Legal Briefing

Winding up petitions: the sharpest debt recovery tool in the box?

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Mergers & Acquisitions | 01 June 2012

As economic pressures continue to affect corporate Britain, companies are imposing their own austerity measures. As suppliers of goods and services, companies want to receive payment as soon as it is due, either in accordance with payment terms set out in their terms of business or within a reasonable time. On the other hand, as consumers, many companies want to pay for the goods and services they receive only where payment is properly due, and then at the last possible moment. These conflicting interests, between the supplier (who wants to receive payment as quickly as possible) and the buyer (who wants to delay payment as long as possible), can often give rise to disputes.

Once irreconcilable positions are adopted, creditor companies are faced with a further challenge: how to recover sums due, quickly and efficiently. Creditor companies may have concerns that High Court or County Court proceedings, seeking judgment in respect of a debt, will be slow and expensive, particularly if the debtor is likely to dispute liability. They may also be put off bringing debt claims by the uncertainty that a judgment will lead to successful enforcement action. These anxieties often lead creditor companies to turn to the insolvency regime as a means of applying pressure to achieve payment of debts. The comments below relate to disputed debts between corporate entities. Different rules, provisions and considerations apply in relation to debts owed by individuals, and these are not addressed in this article.

STATUTORY DEMAND

Although a statutory demand is a written notice in a prescribed form demanding payment of a debt owing to a creditor company by a debtor company, its intended importance within the insolvency regime is in its evidential value1. If, within 21 days of service of a statutory demand, a debtor company fails to make payment of the debt demanded or secure or compound for it to the reasonable satisfaction of the creditor company, this is deemed to constitute evidence of the debtor company’s inability to pay its debts2. The reason why evidence of a debtor company’s inability to pay its debts is important is that this is the most common of the eight grounds on which the court may wind up a company3. Service of a statutory demand should, therefore, signal a creditor company’s intention to present a winding up petition in respect of the debtor company if the relevant debt is not paid.

Notwithstanding the above intent, many creditor companies regard the statutory demand primarily as a quick and inexpensive means of achieving payment of debts due from debtor companies. It can be persuasive.

There will be circumstances in which the debtor company does not ‘pay the debt or secure or compound for it to the reasonable satisfaction of the creditor’, to use the language of statutory demand itself4. The most common reasons for the failure of a debtor company to make the payment demanded by a statutory demand are:

  1. inability to pay; and
  2. a dispute as to liability to pay.

Each scenario has implications for the creditor and the debtor company and we propose to address these below from the perspective of both the creditor company and the debtor company.

YOUR COMPANY IS CONSIDERING PRESENTING A WINDING UP PETITION

Once a debtor company’s inability to pay its debts has been established by its failure to pay the debt demanded by a statutory demand within the stipulated time, the creditor company is entitled to petition the court to wind up the debtor cfompany5. The winding up of the debtor company may not, however, achieve the desired outcome for the petitioning creditor – namely payment of the debt – and may, in fact, have unintended consequences.

Once a winding up petition is presented to the court, the debtor company’s bankers will invariably freeze its bank accounts as soon as they have notice of the existence of the petition. This often does not occur until after notice of the petition has been advertised in accordance with the statutory rules6. In that event, it may be difficult for the debtor company to trade, further reducing the prospect of it becoming able to pay its debts, including that of the petitioning creditor, in future.

Furthermore, once a winding up petition is presented, the fortune of the debtor company is not solely in the hands of the petitioning creditor. If the petitioning creditor decides, subsequent to the presentation of the petition, that it does not want to proceed with it and so fails to advertise it within the requisite time limits or consents to the dismissal, withdrawal or adjournment of its hearing, or otherwise does not support it, the court may, in certain circumstances, order that another creditor or contributory be substituted as petitioner7. That may render any ‘deal’ done between the petitioning creditor and the debtor company after the date of presentation of the petition vulnerable to being unwound. This is because, in the event of the debtor company being wound up, any disposition of the debtor company’s property made after the date of presentation of the petition is, unless the court orders otherwise, void8. This can include payments from the debtor company’s bank account, whether it is in credit or overdraft, although there is some doubt whether this argument holds good for payments out of an account that is overdrawn (Re Gray’s Inn Construction Co Ltd [1980]). The relevant statutory provision is intended to achieve parity for all unsecured creditors of a debtor company in the event of a winding up order being made.

The unintended consequence of a creditor company presenting a winding up petition solely in order to pressurise a debtor company to make payment of its debt could be the making of a winding up order and the debt that is the subject of the petition falling to be claimed in the liquidation of the debtor company.

To quote Evans Lombe J in Re Javelin Promotions Ltd [2003]:

‘A winding up petition is not a legitimate means of collecting debts.’

That said, there is no doubt that it will continue to be considered as such by many creditors.

YOUR COMPANY IS FACING A WINDING UP PETITION

When faced with a winding up petition (or a statutory demand), the consequences of a debtor company doing nothing will invariably be serious and, ultimately, could lead to the making of a winding up order against it.

The mere fact of presentation of a winding up petition, even where it does not lead to the winding up of the debtor company, can be detrimental. The debtor company’s commercial reputation could suffer. As mentioned above, its ability to trade could be damaged if its bank accounts are frozen. Suppliers may be unwilling to provide credit, and may not even be willing to trade on a basis that sees them receive payment in advance or on delivery, for example, due to the risk that acceptance of payment for goods may be deemed to be a void disposition, if a winding up order is made later.

The presentation of a petition against a debtor company will usually trigger breaches of financial covenants in banking and finance agreements and events of default in other contracts to which it is a party. Added to this, a debtor company faces the expense of dealing with the petition.

A debtor company that is served with a statutory demand or winding up petition in respect of an undisputed debt should act with haste to engage with the creditor company, to attempt to make arrangements to pay, secure or compound for the debt to the creditor’s satisfaction.

If the debt is agreed, the debtor company should seek to agree terms of payment with the creditor company, as well as obtain its written agreement not to present or advertise a winding up petition so long as the debt is being repaid in accordance with the agreed terms. If the debtor company is unable to pay the debt in full, it should consider whether it can make payments in instalments or offer to pay the creditor company a reduced amount. The sooner action is taken, the greater the likelihood of avoiding the detrimental consequences mentioned above.

ADVICE FOR CREDITORS

Faced with a debtor company unable to pay its debt in full, creditor companies need to consider the advantage of accepting deferred or reduced payments rather than seeking to have the debtor company wound up by the court. Unsecured creditors in compulsory liquidations will only receive a dividend once the debtor company’s secured creditors and the costs of the liquidation have been paid. In fact, dividends to unsecured creditors are often minimal in compulsory liquidations and it is not unusual for them to receive no payment at all. However, in this type of scenario, the supplier creditor will be best advised to stop accepting orders from the debtor company unless and until given satisfactory evidence of the debtor company’s ability to pay for any future supplies.

ADVICE FOR DEBTOR COMPANIES

It may assist to educate the creditor company on the effect of the presentation of a winding up petition, or if it has already been presented, its advertisement, and the consequential impact on the likelihood of the creditor company receiving payment of the debt.

YOU ARE A DEBTOR COMPANY AND YOU DISPUTE THE DEBT

If a debtor company receives service of either a statutory demand or a winding up petition and the debt that is the subject of it is disputed in full, it should set out in writing to the creditor company the grounds on which the debt is disputed. If a winding up petition has not yet been presented (or has been presented but not yet advertised), the debtor company may seek a written undertaking from the creditor company not to present a winding up petition grounded on the disputed debt (or advertise the petition if already presented). If the creditor company refuses to give such an undertaking, the debtor company may apply to court for an injunction restraining presentation of a winding up petition (or, if it has already been presented, restraining its advertisement), and also seek its costs of the application9. As is evident from recent case law, discussed further below, the court will not be slow to grant an injunction to restrain the issue of a winding up petition where there is a genuine dispute on substantial grounds in relation to the debt.

If a debtor company disputes only part of the debt and cannot reach a compromise with the creditor company in respect of the whole of the debt, it should make payment of the undisputed sum. The statutory demand or winding up petition can then be challenged, as set out above, in respect of the disputed element of the debt.

In Re Javelin Promotions Ltd, the court at first instance dismissed a winding up petition against the debtor company on the grounds that the debt that was the subject of the petition was disputed. That dispute was held to be on the grounds that the underlying contract between the petitioning creditor and the debtor company contained an implied term that time was of the essence for the delivery of goods that were the subject of the contract, and delivery having been made late, there was a total failure of consideration. On appeal, Evans-Lombe J found that the registrar at first instance was not justified in reaching the second of those two conclusions and that, consequently, the debtor company had not demonstrated a bona fide dispute in relation to certain consignments of goods and that in respect of those, the appeal should be allowed. This case serves as a reminder not only that the court will not permit the abuse of the insolvency regime in respect of disputed debts, but also that it has discretion to allow a winding up petition to proceed in respect of the undisputed part of the debt, provided it exceeds the statutory minimum of £750.

In Tallington Lakes Ltd v South Kesteven District Council [2012], the Court of Appeal has recently considered the evidential threshold that should be applied when a debtor company seeks to restrain the presentation of a winding up petition against it. In that case, Tallington Lakes sought permission to appeal the order of Norris J in the lower court by which the court dismissed Tallington Lakes’ application to restrain the presentation of a winding up petition presented by South Kesteven District Council. Lord Justice Etherton found that a debtor company did not face a high threshold when attempting to argue that there was a genuine dispute over the debt forming the basis of the petition. Although, on the facts of this particular case, permission to appeal the lower courts’ refusal to restrain the presentation of a winding up petition was refused, Lord Justice Etherton did provide useful commentary as to the circumstances in which such an application might succeed. He said:

‘I have to emphasise, however… that it is well established that the threshold for establishing that a debt is disputed on substantial grounds in the context of a winding up petition is not a high one for restraining the presentation of the winding up petition, and may be reached even if, on an application for summary judgment, the defence could be regarded as “shadowy”.’

This case offers useful guidance to creditor companies considering pursuing debts by means of statutory demands and winding up petitions in circumstances where the debtor company may have grounds to dispute the debt. Debtor companies should also take note of this case in circumstances where they dispute the debt.

Similarly, where a debtor company has a genuine and serious cross-claim against the petitioning creditor in an amount equal to or exceeding the amount of the debt owing to the creditor company, this can found an application to restrain or a defence to the petition (Seawind Tankers Corporation v Bayoil SA [1998]).

COMMENT

Particularly in the current economic climate, it is important for creditor and debtor companies to engage with one another in relation to debts. Creditor companies are entitled to apply full pressure on debtor companies in respect of debts that are due and in respect of which there is no genuine dispute or cross-claim. The statutory demand and winding up petition are valid weapons in a creditor company’s armoury. They need, however, to be deployed with caution. On the other hand, a debtor company with a genuine dispute or cross-claim should not be reluctant to come forward with full details of the basis for its dispute. If a creditor company fails to pay due regard to that dispute, a debtor company should bear in mind the court’s willingness to intervene to grant it injunctive relief.

It is worth remembering that statutory demands and winding up petitions can have far-reaching consequences for companies, whether they are creditors or debtors.

By Marie-Louise King, partner, and Claire Rigby, trainee solicitor, Druces LLP.

E-mail: m.king@druces.com; c.rigby@druces.com.

Notes

  1. Rule 4.4(2) Insolvency Rules (IR) 1986.
  2. Section 123(1)(a) Insolvency Act (IA) 1986.
  3. Sections 122(1) and 122(1)(f) IA 1986.
  4. Form 4.1.
  5. Section 124(1) IA 1986.
  6. Rule 4.11 IR 1986.
  7. Rule 4.19 IR 1986.
  8. Section 127 IA 1986.
  9. Rule 7.1-7.10 IR 1986.

Re Gray’s Inn Construction Co Ltd [1980] 1 WLR 711

Re Javelin Promotions Ltd [2003] EWHC 1932 (Ch)

Seawind Tankers Corporation v Bayoil SA [1998] EWCA Civ 1364

Tallington Lakes Ltd v South Kesteven District Council [2012] EWCA Civ 443