In the fourth episode in the series we ask "What do I do if…I am threatened with a winding up petition in England?"
Brodies' experts, Jared Oyston and Andrew Scott, discuss the essential actions to take if your business faces this serious legal challenge, from the immediate steps you must take through to the grounds for contesting a petition.
If you would like to find out more about how Brodies can help with matters of litigation, visit our homepage here.
David Lee, Podcast host
David Lee hosts the 'What do I do if...?' podcast. David is an experienced journalist, writer and broadcaster and he is also the host of 'The Case Files' podcast by Brodies.
00:00:05 David Lee, Host
Hello, I'm David Lee and welcome to 'Podcasts by Brodies’. In this series we take an in depth look at some common and not so common questions and scenarios Brodies lawyers have faced over the years.
This series relates to English law. In each episode we talk to Brodies legal experts and some special guests about a specific issue. We hear their insights and experiences that allow them to take the right approach when they're asked the deceptively simple question, ‘What do I do if...?’.
This episode focuses on the threat of a winding up petition, a move that's potentially catastrophic for any business so knowing what to do and who to speak to if faced with such a petition is essential. I'm joined to discuss this important topic by two Brodies experts partner, Jared Oyston, a season regular and senior associate Andrew Scott.
Welcome to you both. Jared, let's start at the very beginning, what, in simple terms is a winding up petition?
00:01:09 Jared Oyston, Partner
A winding up petition is essentially an application that can be made by a creditor, so that's a person, a company, a business who is owed money by a company that they can make to the courts seeking an order that the company that owes them money be wound up on the basis that it cannot pay its debts.
So in other words, it's a means of forcing that company into insolvent liquidation and if a winding up petition is successful, the running of the company will be taken out of the hands of its directors, it'll be handed over to a liquidator and their role really will be, as the name suggests, to liquidate the assets of the company for the purpose of realising funds which will allow it to pay the company's creditors - in accordance with the statutory order of priority.
A winding up petition tends to be instigated by a creditor where there's no real dispute in relation to the amount that's owed, for example, a judgement debt, and in those circumstances the creditor is effectively entitled to conclude that the reason why the company hasn't paid is because it's unable to do so and is therefore insolvent.
00:02:15 David Lee, Host
Why, Jared, can this be such a potential catastrophe for a business, if they're faced by a winding up order? Presumably it tends to apply when a company, as you say, there is a clear debt there, and they're in pretty dire straits.
00:02:33 Jared Oyston, Partner
That's exactly right. So the reason why a winding up petition can be potentially catastrophic is because if, in due course, a winding up order is obtained, it effectively represents the end of the company's business.
The liquidator will come in and take charge, directors will no longer be in situ, the company will cease trading and what was once the company’s business - its assets, its contracts, its licences, any money that was owed by third parties - all of those will cease to be used to generate revenue for the company and will instead effectively be liquidated to raise funds to pay the company's creditors.
00:03:11 David Lee, Host
Andrew, if I can bring you in, if you're facing a winding up petition, what are the options? How can you seek to challenge the kind of threat of been wound up?
00:03:25 Andrew Scott, Senior Associate
I think a stage of a threat of a winding up, I mean Jared mentioned a judgement debt, but often what you will find is that the threat of winding up proceedings can take the form of a letter from a solicitor or even a statutory demand, which is a prescribed form which is issued to company’s setting out what the debt is and demanding that within a period of time.
The first thing you will want to do, if you receive either of those, is to check first of all that it's got the correct party named. It's not uncommon in our experience for a creditor to send a demand to the wrong entity, and we certainly want to check that, but if there's nothing technically wrong with the demand that has been made, the critical question is whether the debt is disputed. If it is undisputed, you're going to have to pay that debt, or certainly, if that's not possible because of cash flow issues, you need to immediately engage with that creditor to agree a time to the agreement. What you don't do in this situation, and what happens in many situations as people bury their heads in the sand, you need to engage.
However, if the debt is disputed, and again, it's not uncommon for creditors to threaten winding up on the basis of a debt which actually is a disputed debt, then you do have a few more options available to you at that stage. That's because the courts are very clear that a winding up process is not the place adjudicate on a disputed debt. If it's disputed on bona fide and substantial grounds, it can't just be ‘I don't think this is due’, there has to be a substantial basis for saying that it's not due. Then that person cannot petition to wind up the company, they don't have the standing to do so.
So on receipt of a statutory demand or on a threat of a winding up petition, what you really want to do is understand what the debt is, is it disputed? Is there any element of disputed debt? Then immediately contact the other side to set out the basis on which it's disputed and ask them to undertake not to make any formal applications to the court to wind up.
It's only really at that stage if they fail to give you that undertaking, that you might need to take proactive steps yourself to prevent them from doing that.
00:05:43 David Lee, Host
So let's assume there's no dispute on the debt, there's no errors made, there's no suggestion of a settlement. We move to the winding up petition.
If a winding up petition is then presented to a court or advertised, what are the first steps a business should take when it's got to that petition stage?
00:06:05 Andrew Scott, Senior Associate
Let's take this scenario again, the petition has been presented but not yet advertised. The mere presentation of a petition has some serious consequences, some of which we'll look at a little bit later, but those only multiply once it's advertised. So if you're only at the stage where it's being presented, again, you want to take very immediate steps to prevent any advertisement if that is possible. Again, if the debt is undisputed - you'll want to arrange payment, or you want to discuss with the creditor and what they will accept in terms of a payment proposal.
But it may be, and it's again not uncommon, that the petition has been presented but you do think there is a genuine dispute to the debt, or there is a basis on how the petition has been presented. You think that the petition has been presented wrongly and at that stage you want to be in immediate contact with your opponent to be able to explain why that is and whether they will withdraw the petition or certainly give an undertaking not to advertise. It's a really small window because ultimately, a creditor, once they have served the petition on you as a company, there are about seven days before they will advertise. So you really have to get your skates on, either to pay the debt if you think that is the right thing to do or if there is a dispute, to engage with them within that.
Once it has been advertised, the next stage is really the hearing of the petition and so you'll be looking to prepare what you're going to do at that hearing. Both of those cases, you really need to be taking immediate action to prevent a more serious consequence coming in the future.
00:07:54 David Lee, Host
Are the majority of threats of winding up resolved before it gets to the advertisement stage?
00:08:01 Andrew Scott, Senior Associate
Yeah, because of the catastrophic implications. As Jared explained, often if a company does have the means to pay the debt, then the threat of a winding up will result in that payment being made and often it will be the trigger for meaningful negotiations between the parties so that it never really reaches the stage of the Court. So, it can often be a catalyst for settlement.
00:08:32 David Lee, Host
Thanks very much. So, back to you Jared, let's talk about the kind of flow of money or not when winding up proceedings happen.
Can a bank freeze a business's account if a winding up petition is presented, and what are the implications of that for the business?
00:08:50 Jared Oyston, Partner
So it is very standard for company’s bank accounts to be frozen as soon as its banks find out that a winding up petition has been presented and in fact, one of the practical effects of advertising the petition is to put banks on notice of the petition so that they can take appropriate steps in accordance with their own procedures and the agreement they have with the company. That will very often include freezing its accounts and the implications of that for the company are obviously very serious. With its accounts frozen, the company's ability to operate its day-to-day business operations - paying staff, paying suppliers - those will be very severely curtailed, and you can see how this scheme could become part of a snowball effect for the business. Parties who go unpaid as a result of the freezing of the company's bank accounts will effectively become part of a growing body of creditors who want their money.
So to the extent that a company may have been seeking to trade its way through and out of a challenging period for the business, that strategy becomes very much more difficult once bank accounts are frozen because of the publication of a winding up petition.
00:10:02 David Lee, Host
What are the knock on effects of that Jared? What are the business risks when your customers, and potentially other creditors, find out about this petition, and what might happen then?
00:10:15 Jared Oyston, Partner
As I say, this is very much part of this snowball effect that can develop.
So once the petition is advertised and becomes public knowledge, you can expect any party that might have an exposure to the company - its creditors, its customers - they'll be put on notice of the potentially imminent winding up, and they will naturally seek to limit their exposure to the company.
That might mean no longer trading with the company on credit, it might mean, where possible, calling in what credit may have already been extended to the company. Customers can be expected to, if possible, avoid purchasing from the company due to the risk that they won't receive the goods or services that they're seeking to purchase and will effectively become creditors themselves of an insolvent company. So really, once a petition is advertised, the risks in terms of your relationships with customers, creditors, suppliers, etc are really quite serious.
00:11:12 David Lee, Host
It's obviously got an impact in terms of credit, as you say, presumably in terms of longer-term credit rating as well, but also wider reputational impacts.
00:11:22 Jared Oyston, Partner
Absolutely. So even if a winding up order is not ultimately made, and it may be that the winding up petition was without proper foundation, but even if it's not ultimately made, the mere fact of there having been a petition presented can have a significant long-term impact on a business.
It'll remain part of the public record and parties such as existing creditors, potential trading partners, current and future customers might draw conclusions as to the company's financial health and/or its attitude towards paying its debts as they fall due.
So at worst parties might conclude that a company is at a very perilous financial situation and not one they want to do business with, but even short of that, parties might wonder whether those who are running the company have a cavalier attitude to the company's obligations to its creditors and the stability of the company generally. So it will raise all kinds of questions among the people that a company depends upon as to who's running the company, the way they're running it, and whether it's someone they can rely on.
Those considerations will obviously be reflected in the company's credit rating, so rating agencies monitor as you'd expect the relevant publications for winding up petitions and site of a winding up petition will almost inevitably see the credit rating of a company downgraded, and even if the winding up order isn't granted in due course, it may not be that that in itself will result in the credit rating bouncing back. As always with credit ratings, it's very easy to lose your credit rating and can take a long time to earn it back.
00:13:00 David Lee, Host
So we're in a pretty difficult situation, Andrew, we've heard the words "catastrophic" and "perilous."
If a company finds itself in these circumstances, what can it do if it wants to continue trading?
00:13:16 Andrew Scott, Senior Associate
So it's a very difficult situation for a company to be in, and because the mere presentation of a petition, as Jared said, even if that petition is ultimately unsuccessful, it can put it in a very difficult situation and it needs to be alive, a company in that situation to a particular section in the Insolvency Act, Section 127, which provides that if a winding up order is made, any disposition any outgoing of the company's property after the presentation of the petition is void.
So in effect, the period between the presentation of the petition and any winding up order, if it is made, any disposition of the company property in that time could be clawed back by a liquidator, and so is potentially void.
Now, the purpose of section 127 is understandable. In that period the liquidator, if one is to be appointed, doesn't want the company's property to be disposed of, but it does mean it makes it very difficult for a company to trade, but the legislation does appreciate that there may be good grounds for why a company might want to make payments, and I think Jared mentioned payments to staff or suppliers and it may be that they can't do that, but they would have to make an application to the court for a validation order in order to do that.
00:14:39 David Lee, Host
Can you tell us a bit more about what validation order does in those circumstances and then what about the other options, potentially injunctions and so on?
00:14:51 Andrew Scott, Senior Associate
The validation order gives comfort to the company, and also to the recipient of any payment, that it's not going to be undone if the company was to go subsequently into liquidation and a liquidator appointed.
To obtain such an order, the company needs to satisfy the court that the payment is in the overall interests of the body of unsecured creditors and that's a relatively high hurdle. So it is a difficult order to obtain, but it's again not uncommon in situations where a company says; this petition has got no basis, there's no grounds, I've got a disputed debt and I will demonstrate that at the hearing, but before that I've got a period of three or four weeks where I need to pay staff, I need to pay suppliers, I need to keep trading. Therefore if you can demonstrate to the court that it is in the overall interest of the creditors for those payments to be made, then you can seek that order prospectively in order to be able to continue trading.
We mentioned injunctions a couple of times previously, if your opponent is not prepared to undertake not to present a petition, or if it's presented and they are not prepared not to advertise, then as a company you can apply for an injunction to prevent them from either presenting the petition or from advertising. Again, if you can demonstrate to the court that you've got a bona fide disputed debt that the petition is not being presented on the right basis, then it prevents them from doing that, and that can give you the time that you need in order to either pay the debt or negotiate with them, or persuade them that actually this isn't the proper course and what needs to be done is that this debt needs to be adjudicated upon in a court action in the normal way, so that injunction can prevent those steps happening which can allow you to continue to trade your company as well.
00:16:54 David Lee, Host
Jared to bring you back in, let’s assume none of that happens, none of the above, the winding up petition reaches court, what happens next?
00:17:05 Jared Oyston, Partner
If no resolution can be reached which sees the winding up petition withdrawn or its advertisement restrained, then a hearing will be held before a judge and that'll usually be a judge with expertise in corporate insolvency so if you're before the High Court in London, that would be a judge from the insolvency and companies court.
So at the hearing, all interested parties will be entitled to appear and make submissions, so that would obviously include the petitioner and the company itself, but also other creditors may have a viewpoint that they want the court to take into account when deciding what order it should make.
In terms of the order that the court would make, the court does have a broad discretion as to how it deals with a winding up petition, but in broad terms, it'll do one of three things. It will either dismiss the petition or it will make the winding up order, or it will make another order essentially to hold the hearing before it is in a position to make one of those other orders. So it may it be, for example, that it decides it wants to adjourn the hearing for a period in order for further information to be gathered to make a more informed decision on the day.
But in terms of how a company could essentially defeat the winding up petition and secure the dismissal of the petition, there are two ways in which to do that and it goes back to the core point that Andrew's spoken about and this is this idea of convincing the court that this is a disputed debt.
Obviously there are other opportunities you have to potentially do that which would avoid you getting to a hearing, but if you haven't taken those steps or you haven't been able to get yourself into a position to put forward a case before the hearing, then you are able at the hearing to seek to convince the judge that there is a genuine dispute in relation to the debt underlying the winding up petition.
If you're successful in doing that, you're not completely out of the woods. What the court will usually do is make an order for the filing and service of evidence in relation to the dispute and adjourn the hearing to a later date once that evidence is ready, so that the court is able to make a decision as to whether there is sufficient evidence or evidence of a dispute there to justify the dismissal of the winding up petition.
The other way in which a company might be able to avoid a winding up petition being made is if it can convince the court that it will be able to make payment of the debts within a reasonable further period of time. The company in that situation will be able to give you a credible explanation, hopefully backed up by clear evidence as to why it can't pay the debt now but will definitely be able to do so within a short further period. In that situation, the court may take the view that it's not in the interests of the parties as a whole to make in order for the winding up of the company. So that's another way in which a party, even if there's no disputed debt and even if it isn't actually capable of paying there and then, might be able to avoid a winding up order being made against it.
But otherwise, the company should brace itself for a winding up order being made and it's fair to say that the court will have very little truck with complaints about market conditions, needing more time to turn things around, perhaps the possibility that the companies owed money by other parties as well, which should have been paid. The court will have relatively little scope to take those kind of factors into account, so once a winding up petition reaches the court, the company really will have its work cut out to avoid a winding up order being made it is really only the existence of a genuine dispute in relation to the debt or a very clear plan to pay the debt within a reasonable timeframe that will avoid that outcome.
00:21:01 David Lee, Host
Thanks very much Jared. It's clearly a complex area, there are a number of options at each stage as to which direction the dispute can go, so why is it important to get early-stage legal advice if you are caught up in this process?
00:21:19 Jared Oyston, Partner
Hopefully, what will be clear from this podcast is that whilst a winding up petition in itself needn't spell doom for a company in its business, it can have very serious consequences for a company and the path to resolving the situation without suffering those consequences is really quite a narrow one. So, the right action has to be taken in a really quite tight time frame in order to avoid some of the snowball effects that we've discussed in this podcast.
So decisions such as whether the company can genuinely dispute the debt, whether it should seek to injunct the advertisement of the petition, those are really quite technical questions that the company will have to reach a view on pretty quickly and given the stakes involved, it is worth investing in appropriate advice in order to ensure that the company gets those big calls right.
00:22:12 David Lee, Host
Thank you very much, Jared, and thank you to Andrew for your tremendous insight today. A really clear explanation there of a very complex area.
This podcast is part of ‘Podcasts by Brodies’, where some of the country's leading lawyers and special guests share their Enlightened Thinking about issues and developments. Having an impact on the legal sector and what they might mean for organisations, businesses and individuals across the UK economy and society.