Section 127 and void dispositions: clarification on validation and the availability of a change of position defence

5th April 2022

Following a recent successful application by liquidators, the Court has provided clarification on certain principles applicable to section 127 of the Insolvency Act 1986, as well as the limitation on the availability of a change of position defence under section 127.

Background

Liquidators were appointed to Changtel Solutions UK Limited (the Company) in 2015 following a petition issued in 2013 by HMRC.  In the period between the petition and winding-up order, significant payments were made to a large number of the Company’s creditors.  These payments were void pursuant to section 127 of the Insolvency Act 1986 (section 127).

Following their appointment, the Liquidators clawed back/ entered into a significant number of settlements in relation to these payments, leaving 16 parties who either failed to respond or with whom settlement was not reached.  The Liquidators issued an application against these 16 parties under section 127 seeking an Order that the payments were void and that they be repaid with interest.

Following the application being issued, confidential settlements were reached with ten of those Respondents, and the Liquidators’ claims against five Respondents were dealt with by way of uncontested disposal hearing. This left one party which contested the application at a substantive hearing.

What did the Court Decide?

Summary

Whilst the Court followed recent section 127 authorities and validation was refused, the judgment[1] provided important clarifications on four issues:

• Limitation in respect of a section 127 application will run from the date of the winding up order and not the date of the void dispositions.

• When a disposition is made by way of cheque then, for the purposes of section 127, the date of the “disposition” of the company’s property will be the date such amounts are debited from the company’s account and not the date the cheque is written out.

• On an application of the test set out in Express Electrical Distributors Ltd v Beavis [2016] 1 WLR 4783, the factual oddities of the case did not give rise to any “special” or “exceptional” circumstances which would mean the Court should validate the void payments.

• A change of position defence is not generally available to a respondent under section 127, in an instance where the Court would not also grant validation.

We consider each of these issues below

Limitation

• The Court confirmed that the effective date for limitation (pursuant to the Limitation Act 1980) in respect of an application under section 127 is the date of the winding up order in respect of the company and not the date of the void dispositions themselves.

• The wording of section 127 begins “On a winding up…“. Until the winding up order is granted, the operation of section 127 is merely prospective (and hence a party could still apply for prospective validation notwithstanding that the provision is not yet in operation).

• The purpose of section 127 is to preserve the pari passu principle in a liquidation. If a petition is dismissed then the payments will be valid and no office holder could seek repayment (though this would not cause detriment to any party who had sought prospective validation anyway). Once the winding up order is made then section 127 becomes operative and those parties who have received void dispositions will find themselves in a better position than the general body of creditors.

Payment of a cheque

• It was common ground between the parties that one of the payments of which the Liquidators sought repayment was made by way of a cheque dated pre-petition but debited post-petition. The question therefore arose as to when the “disposition” was deemed to be made pursuant to section 127.

• The Respondent sought to rely on the Australian case of Re Loteka Pty Ltd Pty Ltd [1989] 7 ACLC 998 which set out that the date of a disposition made by way of cheque is the day the cheque (i.e. the “negotiable instrument“) is written out. The Liquidators successfully contended that the “disposition” for the purposes of section 127 is the date and time the payment is actually debited from the company’s account (Blackburne J in Hollicourt (Contracts) Ltd v Bank of Ireland [2000] 1 WLR 895 at 903 applied: “the debiting to the customer’s account of the amount of his cheque on presentation for payment…seems to me to be in every sense a disposition of the company’s property“).

• The Judge agreed with the Liquidators’ submission that what matters is the “end result” and that, applying Hollicourt, the intermediary steps to get to that end result are not, in and of themselves, dispositions of the company’s property.

• Whilst the handing over of a cheque may well be a disposition of property in the wider sense, in that there is a passing of rights granted by the company to the recipient of the cheque, in the context of section127, the holding of an uncashed cheque does not take a creditor any further on an insolvency than a creditor with a money judgement against the company in liquidation. Conversely, once the payment has been debited, that creditor has been paid in full to the detriment of creditors generally.

Validation

• The Respondent argued that “special” or “exceptional” circumstances existed and therefore in accordance with the comments in Express Electrical the void payments should be validated.

• In relation to special circumstances, the Court confirmed that ‘special circumstance’ may arise where it is shown that the disposition in question will be (in a prospective application case) or has been (in a retrospective application case) for the benefit of the general body of unsecured creditors, such that it is appropriate to disapply the usual pari passu principle.  It also confirmed that the onus is on the recipient in question to satisfy the Court on a balance of probabilities that the disposition has been in the overall interests of the general body of unsecured creditors.  On the facts, the Court determined that the Respondent had not made out its case that the payments were for the benefit of creditors generally.

• The Respondent put forward an alternative case of “exceptional circumstances”, based on the following: (i) the petition not being advertised (ii) the extended period of time between the petition and the date of the winding-up order (iii) the overall loss to the Company’s creditors as a whole (iv) the lack of any intention to prefer (v) whether pari passu of the Company’s creditors is achievable (v) the delay in the Liquidators bringing the application.  On the facts and applying Express Electrical the Court determined that the “exceptional circumstances” test needs to be applied looking at the whole circumstances in which the payments were made.  On the facts, the Court determined that the Respondent had not made out its case.

Change of position

• The Court gave detailed consideration as to whether or not a change of position defence is available in section 127 cases.  Relying on Rose v AIB Group (UK) plc [2003] 1 WLR 2791 the Respondent submitted that a change of position defence is, in principle, available to the respondent of a section 127 application.  It argued that the right of recovery of the company’s property is restitutionary and that change of position is a recognised defence where monies had been received and the defendant’s circumstances had changed detrimentally on reliance of the enrichment.

• The Liquidators submitted in reply that Rose is no longer good law and that a change of position defence is not generally available in respect of a section127 application.

• Having considered the case law at length (in particular, the subsequent case of Re MKG Convenience Ltd [2019] BCC 1070, the Privy Council decision in Skandinaviska Enskilda Banken AB v Conway [2019] UKPC 36 and LJ Trower’s judgment in Bucknall v Wilson [2021] EWHC 2149 (Ch)) the Court concluded the circumstances in which a change of position defence can succeed are constrained in the same way and for the same reasons as the exercise of the Court’s discretion to validate.

• In the present case, the Respondent failed to clear the evidential barrier that it had changed its position.  Moreover, even if the factors raised by the Respondent did amount to a change of position, that change was but one of many factors to consider and it was not a sufficiently strong factor to make it unjust for the Court to require the Respondent to repay the void payments.

What does this mean for you?

• The judgment demonstrates, again, that successfully defending a section 127 application is not straightforward.  Unless special circumstances can clearly be demonstrated, the exceptional circumstances test as set out in Express Electrical must be satisfied. This is a high bar.  Unusual facts do not, in and of themselves, give rise to exceptional circumstances. There must be some exceptional or special circumstance for the payments to be made.

• The case is particularly interesting given the comments on the availability of a change of position defence.  It is clear that the Courts are now of the view that its application will be limited, as it would be inconsistent with the statutory aim of section 127 and the fundamental principle of pari passu distribution of an insolvency company’s assets. A payment is either capable of validation or it is not and it is not apparent that Parliament intended for the statutory scheme to allow for restitutionary defences, including change of position.

Gawain Moore led the team from Walker Morris, with support from Oliver Wheeler (Restructuring & Insolvency).

[1] Re Changtel Solutions UK Ltd (In Liquidation) [2022] EWHC 694 (Ch)