Please repeat after me: “In 2014, I shall be more cautious before using the threat of winding up petitions to recover my corporate debts!”

Why? What the courts say

A judgment handed down last month, in which a nursing home (Foxholes) secured a High Court injunction to restrain the issue of a winding up petition against them by a supplier (Accora), serves as a warning that even the threat of a petition, whether or not preceded by a statutory demand, is capable of blowing up in your face.

In a 59 paragraph judgment ([2013] EWHC 3712 (Ch)), Mr Edward Murray gave as clear an exposition as you will find of the balance which the Court has to strike where the parties are at loggerheads as to whether there is “a substantial dispute on bona fide grounds” that relates to the whole of the debt.

On the one hand, the court wishes to avoid causing injustice by giving undue credence to the attempt of an unwilling debtor to raise a “cloud of objections” that are without merit. On the other, it could also cause injustice to a debtor who may have substantial grounds for disputing the debt, given that a winding up petition can often have immediate and catastrophic consequences for the debtor company, e.g. bank accounts being frozen, complete loss of credit. Underpinning this balance is the important principle set out in another High Court case in 2012 (see http://www.bailii.org/ew/cases/EWHC/Ch/2012/2702.html) that the threat of a winding up petition should not be used to pressure a debtor into paying despite the fact that there appears to be a substantial dispute, which could be litigated through the civil courts in the ordinary way.

On the facts (which centred around a £435,000+VAT contract to supply furniture and furnishings in conjunction with a nursing home redevelopment in which the home withheld the final instalment, having raised issues following delivery) the Judge found grounds to merit a proper court process with the availability of cross-examination of witnesses, etc, having formed the “distinct impression… that the purpose of Accora’s threatening to present a winding up petition… was indeed to pressure Foxholes into paying the amount invoiced despite there being a substantial dispute…”. He noted that “it remains open to Accora to litigate this matter… and seek its remedy, if one is justified… through that avenue.”

In my experience, injunctions to prevent winding up petitions have traditionally been regarded by the courts as ‘a sledgehammer to crack a nut’, such that the (sometimes disproportionate) costs of such an emergency application would have been heavily discounted, or even disallowed, particularly where the alleged debtor was a big company which was clearly and demonstrably solvent. However, now that it is well settled law that even a £750 undisputed element of a much bigger debt can found a successful petition and that solvency in terms of asset values, etc is pretty much irrelevant, such applications have become an active battle ground for parties who for whatever reason have been unable to resolve their differences (here the judge dismissed allegations of bad faith against Foxholes). Often they can ill afford to sustain the cost of such contested proceedings, particularly where the unsuccessful party normally bears both sides’ costs. Neither Foxholes nor Accora were large, cash rich, entities. In another case, such costs exposures could make all the difference to one or both companies’ survival.

Why? Tactics

Whilst it is easy to see the superficial attraction of pursuing a winding up petition to speed up recoveries and / or ‘steal a march’ on other prospective creditors if there are concerns about the debtor’s solvency, this avenue really only lives up to its promise in the most straightforward cases where the debtor can in fact pay and has no reason not to pay, but is simply refusing to do so. It is of course sometimes very difficult for a creditor to judge if this is the case, or whether the non-payment of your account is symptomatic of a larger problem.

It must also be remembered that winding up petitions were never designed as a debt recovery tool; they are a collective insolvency procedure designed to ensure that a liquidator takes control of the debtor’s assets sooner rather than later with a view to their being realised for best available value and distributed fairly amongst all creditors. As such, if you issue a winding up petition and this results in payment, insolvency law provides that you cannot retain that payment in the event that you are unable to withdraw the petition, e.g. if you have advertised it prematurely and/or if some other creditor takes over your petition. It is also a commonly held misconception that if you do not at least threaten a winding up petition you are not exerting genuine commercial pressure, such as to allow you to retain payments from companies which may fail at a later date and which turn out to have been insolvent at the time they made you a payment or as a result of it (an unlawful preference). The reality is that if you issue ordinary civil court proceedings, or even a firm letter before action, and this results in payment, this pressure is no less likely to protect those payments in the event of the debtor subsequently entering an insolvent procedure. Of course there are other ways to exert pressure, too, including withholding essential deliveries or services pending payment.

It follows that if there is any expectation at all that the whole of a claim may be defended on grounds which are more than entirely spurious (having considered any possible weaknesses in your case with your legal team), the civil court claim and the prompt pursuit of judgment within that claim will generally be the wiser choice. It is, after all, normally a good deal easier to extricate yourself from a civil court claim which takes an unwelcome turn than it is from contested winding up petition proceedings where the stakes are raised very high, very quickly.

What? Your Resolutions

So how should parties navigate this minefield in 2014?

Resolution 1: Remember that a lot of disputes can be avoided by achieving the highest available level of clarity in contractual terms at the outset, and as a project evolves post-contract. Take appropriate advice when documenting your terms and resolving any issues as you go. In the longer term this will almost always save you money.

Resolution 2: Be aware that most disputes are suitable for some form of alternative dispute resolution, whatever form that may take, and be prepared to explore all options. Again, take appropriate advice to help you focus all parties on the commercial outcome you are looking for rather than entrenched positions. Unless the other parties are completely intransigent, this will also save you money in the long term, and if they are unwilling, the fact that you have offered will place you at a strategic advantage.

Resolution 3: If you really feel that a debtor is leaving you no other option, only follow the winding up petition route if you are really sure of your ground, e.g. if your advisors tell you that you have a very secure position such as a clear admission of liability in the face of an unambiguous case, or better yet a judgment in the civil courts.

Resolution 4: If you do decide to proceed with a petition, it is normally advisable (though not technically essential) to validly serve a statutory demand first, if only to flush out any suggestion that the debtor might look to injunct against your proposed petition, and/or to give them an opportunity (if they are genuinely insolvent) to appoint administrators or voluntary liquidators (with whom you can then actively engage) and thus save you the cost of the petition. A debtor can normally be expected to (be advised to) give you some notice of their intention to injunct against the petition or to appoint insolvency practitioners, in which case you can always offer to withdraw the statutory demand as appropriate, at little or no cost as the demand itself is not considered to be part of any legal process, just a precursor to one. A valid statutory demand can often be recycled as initial evidence of your claim in any insolvency, e.g. for voting purposes. If a company debtor applies for an injunction without any warning of their intention to do so, and you are not already on notice of any dispute (particularly if you can evidence you have considered any possible defences with your legal team and discounted them), the court might well be persuaded that the debtor should bear their own costs of the injunction, even if they are successful in securing one.

In short, therefore, winding up petitions remain useful devices which are capable of limiting your exposure to reluctant debtors, but they are also inherently dangerous and must be handled with great care if you are to avoid them going off prematurely and blowing a hole in your bank balance!

Happy New Year to all, and here’s to a year of careful and successful credit management!