking payment for goods supplied. The system that Nisa appeared to operate was that a payment was taken from each account on a weekly basis in respect of invoices that had been raised two weeks previously.

Direct debits were taken by Nisa from MKG’s bank accounts after a winding-up petition had been presented against MKG and continued to be taken after the petition was advertised and the winding-up order was made

The liquidators applied to court for, amongst other things, a declaration that the direct debits made after the winding-up petition was presented were void and that they should be repaid. In respect of that aspect of the claim, the respondent sought an order validating the payments. Alternatively, it resisted an order for repayment on the basis that it changed its position relying in good faith on their validity.  

Disapplying the ‘pari passu’ principle

The court noted the principles set out in the Judgment of Sales LJ in Express Electricals that, save in exceptional circumstances, a validation order should only be made in relation to dispositions occurring after presentation of a winding-up petition if there is some special circumstance which shows that the disposition in question will be (in a prospective application) or has been (in a retrospective application) for the benefit of the general body of unsecured creditors, such that it is appropriate to disapply the pari passu principle. It is not sufficient for an applicant on a validation order to show (a) that the disposition was in the ordinary course of business and/or (b) that he was unaware of the presentation of the petition and/or (c) that he acted in good faith, although these will be relevant matters to consider in the exercise of the court’s discretion. He must demonstrate the special circumstances in that the transaction has been for the benefit of the creditors generally or other exceptional circumstances.

The court was not able to find exceptional circumstances that would justify disapplying the provisions of statute by making a validation order in respect of the direct debit payments. The court therefore refused to make the validation order.

Court finds against Nisa

With regard to the change of position defence, the court held that such a defence was available in principle even where the insolvency legislation had invalidated the disposition and would succeed if it would be more unjust to require the defendant to repay the money than it would be to allow them to retain it. However, the circumstances in which such a defence could succeed were constrained in the same way and for the same reasons as the exercise of the court’s discretion to validate. The respondent is required on the facts to evidence that the injustice of repaying outweighs the policy underpinning Section 127 IA86.

The court found that Nisa had not shown that it had changed its position such that it would make it unjust to repay the direct debit payments. The Court was also not satisfied that Nisa had shown that it acted in good faith either before or after the petition had been advertised.

Further, once the petition had been advertised, the defence was no longer available. It would not be equitable for the respondent to be able to rely on its own ignorance when an advertisement of a winding-up petition constitutes notice to the world.

About the author

Caroline advises on all aspects of contentious and non-contentious personal and corporate insolvency matters.

Caroline Benfield

Caroline advises on all aspects of contentious and non-contentious personal and corporate insolvency matters.

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