For years, companies have been able to legally stall or alter insolvency proceedings using notices of intention or validation orders.
However, recent cases suggest that the way in which these two solutions are used is about to change.
Here, we’ll explore how we use notices of intention and validation orders at present. Then, we’ll analyse the cases that cause concern and suggest what you, as a director, can do next.
When should you use notices of intention and validation orders?
If a company experiences financial difficulty, directors often believe that if they wait a while their fortunes may change. However, this is not always the case and their company can face severe repercussions, such as:
This is the stage where directors usually choose to seek professional advice. It is also the point at which notices of intention and validation orders tend to come into play.
While both are legitimate parts of insolvency proceedings (administration and winding up, respectively), they are also seen as acceptable short-term solutions for insolvent companies. They prevent creditors from taking action, while directors figure out their next steps.
1) Notices of intention
A company files a notice of intention (also known as an NOI). It then has ten business days to appoint an administrator. During this time, a moratorium protects the company against creditor action.
Companies can file a further notice of intention if they don’t make an appointment. As company turnaround experts, we have seen one company file four notices in quick succession. None of these notices resulted in the appointment of an administrator, but they did allow the company time to restructure.
2) Validation order
When a winding up petition is presented, a company can seek an adjournment or a validation order. The latter is a court order the company applies for, to ‘unfreeze’ its bank account.
This can ensure that lucrative projects continue, which improves returns for the main body of creditors.
Both of these solutions seem sensible, as they give directors time and seem to benefit creditors also. However, there are concerns that many companies abuse them, and their use could now could result in severe consequences for your business.
Case law: notices of intention and validation orders
Notice of intention example: JCAM Commercial Real Estate Property XV Ltd vs Davis Haulage Ltd
Davis Haulage ran a business from a warehouse it rented from JCAM, however it was in substantial rent arrears. JCAM notified Davis Haulage of its intention to take possession of the premises, so Davis Haulage filed a notice of intention to appoint administrators.
It then filed three more notices, one after the other, and benefited from the moratorium placed on the business. Meanwhile, the company proposed a Company Voluntary Arrangement to its creditors, and explored alternative rescue options.
By the fourth notice, it was clear that Davis Haulage would only appoint administrators if its creditors would not accept the CVA. JCAM sought an order to remove this notice from the court file as it was an abuse of the process – after all, the company had no intention of appointing an administrator.
Originally, the High Court found that it was not necessary to have settled intention at the time of the notice, but JCAM appealed.
The Court of Appeal ruled that a conditional proposal, where a company investigates other options, does not entitle or oblige a company (or its directors) to give notice and obtain the benefits of a moratorium – according to paragraph 26 of schedule B1.
Therefore, JCAM won the appeal. The notice was removed from the file, allowing creditors including JCAM, to take action against Davis Haulage.
Validation order example: Express Electrical Distributors Ltd vs Beavis
Express Electrical Distributors is a company that trades in wholesale electrical goods. Edge Electrical (represented by Beavis) was its customer. After several disruptions to monthly payments, Express Electrical Distributors placed Edge on credit hold.
On 29 May 2013, Edge paid Express Electrical Distributors £30,000; more than enough to cover all invoices due in May. However, unbeknown to Express Electrical Distributors, on 22 May 2013 another creditor chose to present a winding up petition to Edge.
Edge’s liquidators wrote to Express Electrical Distributors demanding repayment of the £30,000, as payment occurred after presentation of the winding up petition. The company intended to distribute the money among the general body of creditors.
Its argument was based on s.127 of the Insolvency Act 1986:
“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.”
This meant that Express Electrical Distributors had to pay the money to Edge’s liquidators, unless the court exercised its discretion to make a validation order permitting otherwise. This only happens in special circumstances that show the order would benefit all the creditors, not just one.
Despite the disposition being carried out in good faith, the request for a validation order was declined and Express Electrical Distributors was forced to repay the £30,000 to the liquidators.
This case marks a change in the validation order process. They will now be even harder to obtain, particularly if they are retrospective. Applicants will need strong evidence to demonstrate the benefit for creditors, otherwise they will not receive a validation order.
What happens next?
The Insolvency Service is evaluating responses on its recent consultation about the Corporate Insolvency Framework. This includes a proposal for a general restructuring moratorium that is available to all companies.
This would act as a gateway to different forms of restructuring, including informal arrangements, contractual/consensual workout, CVA and administration. It would be a welcome change in light of recent court decisions. However, it will take a long time for these changes to come into effect.
In the meantime, directors must act much quicker to avoid penalties for improper use of notices of intention and validation orders.
Seek expert advice as soon as you are aware of any financial issues facing your company and avoid accusations of wrongful or fraudulent trading.
If you are concerned about notices of intention or validation orders, or your company finances in general, talk to our experts today for advice tailored to your company’s situation.
Robert Moore is the Marketing Manager for KSA Group Ltd who run the website Company Rescue. KSA Group are licensed insolvency practitioners and turnaround specialists where rescue is always looked at as the first option.