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Validation Orders Not to be Used to ‘Buy Time’ for Debtors

In the context of winding up proceedings, the High Court has emphasised that applications for validation orders under section 127 of the Companies Act 1985 are not to be used to ‘buy time’ to pay off creditors. Where a substantial debt to Her Majesty’s Revenue and Customs (HMRC) was not disputed, it was inappropriate to grant such an order to facilitate the indebted company’s payment of legal fees.

HMRC had launched winding up proceedings against a brewery in respect of £1.485 million in unpaid beer duty. The company had instructed lawyers to apply for an order restraining advertisement of the petition which was ultimately postponed after the appointment of an administrator was proposed. The company sought a validation order in respect of £50,000 it had paid or intended to pay its legal advisers in respect of those proceedings.

Refusing to make such an order, the court noted that the debt was not in dispute and that it was agreed that the company was not in a position to meet its liabilities. The court underlined that validation orders are only generally granted in circumstances where a company has a viable defence to a winding up petition, where there is no serious risk of prejudice to creditors or where a company is likely to improve the position of creditors by trading at a profit.

In circumstances were HMRC had a clear right to payment, where there was nothing improper in the presentation of the petition and where the grant of a validation order would reduce sums available to other creditors, the company’s arguments in favour of such an order being granted were ‘very weak’.

The court concluded: “It is one thing to allow a company to fund a genuine defence to a petition which, if successful, would show that the petition should never have been brought in the first place. It is quite another to allow the company to fund an application to buy time to pay off its liability to HMRC”.