It is a basic principle of the law of corporate insolvency that the assets of a company are effectively frozen for the benefit of all of the company’s creditors when a liquidator is appointed. The principle is provided for under Section 602 of the Companies Act 2014. It provides that any disposition of company property, which includes the sale of shares in the company and the charging of company property, that is done without the sanction of the liquidator or a director who has retained the power to do so, will be void unless the court otherwise orders.

There are special circumstances in which a court may deviate from this general principle and exercise its discretion to validate post commencement dispositions. This was recently considered by the High Court in Van Dessel v Connolly & anor [2020] IEHC 663.

Background

A liquidator was appointed to the company in question by the High Court on 4 December 2017 on foot of a petition in November of that year. Three days after the presentation of the petition, the company executed a charge in favour of two individuals over a property in Tallaght, Dublin. The individuals in question were partners in the company’s former auditors and accountants (the Lenders). The charge was executed by the company as security for a loan advanced to the company by the Lenders under a loan agreement dated 16 September 2016. This was over a year prior to the charge being entered into.

The liquidator did not consent to the company entering into the charge and he only became aware of it upon carrying out searches in the Companies Registration Office (CRO). The search revealed that the charge in question was registered on 30 November 2017. In circumstances where the Lenders insisted on the validity of the charge in question, the liquidator brought a directions application under Section 631 of the Companies Act 2014 asking the court to determine whether in all of the circumstances the charge was void.

The submissions

The Lenders submitted that the charge entered into by them with the company was not a “disposition” within the meaning of Section 602 of the Companies Act 2014. They maintained that in circumstances where the company had entered into an unconditional contract to put the charge in place before the presentation of the petition to wind the company up, the charge was valid. In essence, the argument advanced was that the loan itself, which was entered into over a year prior to the presentation of the petition, was the key agreement for the purpose of Section 602^[1]. In the alternative it was argued that in circumstances where:

• The Lenders entered into a bona fide agreement with the company to put in place a charge for the property, and

• There was a delay on the part of the company in complying with this contractual obligation the court should exercise its discretion to validate the charge.

The Liquidator submitted that the principles applicable to the validation of post-liquidation dispositions prevented the charge being valid. The Liquidator pointed to certain circumstances in particular, including:

• Where the effect of this validation would be to grant priority to the Lenders over the company’s preferential, and/or unsecured creditors, and

• Reduce any dividend that may be payable to them in the liquidation

It was further submitted that the Lenders or their solicitors were on constructive notice of the presentation of the winding up petition prior to the date that the charge was executed.

The law

The court held that the act of charging company property was clearly a “disposition” within the meaning of Section 602 of the Companies Act 2014. It cited authorities to the effect that where a company is insolvent, a disposition will only be sanctioned by the court where it will clearly benefit the creditors or there is some other very good reason for doing so.^[2] It should also not validate any transaction “in the absence of special circumstances making such a course desirable in the interests of the unsecured creditors as a body”^[3]. As to what might constitute such “special circumstances”, the court referred to the decision of Justice Costello in Re Lynch Monaghan & O’Brien Ltd.^[4] Here it was observed that the discretionary validation jurisdiction is intended primarily for dispositions to creditors whose debts arise after the presentation of the petition and not before.

Importantly, the court cited with approval the decision of Justice Clarke in Re World Port Ireland Limited^[5] and held that “Clearly, the purpose of s602 is to freeze the affairs of the company upon the presentation of the winding-up petition, so that the directors cannot thereafter choose to take steps to place certain creditors in a better position than others as regards payment of debts”.

The court rejected the argument that the requirement in the loan agreement to execute a charge was an unconditional contractual term. It also rejected the submission that the execution of the charge post presentation of the petition did not trigger Section 602, on the basis that the execution of the agreement itself did not legally effect a charge over the secured property.

The court concluded that the Lenders had constructive notice of the presentation of the petition to wind the company up prior to the execution of the charge in circumstances where they were aware of the fact that a statutory demand had been served on the company.

Conclusion

Only in special circumstances, where it is desirable in the interests of the creditors as a whole, will a court exercise its discretion to validate post-liquidation dispositions of company property.

This case is a timely reminder around the risks involved in seeking to put in place corporate security in respect of companies that are in financial difficulty, or indeed as was the case here, that are already insolvent.

For more information on post liquidation dispositions, contact a member of our Restructuring & Insolvency team.

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