Insolvency Made Clear: A Guide for Debtors

Insolvency Law Made Clear – A Guide For Debtors
Box 7:
VALIDATION ORDERS
In virtue of s284 of the Act, after a bankruptcy petition has been presented
all dispositions of property are void unless they were made
with the consent of the court, either before or after the disposition.
This does not allow any claim against a third party who received property
for its fair price (‘for value’) and without notice that the petition
had been presented. However, if a third party does have notice then it
is not safe for them to trade with the debtor because the Trustee can
claim against them. The section therefore creates a problem for the
debtor if they need to sell property or grant a charge over property in
order to raise money to pay their debts.
The solution is to apply to the court for permission to make the sale,
known as a ‘validation order’. The debtor should give notice of the
application to the petitioning creditor. A petitioning creditor is likely
to agree to this application, if they think that the transaction is legitimate.
The rules for the application are found in paragraph 12.8 of
the PDIP. The court will make the order if it is satisfied that either the
debtor is solvent and able to pay their debts, or that the transaction
will be beneficial to and not prejudice the unsecured creditors of the
debtor as a whole.
The selling of an asset for value will not usually prejudice the unsecured
creditors. For example, imagine the debtor owns a car worth
£10,000. Before the sale, the debtor held an asset, the car. After the
sale, the debtor holds £10,000. The unsecured creditors are no worse
off: if anything, their position has been improved since the debtor is
now able to pay the creditors more easily.
An example application for a validation order for a company is at
Annex 1.
4. Transactions defrauding creditors: s423 of the Act. This applies even
when the individual has not gone bankrupt, but where they entered into
a transaction at an undervalue and the purpose of the transaction was to
defraud the creditors, i.e. to put assets outside of their reach. Where there
are multiple purposes, the court will apply a ‘substantial purpose’ test, i.e.
that one important result which the debtor intended to achieve by the
transaction was that creditors would be put in a worse position. In general,
Trustees will prefer to use the standard ‘transaction at an undervalue’ approach
where it would not be necessary to demonstrate that the bankrupt
had a particular intention.
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