A case study into the S127 Insolvency Act 1986 and validation order applications
The decision at first instance follows the principles applied in the decision of Express Electrical Distributors Limited v Beavis and Others  1 WLR 4783 and provides some useful insight into how a change of position defence could be argued and challenged.
The company, Grabal Alok (UK) Limited (“Grabal”) was a company with over 200 retail stores specialising in clothing and jewellery.
The supplier (Touchstone Retail Limited) was a company which supplied jewellery and other products to the Company pursuant to a concession agreement between the parties.
The concession arrangement between the Company and the supplier was as one would expect. The supplier’s products were sold by their staff on their own stands within the Company’s stores. The Company took payment at the till from customers and would then bank the sale receipts within the company account. The supplier would send the Company an invoice on its share of the sales with payment to be made within 30 days of receipt.
The Company started to run into difficulties and in July 2016, it entered into a company voluntary arrangement (“CVA”). The supplier (along with several others) continued to supply products to the Company for the duration of the CVA.
In April 2017 HMRC petitioned to wind up the Company. After the winding up petition was presented, the supplier received several large payments from the Company for products supplied both before and after the petition was presented. The Company entered into Liquidation on 10 July 2017. It is these payments received after presentation of the petition that are the issue; they are void by default and liable to be repaid to the Company (now in liquidation) unless validated by the court.
Naturally, the Liquidators demanded repayment of the void payments. Instead of repaying the monies, the supplier made an application to court for a ‘retrospective’ validation order pursuant to section 127 of the Insolvency Act 1986 in respect of the void payments received after the petition was presented by HMRC.
The supplier believed it should be entitled to keep the payments and they relied mainly on two arguments:
Argument one: the benefit to the Company
The central argument of the supplier was that the court should retrospectively validate the void payments because:
- The Company made a profit from the sale of the supplier’s products;
- The Company would retain monies from sales after presentation the winding up petition without paying the supplier anything;
- The Company’s ability to remain in business depended on suppliers such as themselves.
In response, the essence of our argument on behalf of the Liquidators was that the supplier was in a better position than the other unsecured creditors and that there were no exceptional or special circumstances for them to be treated any differently. This required detailed financial analysis of the Company’s trading position before insolvency and a thorough fact and document gathering exercise.
When considering the facts of our case, the court relied on the key case of Express Electrical Distributors Limited v Beavis and Others  1 WLR 4783 (“Electrical Express”); the central point arising from that authority was that a payment (or transaction), for which a validation order is sought, must be for the benefit of the general body of creditors. For a payment to be validated, one needs to demonstrate exceptional or special circumstances.
When considering what could amount to special circumstances, the court applied the Electrical express case and another authority.
Ultimately, the court concluded that it had discretion in these applications and that every case must be considered on its own particular facts.
In our case, the supplier failed to convince the court that the transactions concerned were for the benefit of the general body of creditors.
The court stressed the importance of the evidence concerning the Company’s declining trading position after presentation of the petition. This was contrary to the supplier’s assertion that the sales of its products had resulted in a profit for the Company. The latter assertion was rejected.
It was also interesting to note that while the supplier had retained title over its products until final sale to the customer, the court did not consider its position to be any different to that of any other creditor who had allowed the Company to sell its goods and never received money, or who had sold goods to the Company but for which it was never paid.
Submission 2: ‘change of position’/’unjust enrichment’
Having failed to convince the court that the sales of the suppliers goods were for the benefit of the general of body of creditors, the Supplier’s second submission was then considered.
The Supplier argued, in the alternative, that any re-payment by the supplier to the liquidators of the ‘void payment’ would unjustly enrich the Company as it would have kept the sale proceeds of the goods and would not have to pay the for the supply. Their rationale was that the supplier had changed its position by enabling the Company to generate a commission from the products it had made available for sale.
The court considered a further authority, to which the musician Phil Collins was a party, and considered four principles:
1. The party asserting that it has changed its position must satisfy the court evidentially to make good such a defence;
2. The decision to allow the Company to keep the suppliers products was akin to the supplier maintaining its position as opposed to changing it;
3. There has to be a causal link between the change of position and ‘void’ payments – the court believed this link to be broken as the supplier had received payment while making the decision to keep products instore;
4. The defence is only available if the change of position makes the recovery unjust – which the court concluded was not the case on the facts.
Ultimately, the court followed the decision made in Electrical Express which should be welcoming for practitioners who often face such applications. The court’s decision in this case reiterates that, in order for the court to make a validation order, it must be shown that the transaction was for the benefit for the general body of creditors. The court’s decision also shows that the change of position defence has a high evidential burden.
For insolvency practitioners, this will require close scrutiny of the documents available relating to the company’s trading and profit position during the petition period and considering whether the transaction in question had a detrimental or positive impact to the business overall as opposed to considering in isolation whether or not the transaction itself was profitable.
For suppliers who face the difficult decision about whether or not they should cease trading with a company who is facing financial/trading difficulty, they need to bear in mind that the risk and commercial decision in continuing to trade lies with them