The Risks Of Void Transactions In Insolvency

• Published date: 26 July 2022
• Subject Matter: Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Corporate and Company Law, Insolvency/Bankruptcy
• Law Firm: Shepherd and Wedderburn LLP
• Author: Mr Jamie Yule

With the lifting of the restrictions on the presentation of winding up petitions, and the likely cash flow pressures caused by price inflation, it is widely anticipated that we will see an increase in the number of companies subject to winding up proceedings. For any business dealing with a company in financial distress, a recent decision of the High Court of England and Wales serves as an important reminder that transactions which take place before the company has been wound up can be vulnerable to challenge. Directors who cause transactions to take place which amount to a disposition of the company's property can also be at risk of action being taken against them personally for failing to meet their duties and for misappropriation of assets.

Background

Section 127 of the Insolvency Act 1986 renders void any disposition of a company's property or transfer of its shares made once a winding up petition has been presented. A court liquidation is deemed to commence when the winding up petition is presented to the court even although the winding up order may not be made until some time later. The rationale for the provision is to seek to ensure that company assets are preserved for the benefit of all creditors and to seek to uphold the principle that unsecured creditors ought to be treated equally in the event of insolvency. The directors of a company are also subject to a legal duty to act in the best interests of the company and, where a company is insolvent, or on the verge of insolvency, that duty is owed not just to the company and its shareholders but to its creditors. For that reason, directors ought not to be entering into transactions which reduce the available assets to the detriment of creditor interests.

Liquidators may therefore rely upon Section 127 to challenge any transaction which has taken place in the period between the presentation of the liquidation petition and the winding up of a company. Liquidators may also take action against directors for breach of fiduciary duties and seek payment of a sum equivalent to the loss suffered by the company (and by implication its creditors) as a result of the transaction.

To seek to address the risk of a transaction being void under section 127, and action being brought by the liquidator for return of the property or an order for payment of the equivalent value if return of the property is not practicable, the legislation provides that an application can be made to the court for a validation order...