How lenders can protect against winding-up petition risk

Though there remains an exception in relation to unpaid rent to a landlord, the expiry of the temporary measures means that businesses are at risk of winding-up petitions being presented against them in respect of unpaid and undisputed debts of £750 or more. We are seeing a large increase in the number of winding-up petitions being presented across all sectors as a result.

The presentation of a winding-up petition presents a risk to lenders to the affected business. There are steps lenders can take, however, to protect themselves from the impact of a winding-up petition.

Void dispositions

Any payments or disposals of property or assets made by a lender’s customer after a winding up petition is presented will be void in a subsequent liquidation, unless the court orders otherwise, and must be repaid to the liquidator. This is set out in section 127 of the Insolvency Act 1986 (IA86): “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.”

Lenders need to be aware and take precautions to ensure they are not liable to repay money received by customers subject to winding-up petitions.

Examples of void dispositions

Void dispositions can apply to the lender too. The lender could be liable to repay sums it has received from or on behalf of the customer in a subsequent liquidation. This could include payments made after the date of the petition into overdrawn accounts, in repayments of loans, or payments made under other funding agreements.

The lender will not be liable to repay monies paid into the customer’s account which is in credit – the credit balance will be considered the customer’s property available to liquidators. However, payments made from the customer’s bank account to third parties are likely to be caught by the restrictions under s127. This could be a risk for the lender if the lender is on notice of the petition and allows such payments to be made.

Freezing the bank account

As a result of the risks of void dispositions, it is common practice for lenders to “freeze” or rule off customer accounts as soon as the lender becomes aware of the winding-up petition. The lender should also stop any payments from being made into an overdrawn account.

Freezing the bank accounts is the clearest and quickest way for the lender to mitigate its risk of allowing, or being a party to, any payments which could be deemed void if the customer is subsequently wound up. Freezing the bank accounts can have a material impact on the customer’s ability to trade and can often cause friction with customer, which is why lenders also need to consider the potential for validation orders and the withdrawal of winding-up petitions on their approach on an urgent basis.  

Validation orders

Post-petition payments can be ratified by applying to the court for a validation order. If a validation order is granted, the payments subject to that order will not be void in a subsequent winding-up of the customer, and the lender can “unfreeze” the bank account to allow these payments to be made. 

Obtaining a validation order will often need to be done urgently to allow the customer to make business critical payments necessary for it to continue to trade. It is also a route available to the lender if it has received a post-petition payment from the customer that may become void.

To obtain a validation order, the customer will need to show that the payments requested to be made are business critical and are necessary for the benefit of the general body of creditors or for exceptional circumstances. Cashflow and financial evidence is often required by the court to validate the payments. Successful applications will depend on the circumstances. They will typically succeed, however, where payments are shown to promote a benefit to the company and are not prejudicial to its creditors.

Validation orders will not typically be granted if the payments requested benefit the directors or connected creditors, rather than the creditors as a whole – such as a reduction in a director’s liability under a personal guarantee or the repayment of an intra-group loan.

Withdrawal of a winding up petition

If the petition debt is undisputed and the customer has the ability to pay the debt in full, payment should be arranged as soon as possible. If the petition debt is satisfied in full, the petition can be withdrawn, and the risk of winding-up will fall away – in which case a validation order may not be needed.

If a petition debt is paid in full before the petition has been advertised and no creditors have come forward in opposition or support, then the petition can be withdrawn by an application to the court.

How quickly a petition is withdrawn depends on whether it has already been advertised. Advertisement can take place as early as seven business days after service of the petition on the customer. If the petition is advertised, it cannot be withdrawn or dismissed until the date of the hearing of the petition, which could be four to six weeks later.

This is the case even if the petition debt is settled in full well before the hearing date. This will be value destructive for the business and could accelerate its insolvency. Therefore, it is critical that the lender works with the customer to get an express undertaking from the creditor that it will not advertise the petition in circumstances where the petition debt is to be repaid in full.