But how successful is the insolvency strategy of the obstructive spouse? A number of recent cases have caught the headlines, such as those involving the late Scot Young and Michael Prest. In each case a husband sought to frustrate his former wife, and the Court, by hiding his assets in response to a claim for financial support.

What may not be familiar to practitioners advising spouses in similar situations is the provisions in the Insolvency Act 1986 (the Act) that may assist in setting aside a transaction entered into by the obstructive spouse who is subject to an insolvency procedure, such as a voluntary arrangement or bankruptcy. For example, section 423 of the Act includes provision for not just a Trustee in Bankruptcy (TiB) but any creditor or victim (including a spouse with an unsatisfied financial order) to seek to set aside avoidance transactions.

The Court will need to be satisfied that the bankrupt has deliberately put the asset out of reach of his creditors but it is enough that the intention to put assets out of reach is a substantial factor rather than dominant purpose. Moreover section 423 is extra territorial, whilst limitation is also benevolent: in any action brought by the “victim”, limitation is 12 years; and if the obstructive spouse is insolvent, the TiB has 12 years from his appointment to apply to the court. In those circumstances, a Bankruptcy Judge can, amongst other things, order the transfer of assets back to the debtor’s TiB or even to the aggrieved spouse, as was the finding in a recent case in which we acted for a “victim”

Practitioners will also be familiar with the scenario of a TiB challenging a former spouse’s entitlement to an asset that was transferred pursuant to an order in ancillary relief proceedings. In light of the recent case of Sands v Singh [2016], where the TiB failed to show undervalue in the transaction, a TiB will find it harder to overturn such a transfer in the absence of dishonesty or collusion between the parties. But how does that sit with section 423 of the Act? What happens where the evidence suggests lawyers for one spouse knew of the imminent bankruptcy of the other spouse but did not share this information with their client or the Court, as happened in a recent case in which we acted for the TiB? Moreover, a TiB has additional power to challenge periodical payments on the basis that the receiving spouse is being preferred to other creditors.

Finally, be aware of the trapdoor that is section 284 of the Act, which declares any transaction entered into by a debtor between the presentation of a petition and a bankruptcy order is void. This includes property adjustment orders; the unwitting matrimonial court is not validating the obstructive spouse’s scheme, which may still be set aside by the Insolvency and Companies Court.

The Restructuring & Insolvency team at Edwin Coe has experience of assisting practitioners and advising spouses in these situations. We have particular expertise in pursuing complex, cross-border claims against wealthy individuals.

Our team is top ranked by the independently researched legal directory Chambers UK 2021, for our Personal Insolvency practice, and Partners, Ali Zaidi and Simeon Gilchrist are both individually ranked. According to clients in Chambers, Ali Zaidi is “professional, approachable and has a commercial understanding of the ground realities,” and another client says of Simeon Gilchrist: “If I have an insolvency-based issue I can’t get my head around, he is the closest I have to a go-to guy for getting me out of the woods.”

Unsurprisingly this has become increasingly contentious for HMRC which is often the largest creditor in any subsequent insolvency. Increasingly we are seeing HMRC exerting pressure on Insolvency Practitioners to pursue directors personally for operating an abusive EBT, not to mention encouraging liquidators to file adverse reports recommending the commencement of director disqualification proceedings.

Practitioners will be aware that HMRC has led the challenge to disguised remuneration schemes, taking the view that funds paid into these schemes are earnings on which PAYE and NIC were due and which the employer should have accounted for. Concerted efforts have been made to clampdown on their use, including the issuing of accelerated payment notices (APN) when there are arrangements that fall within DOTAS rules. This has been followed by the Finance Act 2018 implementing charges on employers with unpaid tax liabilities arising from disguised remuneration schemes, should these liabilities not be settled by April 2019. Employers can also be held liable for unlimited fines and/or criminal prosecution if the employers have been involved in tax evasion. Future proposals include how HMRC will deal with directors who misuse insolvency for the purpose of avoiding tax.

These, and various other legislative provisions, give rise to two potential claims that Insolvency Practitioners may have against directors. The first is for misfeasance pursuant to Section 212 of the Insolvency Act 1986 (the Act). The second is for transactions defrauding creditors pursuant to Section 423 of the Act.

The misfeasance argument goes as follows. All directors owe a fiduciary duty to act in the best interest of the company and this is breached by participating in tax avoidance schemes which give rise to a loss to creditors, including HMRC. Whilst a director may try and rely upon the advice given by the scheme’s introducer (normally backed by a QC’s opinion) that may not necessarily apply post 2011 when HMRC first began targeting such schemes (following the Finance Act 2011) and the publicity surrounding the Glasgow Rangers case.

Where a director is found guilty of misfeasance then a Court has very wide sanctions, including ordering a director to contribute to the losses to the creditors.

The argument that paying funds into a tax avoidance scheme is a transaction to defraud creditors is as follows. All directors are aware of their duty to ensure a company pays tax on behalf of itself and its employees.

By paying monies that would otherwise be available to pay such tax for some other purpose – usually disguised remuneration – means monies that should otherwise have been available to pay HMRC have been put out of HMRC’s reach. Contrary to its title there is no need for a liquidator to prove fraud. All they have to prove is that the payment was one of several substantial reasons. Moreover Section 423 of the Act allows HMRC to pursue claims directly against directors, without the involvement of the liquidator. Increasingly we are seeing HMRC working hand-in-glove with Insolvency Practitioners by nominating them to become liquidators and then supporting them, sometimes with financial assistance, to pursue directors.

So what defence would a director have in these circumstances? In reality it all depends upon the legal advice they received at the time of entering the scheme and whether in doing so they exercised reasonable care, skill and diligence and/or acted honestly and reasonably.

Weighed against this HMRC will argue that directors are often fully aware of the risks they were taking, particularly given the critical environment within which EBT structures are being challenged. Even relying upon professional advice is sometimes difficult given that the advice normally contains numerous caveats and often will include advice to reserve funds in case a scheme does not work.

There have been various recent cases involving challenges by HMRC and liquidators, often at the prompting of HMRC, and these cases will undoubtedly increase in volume as the political climate of ‘austerity versus corporate greed’ prevails. We at Edwin Coe have extensive experience of acting with directors facing such claims, as well as their advisors, whom HRMC and Insolvency Practitioners are increasingly considering their role in promoting such schemes. If you or your clients would like advice or assistance then please do not hesitate to contact us.

Essentially, a Validation Order is a court order which authorises a company to continue trading notwithstanding being subject to a creditor’s winding up petition. A Validation Order is usually required to unfreeze a company’s bank account and effectively authorises (i.e. ‘validates’) payments and other dispositions that the company is required to make as part of its business operations.

The payments can include:

• payments out of the company’s business bank account in the usual course of its business such as payments to key suppliers, HMRC, trade creditors, rent and utilities and employees
• disposing of tangible and intangible assets owned by the company (for example, shares and other property assets)
• any other payments or dispositions that the company is required to make in the ordinary course of its business.

It is very important to appreciate that the court will only grant a Validation Order if it is satisfied that doing so will not prejudice or make worse the interest of the company’s unsecured creditors as a whole. For example, a Validation Order application for a specific transaction that would have the effect of reducing the company’s assets available to creditors in a proposed insolvency process is unlikely to be permitted by the court.

Why do I need a Validation Order?

Section 127(1) of the Insolvency Act 1986 (IA 1986) provides:

“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.”

In this context, the commencement of the winding up is the date when the winding up petition is presented to the court and before any winding up order is made. Therefore, after a winding up petition has been presented against a company, any transactions made by the company are potentially void.

This means that if the company continues trading and/or disposes of any of its assets whilst subject to a winding up petition, any subsequently appointed liquidator (i.e. the Official Receiver or a licensed Insolvency Practitioner) can seek to reverse the transaction(s) for the benefit of creditors.

The reasons for the rules on void dispositions are to:

• preserve the assets of the company for the benefit of its creditors in a compulsory liquidation process
• protect against the risk of one unsecured creditor being paid before another, protecting the pari passu principle of asset distribution in a compulsory liquidation.

A Validation Order can also help reduce the risk of directors being held personally liable for the company’s debts and being ordered to contribute to the company’s assets in a prospective liquidation.

How can I obtain a Validation Order?

In order to obtain a Validation Order from the court, the company will need to:

• file an Application Notice with the court stating that a Validation Order is sought under Section 127(1) of the Insolvency Act 1986
• include a detailed witness statement setting out the reasons why a Validation Order is required
• include a draft order detailing the company’s bank account(s) which is/are required to be unfrozen and/or details of the specific transaction or disposition the company is seeking to validate.

The witness statement in support of the application for a Validation Order should normally be made by a director of the company (or someone authorised to act on the directors’ behalf) who is involved in the company’s business operations and affairs. If appropriate, supporting evidence in the form of a witness statement from the company’s accountant should be produced.

The type of information and supporting evidence required will vary according to each company and the particular circumstances of each case, however, the following evidence should be included in the application.

Evidence in support of a Validation Order

The Insolvency Practice Direction provides that the following information should be included as far as possible in an application for a Validation Order:

• when and to whom notice has been given
• the company’s registered office
• the company’s nominal and paid-up capital
• brief details of the circumstances leading to the presentation of the winding up petition
• how the company became aware of the presentation of the petition
• where the petition debt is admitted or disputed and, if the latter, brief details of the basis on which it is disputed
• full details of the company’s financial position, including details of its assets (including details of any security and the amount(s) secured) and liabilities, which should be supported, as far as possible, by documentary evidence, eg the latest filed accounts, any draft audited accounts, management accounts or estimated statement of affairs
• a cash flow forecast and profit and loss projection for the period for which the order is sought
• details of the dispositions or payments in respect of which the order is sought
• the reasons relied on in support of the need for such dispositions or payments to be made any other information relevant to the exercise of the court’s discretion
• details of any consents obtained from the persons mentioned above (supported by documentary evidence where appropriate)
• details of any relevant bank account, including its number and the address and sort code of the bank at which such account is held and the amount of the credit or debit balance on such account at the time of making the application
• where an application is made urgently to enable payments to be made which are essential to continued trading (e.g. wages) and it is not possible to assemble all the evidence listed above, the Court may consider granting limited relief for a short period, but there should be sufficient evidence to satisfy the Court that the interests of creditors are unlikely to be prejudiced by the grant of limited relief.

Where the Validation Order application involves a disposition of property, the Court will need details of the property (including its title number if the property is land) and to be satisfied that any proposed disposal will be at a proper value. Accordingly, an independent valuation should be obtained and exhibited to the evidence.

The Court will need to be satisfied by credible evidence either that the company is solvent and able to pay its debts as they fall due or that a particular transaction or series of transactions in respect of which the order is sought will be beneficial to or will not prejudice the interests of all the unsecured creditors as a class.

A draft of the Validation Order sought should be attached to the application.

Similar considerations to those set out above are likely to apply to applications seeking ratification of a transaction or payment after the making of a winding up order.

Who do I need to serve with the Validation Order application?

A Validation Order application should be served on the following persons:

• the petitioning creditor
• any person entitled to receive a copy of the winding up petition
• any creditor who has given notice to the petitioner of their intention appear on the hearing of the petition
• any creditor who has been substituted as the petitioner.

It is important to ensure that the Validation Order Application has been properly served as failure to do so could lead to the application being adjourned or dismissed.

It should be served as soon as reasonably practicable after it is filed and, in any event, no later than 14 days before the hearing date.

What court do you apply to for a Validation Order?

When applying for a Validation Order, the application should be made to the same court that is dealing with the winding up petition. For example, a County Court or the High Court.

If the application is made in the High Court, it will normally be heard by a specialist Insolvency and Companies Court Judge.

When should a Validation Order application be made?

The application for a Validation Order is normally made after the company has been served with a winding up petition, however, it can be made before a winding up petition has been issued.

Where the Validation Order application is made before the disposition of assets has occurred, the court will grant an antecedent Validation Order only if it is satisfied that one of the following apply:

• the company is solvent and able to pay its debts as they fall due
• the transaction or transactions to be validated will be beneficial to, or will not prejudice, the interests of all the unsecured creditors as a class.

If the company continues to trade or otherwise disposes of assets without first obtaining a Validation Order it may be possible to obtain a retrospective Validation Order authorising the transaction(s) or disposition(s) at issue.

On an application for a retrospective Validation Order, the court will try to balance the interests of the recipient of the property or transaction at issue with the interests of the company’s creditors. However, it is not possible to guarantee that a retrospective Validation Order will be made and the court will need to find special circumstances that justify the overriding of the principle of pari passu payment of unsecured creditors.

When will the Validation Order application be heard?

If the Validation Order application is presented to the High Court, it will normally be heard in the interim applications list in the Business and Property Courts, which takes place on Thursdays, Fridays and every second Monday.

Urgent applications for a Validation Order typically require a Certificate of Urgency certifying that the matter is urgent and cannot await a hearing before the judge in its due turn and specifying the reasons why. This can include the need to pay staff wages, the petition debt and/or other key suppliers and creditors of the company.

When will the court grant a Validation Order?

Validation Order applications are at the discretion of the court.

As a general rule however, a Validation Order will only be granted if the court is satisfied that doing so is likely to improve the position of the company’s creditors – particularly its unsecured creditors.

Where a Validation Order is sought to validate the sale of a specific asset, for example, the court will need to be satisfied that the proposed sale will be a proper value. The asset should therefore be sufficiently identifiable and an independent valuation provided in support of the application.

What might happen if I do not obtain a Validation Order?

If your company is subject to a winding up petition and you dispose of any company assets without obtaining a Validation Order and the company is ultimately wound up, the directors could be found personally liable for the company’s debts. In these circumstances, a liquidator could decide to issue proceedings against the directors for causing the company to trade or enter into void transactions where the court could order the directors to contribute to the company’s assets by way of compensation.

Often when a company disputes the winding up petition, it will want to continue trading between the date of presentation of the petition and the hearing. Therefore, once directors become aware that a petition has been presented, it is important to obtain a Validation Order in respect of all transactions and dispositions that are required  to be made by the company.

Costs of a Validation Order application

The costs of a Validation order application are awarded at the court’s discretion. Where the Validation Order application is unopposed by the petitioning creditor and a Validation Order is granted, the court could order that the costs of the application be “In the petition”. This means that if the winding up petition is dismissed, the petitioner could be ordered to pay the costs of the application for a Validation Order.

Alternatively, if the petition debt is not disputed and the company requires a Validation Order to pay the petition debt, the court may grant a Validation Order on a no order as to costs basis.

Edwin Coe has many years of experience in assisting businesses obtaining Validation Orders and unfreezing bank accounts allowing businesses to continue trading, despite being subject to winding up petitions.  If your company has been served with a winding up petition and you need to continue trading in the meantime, please call our experts.