Royal Courts of Justice
9th June 2003
Between:
Applicant
- and -
Respondents
This is the official judgment of the court and I direct that no further note or transcript be made.
1. By this application, Mr Rose, the Liquidator of Tain Construction Ltd ('Tain') seeks a declaration that payments totalling £51,662.02 made by Tain to the first respondent ('the Bank') between 4 February 1997 and 29 August 1997 are void pursuant to section 127 insolvency Act 1986 and an order for payment accordingly. The Bank seeks validation of the payments. There is a similar application by the Liquidator against the second respondent in relation to the sum of £10,400: she does not appear and has, in fact, been debarred from defending as a result of non-compliance with an 'unless' order made against her. She makes no application for validation under the section. I am satisfied that she has been properly served with these proceedings.
2. Section 127 reads as follows:
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.
3. The background history is as follows:
a. Tain was incorporated on 13 May 1981. It started trading in 1986 as a building company. At all material times Mr. Alan Bernard ('Mr. Bernard') has been its sole director and shareholder. Tain had a share capital of £100 divided into 100 £1 ordinary shares. Its paid up capital was £2. One share was registered in the name of Mr Bernard.
b. A winding up petition ('the Petition ) was presented against Tain by HM Customs & Excise ('C&E') on 4 February 1997, based on alleged unpaid VAT in the sum of £38,730.02. It was served on 17 February 1997, and advertised in Stubbs Gazette on 5 September 1997. Tain was wound up by order made on 8 September 1997. The Liquidator was appointed as liquidator with effect from 8 December 1997.
c. The Bank was Tain's banker. Tain maintained a No 1 current account ('the Current Account') and a loan account ('the Loan Account') with the Bank at its Hammersmith Branch. As far as the Bank was concerned, Tain used the accounts for its ordinary business purposes.
d. Tain's liability to the Bank was secured by a personal guarantee executed by Mr. Bernard dated 2 March 1994, limited to £94,000, supported by a pre-existing legal charge dated 19 March 1988 over his house at 1, Netherton Road, Twickenham, Middlesex. The first charge over that property secured only some £50,000 in 1997, with the property being then worth some £350,000.
e. The Bank knew nothing of the Petition until it learnt of the advertisement in Stubbs Gazette on 5 September 1997. Up to that date payments continued to be made into and out of Tain's accounts with the Bank. As far as the Bank was aware these payments were in the ordinary course of business. During the period after presentation of the Petition, Tain did continue in business but only to complete existing contracts.
4. It appears that the debit balances on the accounts on 4 February (the day before presentation of the petition) were £31,667 (current account) and £17,837 (loan account) a total of £49,504. The witness statement filed on behalf of the Liquidator states that the total indebtedness on that date was £51,666 but it is not apparent from the documents before me where that sum comes from. I propose to take the smaller figures as the true indebtedness. As at 3 February 1997, the overdraft limits on the current account and loan accounts were (according to the heading of a letter of that date from the Bank to Mr Bernard) £35,000 and £19,887, but these figures appear to fluctuate up and down as time goes by.
5. During the course of the following months, up until the advertisement of the Petition on 5 September 1997, the Bank continued, as I have said, to operate the accounts as usual. By that date, both accounts had been fully discharged and nothing appeared to be owing to the Bank. The Current Account balance fluctuated and appears periodically to have been in balance and in overdraft, on occasions the limit being exceeded. I have no information about the state, over the relevant period, of the balance on the Loan Account.
6. Bank statements for the Current Account for period show considerable payments in and out over the period. The source and destination of these is not apparent and the parties were not able provide details to me. However, it is reasonable to infer, which I do, that significant payments were received from customers in relation to the completion of the contracts which I have mentioned. Further, it is also reasonable to infer, as I do, that other receipts were of monies which were Tain's own property. There is, at least, no evidence that there were any gratuitous payments and while it is not impossible that gratuitous payments were made by one or more the directors or by associated enterprises, it strikes me as highly unlikely; there is certainly no evidence at all that that was the case.
7. The Bank released its charge following a request from Mr Bernard in January 1999. It did so, according to the witness statement of Mr Foley (an Assistant Manger with the Bank) 'assuming that all Tain's liabilities to it had been validly discharged'. The guarantee given by Mr Bernard was not released but the Bank points out that it may not be entirely straightforward for it now to assert any liability under the guarantee. Mr Bernard, having obtained a release of the charge, might well have been led into thinking that the guarantee had gone with it, so that the Bank is now estopped from relying on it. Without seeing the evidence relevant to such a claim, I express no view at all on it other than to say that it is not possible to reject it out of hand as a possibility.
8. In his first witness statement, at, paragraph 15, the Liquidator refers to an interview by his assistant Mr Harries of Mr Bernard on 27 July 2000. He says that Mr Bernard admitted a deliberate plan on his part to prefer the Bank and the second respondent by procuring that Tain make payments to them rather than to C&E. The contemporaneous handwritten notes made of the interview contain no express reference to such an admission. It is recorded, however, that Mr Bernard did not tell the Bank of the winding up petition 'for fear of danger of freezing a/c'; in response to a suggestion that payments to the second respondent and to Mr Young were preferences his reply was to the effect that 'defence is in trying to help friends, pay off obligations'; and he also said 'can't treat people all the same'. Further, it is certainly the case that correspondence indicates a keenness by Mr Bernard on behalf of Tain to discharge the indebtedness to the Bank.
9. So far as concerns the second respondent, the evidence is that payments totalling £10,400 were made to her between 7 February and 27 March 1997. Tain's indebtedness to her is not stated in the evidence but it reasonable to infer, as I do, that it must have been at least that amount.
10. It is submitted by Mr Cherryman on behalf of the Bank that the uncertainty surrounding the source of the payments to the Bank from 4 February 1997 to 5 September 1997 means that it cannot be said that there has been a disposition of Tain's property within section 127 since the relevant property cannot be identified. I do not consider that that is correct. As I have said already, there is no evidence that any of the payments were gratuitous and we know that significant payments must have been made in respect of ordinary commercial contracts entered into by Tain. It is unrealistic in all the circumstances to think that the payments received or collected by the Bank were other than of property of Tain.
11. Mr Cherryman further submitted that payments into the Current Account and Loan Account, even when they were overdrawn did not constitute dispositions to the Bank of Tain's property which it received. In relation to a payment into an overdrawn account, that submission is flatly inconsistent with the ratio of the decision of the Court of Appeal in Gray's Inn Construction Co Ltd [1980] 1 WLR 711. Nonetheless, Mr Cherryman refers to the decision of HH Judge Rich in Barn Crown Ltd [1995] 1 WLR 147. In that case, the judge analysed what happens when a bank collects a cheque. Mr Cherryman says that the reasoning of the judge (who held that there is no disposition of the company's property where a bank collects a cheque and credits the customer's account which is already in credit) applies equally where the account is overdrawn and that it is therefore difficult to see how the Court of Appeal's decision is be explained. He relies on the passage at p156G-H, in particular the proposition that 'All that happens between the customer and the banker is an adjustment of entries in the statement recording the accounts between them.' But that is prefaced by these words: 'If the account is already in credit, no disposition of the property of the customer takes place in favour of the bank'. Where the account is overdrawn, it is not true to say that all that happens is an adjustment of entries between the bank and the customer. In such a case, there is a disposition of the customer's property in favour of the bank. I see no inconsistency between the decision in Gray's Inn Construction and the reasoning of Judge Rich. I am sure that Judge Rich was careful to confine his decision to cases where the customer's account is in credit and did not regard his reasoning as applicable to a case where the account is overdrawn. Accordingly, I reject Mr Cherryman's submission.
12. The issue, then, is whether I should make a validation order under section 127. In the absence of such an order, it is clear that the credits to Tain's accounts with the Bank, at a time when the relevant account was in overdraft, since the date of presentation of the Petition are void. The result would be that the Bank would have to account for those credit entries to the accounts, subject to one possible defence (change of position) which I consider later.
13. It has been said that the courts will, almost as a matter of course, validate dispositions made before the petition has been advertised and before the party concerned knew of the petition. That is, perhaps, stating the matter too generally and too widely. The approach which the court should adopt to validation can best be understood by reference to two cases: the Gray's Inn Construction case and Denney v. John Hudson & Co Ltd [1992] BCLC 901.
14. In the latter case, the Court of Appeal stated some general principles on which the court will validate a transaction: it must be remembered that these are only general principles and are not to be applied rigorously as if they were legislation. These principles were regarded as having been approved by the judgment of Buckley LJ in Gray's Inn Construction itself.
a. First, the discretion is at large.
b. The basis principle is one of pari passu distribution. Lightman J explains the principle in Coutts & Co v. Stock [2000] 1 WLR 906 at 909. In a passage at paragraph 6 (cited with approval by the Court of Appeal in Hollicount (Contracts) Ltd v. Bank of Ireland [2001] Ch 555 at 563 para 21) he describes the invalidation of dispositions under section 127:
as part of the statutory scheme designed to prevent the directors of a company, when liquidation is imminent, from disposing of the company's assets to the prejudice of its creditors, and to preserve those assets for the benefit of the general body of creditors.
c. In determining whether a validation order should be made, the court should ensure that the interests of the unsecured creditors are not prejudiced.
d. The court should not, except in special circumstances where it was in the interests of creditors generally, validate a transaction which would result in one or more pre-liquidation creditors being paid in full where other such creditors would only receive a dividend.
e. A disposition carried out by the parties in good faith at a time when they were unaware that a petition had been presented would normally be validated unless there are grounds for thinking that the transaction was an attempt to prefer the disponee.
15. The Court of Appeal, having accepted that the parties were acting in good faith, stated (see p 905 g-i) that good faith by itself is not enough to justify validation. Fox LJ cited a passage from the judgment of Oliver J in Re J Leslie Engineers Co Ltd [1976] 1 WLR 292 at p 304B-D which I should repeat here:
Whilst obviously the absence of any actual knowledge in the recipient of a payment that a petition is in being is a factor – indeed a very powerful factor – to be considered in relation to the exercise of discretion, I do not think that, by itself, it can be conclusive and, indeed, Mr. Potts does not so contend. I think that in exercising discretion the court must keep in view the evident purpose of the section which, as Chitty J. said In re Civil Service and General Store Ltd., 58 L.T. 220, 221, is to ensure that the creditors are paid pari passu. Obviously there are circumstances where this cannot in fairness be the sole criterion in cases where, for instance, the creditor concerned has since the presentation of the petition helped to keep the company afloat, or has otherwise swollen the company's assets, salvage cases and that sort of thing.
16. Fox LJ considered that the essential questions, on the facts of the case, were these: (1) Were the parties acting in the ordinary course of business? (2) Were the relevant transactions likely to be for the benefit of creditors generally? See at p 906a-b. In the present case, it is accepted on behalf of the Liquidator that the Bank was acting in good faith and that it believed that the payments into and out of the accounts were in the ordinary course of business. Nonetheless, there is no doubt that to validate the transactions in their totality would result in a breach of the pari passu principle and in the Bank's pre-liquidation debt being paid in full to the detriment of the other main creditor, C&E.
17. There are of course many situations in which the continuation of a company' ;s business could reasonably be regarded as for the benefit of its creditors generally: and that is recognised in the cases, in particular in Gray's Inn Construction at pp 717D-718C, the passages on which, no doubt, some of the propositions summarised in Denney were based. Buckley LJ went on, at p718F, to say this:
A disposition carried out in good faith in the ordinary course of business at a time when the parties are unaware that a petition has been presented may, it seems, normally be validated by the court (see In re Wiltshire Iron Co. (1868) L.R. 3 Ch.App. 443; In re Neath Harbour Smelting and Rolling Works (1887) 56 L.T. 727, 729; In re Liverpool Civil Service Association (1874) L.R. 9 Ch.App. 511, 512) unless there is any ground for thinking that the transaction may involve an attempt to prefer the disponee, in which case the transaction would probably not be validated.
18. However, in Denney, where the payments were made post-presentation of petition but before the payee knew of the petition, the Court nonetheless regarded one essential question as whether the relevant transactions were likely to be for the benefit of the creditors generally. On the facts, the company obtained a benefit from the payment viz the capacity to give further orders for fuel which would enable it to continue in business.
19. In the present case, I do not consider that there is any real benefit to the creditors generally in relation to the relevant transactions ie the collection of cheques and receipt of payments by the bank by crediting the overdrawn account so as to reduce the overdraft on the two accounts below their amounts at the date of presentation of the Petition. There is no evidence that the reduction of the overdraft below that amount was required by the Bank in order to permit Tain to continue in business when otherwise it could not have done so. In any event, Tain was only continuing to operate at all to run off its existing contracts.
20. In principle, therefore, I consider (subject to the points discussed later in this judgment) that the Bank should not be entitled to take the benefit of the credits to the accounts up to an amount of the overdraft subsisting at the date of the presentation of the Petition some £49,514, nor do I, so far and subject to Mr Cherryman's further submissions, consider that a validation order should be made which would have that effect. The position in effect, should be the same as it would have been if the Bank 'ruled off' the two accounts as at the date of presentation of the Petition; the correct approach, if a validation order is to be made at all, would be to declare invalid the earliest payments into the accounts up to an amount equal to the outstanding overdrafts on 17 February 1997 but validating as between Tain and the Bank, all other payments into the accounts.
21. Quite apart from that, and as a separate reason for my conclusion so far, it seems to me that the evidence establishes that Mr Bernard was, in effect, attempting to gain a personal advantage by the transactions in question. It was he who controlled Tain and procured payments into the overdrawn accounts at a time when he knew, or must have known, of Tain's insolvency and certainly knew of C&E's petition (served on Tain on 17 February 1997 and which must have come to his knowledge). It has to be remembered that, at the time when the Petition was advertised and had first come to the notice of the Bank, the Bank held valid and valuable security from Mr Bernard in support of the guarantee given by him in respect of Tain's indebtedness to the Bank. Had a validation order been sought at that time, before the security had been released, it is, I think, clear that the Court would not have granted such an order: as well as preferring the Bank to other creditors, the economic effect of so doing would have been to benefit Mr Bernard – who would, as a result, no longer have had any liability under his guarantee – at the expense of Tain's creditors. To allow a benefit to a director and sole shareholder at the expense of creditors in this way would be unacceptable. That reinforces the conclusion that a validation order should not be made. In the language used in Gray's Inn Construction, I consider that there was here an attempt by Tain to prefer the Bank in order to benefit Mr Bernard. In the context of the application of preference to section 127 and its predecessors, I do not think that judges have been using the word 'prefer' (see for instance Buckley LJ at p 718H) in the technical sense of preference under the sections avoiding transactions as preferences (whether under the old or existing law); rather, it has been and is to be taken as meaning a circumvention of the pari passu distribution of assets which it is the policy of section 127 to achieve. Mr Cherryman submits that the Bank was no better off as a result of the payment since it had an excellent security in support of a cast-iron guarantee. But I do not think that that is an answer since the security was not over Tain's own property, the payment off of the overdraft did not release any of Tain's property from the charge so as to increase the assets available for general creditors and was capable of preferring the Bank in the way that word is to be understood in this context.
22. Now, it might be said that such a conclusion is inconsistent with the approach of the court in Gray's Inn Construction where payments into the overdrawn account in the period before advertisement of the petition were validated. However, in that case, the Court of Appeal simply said that on the facts of the case it was proper in the exercise of the Court's discretion to validate the credits amounting to £2,750 which were credited to the account before advertisement of the petition. The decision does not support the proposition that a judge should always validate credits to an overdrawn bank account where those credits are apparently in the ordinary course of business.
23. There are four other factors relied on by Mr Cherryman to support his application for a wider validation order, in effect validating all the payments into the account and thus allowing the Bank to take a priority over C&E as the other main creditor at the date of presentation of the petition.
24. First, it is correctly pointed out that C&E failed to advertise the Petition and that they are really the authors of their own misfortune. But that of itself has not prejudiced the Bank in any way. At the time when the Petition was advertised and came to the notice of the Bank, the Bank held a valid and valuable guarantee and security from Mr Bernard and, as I have already suggested, the Court would not have made a validation order if one had been sought at that stage. It is the subsequent release of the charge which has caused any prejudice which the Bank may have suffered.
25. Second, it is again correctly pointed out that the Liquidator did not raise the claim against the Bank for a significant period even after the Petition had been advertised and come to the notice of the Bank. But again, that of itself does not appear to me to have caused the Bank any prejudice absent the release of the charge.
26. Those two factors, by themselves, do not, in my judgment, justify the making of a validation order They are insufficient to warrant departing from the principle of pari passu distribution which is at the foundation of insolvency law.
27. Third, it is said that the Liquidator should first exhaust his remedies against other creditors who have been paid in full In that respect, the submission is said to mirror that made on behalf of the bank in Hollicourt and which the Court of Appeal found it unnecessary to decide. But the present case is entirely different from the situation in Hollicourt. In that case, it was sought to make the bank liable for payments out of the account if recovery were made from payees it would follow that there would be no recovery from the bank, because the loss, if I may describe it that way, would have been made good. In contrast, in the present case, the effect of the payments into the overdrawn accounts was, apart from section 127, to reduce the amount of the overdraft and was, in commercial terms, no different from the discharge of any other creditor's debt. It is not a sustainable proposition that a liquidator should not seek recovery under section 127 against one creditor without at the same time seeking recovery from all other creditors payment to whom could be attacked under the section. Oliver J took a similar approach in In re Leslie Engineers Co Ltd: see at p 304E.
28. Fourth, and most importantly, it is said that the Bank has acted to its detriment in releasing its charge over Mr Bernard's house and that it did so on the assumption that Tain's liabilities had been discharged. In this context, Mr Cherryman points out that the Bank had every good reason not to be concerned:
a. The Liquidator did not query the operation of the accounts with the Bank until March 2001, nearly three and a half years after his appointment.
b. In March 1998, the Liquidator expressly stated that his investigation would be finished within 3 months and that proceedings would follow within a year. As already pointed out, proceedings did not follow and nor was it indicated to the Bank that investigations were continuing.
c. The Bank was never treated as a creditor by the Liquidator and none of the forms which the Liquidator is required to send to creditors were sent to the Bank.
d. Various other criticisms are made of the Liquidator and the speed with which he carried out his duties. It is also said that the Liquidator knew that the Bank had treated Tain's debts to it as fully discharged, that securities had been given in respect of those debts and that they would be likely to be released: any claim under section 127 should have been notified, so it is submitted, at latest by the end of 1998.
29. I do not consider that any of this change of position justifies the making of a validation order. This is for two reasons. First, the discretion under section 127 is not concerned with providing a remedy for errors or mistakes on the part of the Liquidator or the creditor: it is there to validate transactions which are or may be for the benefit of the creditors generally. Second, even if that were not so, I would decline to exercise the discretion for much the same reasons as for rejecting a change of position defence to the Liquidator's restitutionary claim (as to which see below).
30. As has been pointed out (see most recently Hollicourt at p563 paragraph 22) the invalidating provisions of section 127 do not spell out the appropriate remedy of the company when a disposition is avoided. That same paragraph indicates that the right of recovery is, as Mr Cherryman says, restitutionary. It is submitted that the normal defences, in particular the defence of change of position, are available to the Bank; and that that particular defence is, on the facts, made out. If the defence is made out then it follows that either (a) the Court should make a validation order, since there is no point in refusing it when the result will be simply to give rise to a restitutionary claim to which there is a defence or (b) if no validation order is made, the Liquidator is not entitled to the order for repayment which he seeks.
31. The Liquidator responds that such a defence is not available at all in the context of section 127, and even if that is wrong it is not available on the facts.
32. On the facts, it is pointed out that the Bank retains the benefit of the guarantee and that there is no reason to think that Mr Bernard will not be able to meet his liabilities. The Bank, it is said, has put forward no evidence that, in financial terms, it has been prejudiced by the release of the security over Mr Bernard's houses. Accordingly, it is said, the Bank has not in any substantial way changed its position and has not demonstrated any actual financial detriment. However, I would simply remark at this stage that it would obviously be easier for the Bank to rely on a valid security and a certain guarantee than to have to sue Mr Bernard on the guarantee (without any certainty at present that he has assets to meet a judgment) and to meet possible challenges to the guarantee as suggested earlier in this judgment.
33. It is also said by the Liquidator that the Bank's own behaviour disqualifies it from relying on any change of position defence which might in principle be available. It is pointed out that at the time when it released its security, the Bank knew that the Tain was in liquidation; it knew that it had received payments since the date of the presentation of the Petition and that Tain's overdrawn accounts had been discharged to the benefit of the Bank. The provisions of section 127 are well known to all banks and the Bank would have known (had it addressed its mind to the question) of the risk that the court would not validate the payments; for all I know, it did appreciate the risk. There is no evidence at all about why the Bank released the charge. In these circumstances, it is said that the risk that the court would not validate the transactions was one which falls on the Bank and it cannot escape that risk by casting the blame on the Liquidator for failing to make his claim earlier or by reason of the other matters already referred to which Mr Cherryman relies on.
34. To that, Mr Cherryman responds that, even if the Bank has not acted as it might have, the fault of a party is not relevant to the defence of change of position, relying on the decision of the Privy Council in Dextra Bank & Trust Co Ltd v. Bank of Jamaica [2002] 1 All ER (Comm) 193. The Liquidator submits, in response to that, that the effect of Dextra (if I am to follow it) is that good faith has become a touchstone in establishing the change of position defence. In relation to good and bad faith, I was referred to what Lord Goff said in Lipkin Gorman v. Karpnale Ltd [1991] 2 AC 548 at 580C where he identified bad faith as arising where
the defendant has paid away money with knowledge of the facts entitling the plaintiff to restitution.
In the context of the present case, it is suggested that the Bank was guilty of bad faith because it released its security with knowledge of the facts entitling Tain through the Liquidator to restitution of the monies paid into the overdrawn account - there can be no doubt, it is said, that the Bank knew of all the relevant facts resulting in the payments into the overdrawn accounts being void (subject to any validation order).
35. The general principle in relation to change of position is stated very widely by Lord Goff in Lipkin Gorman at 580:
I do not wish to state the principle any less broadly than this: that the defence is available to a person whose position has so changed that, it would be inequitable in all the circumstances to require him to make restitution, or alternatively to make restitution in full.
This general principle is to be developed and refined on a case by case basis.
36. It would appear that the defence of change of position may not be available at all in relation to some restitutionary claims. For instance, it may not be available in relation to a claim against recipients of a legacy under a will, although Goff & Jones: The Law of Restitution (6th ed) at paragraph 40-002 consider that the Court should no longer feel bound to reject the defence in such a context.
37. Mr Prentis submits that there is simply no need, or room, for a defence of change of position in the context of section 127. In other words, if a disposition is not validated under the section, it is not open to the defendant to assert a change of position in resisting the claim for restitution. That section, he says, not only provides the foundation for a liquidator's claim (by rendering void the relevant disposition of the company's property) but also provides within its terms a remedy to avoid injustice (the power of the court to validate transactions). It is implicit in his submission I think that change of position is not a factor which should come into the assessment of how the Court should exercise its discretion to validate under section 127 or at least, if it is, then different principles should be applied in the context of section 127 from those which would apply to the defence to a restitutionary claim.
38. Moreover, as he submits, section 127 must be considered in the context of other provisions of the Insolvency Act 1986. He refers to sections 238 and 239 (transactions at undervalue and preferences) and submits that there is no room at all for a change of position defence where either of those sections bite. Section 127, he says, takes over from those sections (as well as having a wider scope) once a winding-up has commenced. It would be odd if a liquidator's claim in relation to a transaction at an undervalue, or a preference taking place the day after the commencement of the winding-up, could be defeated by a change of position defence when the corresponding claim in relation to such a transaction or preference taking place the day before the commencement of the winding-up could not be so defeated.
39. The inter-relation between section 127 and restitutionary principles is not a matter which has been the subject of any English judicial decision or academic writing. There is one relevant Canadian decision - Re Ernst and Young Inc and Anderson et al 147 DLR (4th) 229. That case concerned section 95 Bankruptcy and Insolvency Act RSC 1985 concerning preferences. Any transaction to which section 95 applies is 'deemed fraudulent and void as against the trustee in the bankruptcy'. A defence of change of position was held not to be available as a defence to the trustee in bankruptcy's claim to recover moneys from innocent recipients. Having analysed the purpose of the legislation as being to treat all creditors equally and to see that they receive pro rata distribution of assets, the Court said this at p234b-c:
The whole idea of the defence of change of position is that the equity lies with the payee and not with the payor who wants to get back his payment. But where a trustee in bankruptcy carries out a duty to sue to undo a fraudulent payment, it is difficult to say that change of position makes the trustee's suit inequitable.
Mr Prentis for the Liquidator relies on that decision in support of his submission that the change of position is defence is simply unavailable in the context of claim to recover monies the payment of which, as a result of section 127, is rendered void.
40. I find that case of little help. It concerns a provision significantly different from section 127, that section containing as it does the power for the court to validate transactions. Further, there is no discussion of the relevant restitutionary principles nor was Lipkin Gorman even referred to.
41. Attractively as the argument was presented by Mr Prentis, I do not consider that change of position can be entirely ruled out as a possible way of resisting a claim for repayment by a liquidator. It seems to me that the question of validation of a disposition is distinct from the question of actual recovery if the disposition is not validated. I do not see why the defence should not be available where, for instance, a creditor did not know and could not have known (because it had not yet been advertised) of the existence of the petition. After all in other cases where payments can be treated as void or ultra vires it is commonplace that restitution is available subject to restitutionary defences. The purpose behind the discretion conferred on the Court to validate a disposition is not the same as the purpose of the change of position defence, albeit that both are based on an overarching concept of fairness. The former is directed principally at achieving a pari passu distribution of assets whilst permitting transactions which are, or are likely to be, of benefit to the company to take place, the latter is an inherent qualification to the right of restitution and which, in its very nature, will be detrimental to the company and distort the pari passu distribution of assets.
42. I do not consider that the comparison with sections 238 and 239 improves the argument that section 127 excludes a change of position defence in all cases. Those sections provide express remedies to which the liquidator is entitled if certain conditions are satisfied, in the case of section 127, in contrast, no remedy at all is provided for recovery (where a validation order is not made) and the matter is left to the general law. The result is not incongruous because a liquidator must establish something more under sections 238 and 239 if he wishes to take advantage of the express statutory remedies.
43. However, whether the change of position defence succeeds will then depend on the individual facts. It is clear, for instance, that a payee cannot rely on a change of position defence if he knows, when he changes his position, that the payment to him was invalid. It might be said that this is because he is not acting in 'good faith' or not acting on 'the faith of the receipt'.
44. Good faith and bad faith are relevant concepts in relation to the defence of change of position because, if for no other reason, of the decisions in Lipkin Gorman and Dextra. In the former Lord Goff refers to a person who 'acting in good faith pays the money or part of it to charity' (see at p 579) and refers to 'bona fide change of position' as a defence; and he also refers to 'bad faith' as disqualifying a person from relying on the defence 'as where the defendant has paid away the money with knowledge of the facts entitling the plaintiff to restitution'. In Dextra, in rejecting the introduction of relative fault into the law of restitution, Lord Bingham and Lord Goff say that they 'regard good faith on the part of the recipient as a sufficient requirement in this context'. One must take these uses of 'good faith', 'bona fides' and 'bad faith' in their context. Clearly Lord Goff is using 'good faith' and 'bona fides' as indicating, in the context of an action against the recipient, that he has changed his position in reliance on the validity of the payment to him. And he uses 'bad faith', in my judgment, in the context of a person who not only knows the facts entitling the plaintiff to restitution but who also realises that he has no right to pay that money away. Mr Prentis submits that Lord Goff is actually referring to a person who simply knows the facts even if he does not realise, quite innocently, that there is any possibility of a claim against him, but I cannot regard Lord Goff as using a phrase such as 'bad faith' in relation to a person who is morally entirely blameless. For my part, I think that it is important to remember that 'good faith' and 'bad faith' are being used to help identify when it is appropriate that the defence of change of position should be available: in that context, it is best to go back to the general principle which Lord Goff sets out in Lipkin Gorman and to view 'bad faith' simply as an aid to identifying circumstances in which it would be inequitable to allow the defence to operate.
45. For the purposes of characterising conduct as being in 'bad faith' for these purposes it would be safe to start by identifying some mental element. At one end of the scale, an informed creditor, such as a bank, well aware of the effect of section 127 and with knowledge of the presentation of a petition, who would, save perhaps in exceptional circumstances, know that a post-petition payment to it was void and would be unable to rely on such a defence. It seems to me an open question whether after advertisement of a petition a creditor could assert a change in position on the footing that he had not seen the advertisement and was in fact ignorant of the petition or had indeed seen the advertisement but was nevertheless ignorant of the law. It can be argued with some force (a) that, since advertisement of a petition is notice to the world of the presentation of the petition, it would defeat the policy behind that provision if a creditor was able to rely on a change of position defence when he can show that, in fact, he did not know of the petition; and (b) that once a creditor knows of the petition, he must be taken to be aware of the legal consequences which flow from section 127, even if he does not in fact do so. That issue does not, however, arise in the present case because the Bank did know of the Petition by the time it released its security and, as I shall explain, must be taken to have been well aware of the consequences of section 127.
46. The issue which does arise is whether a creditor who does know of the existence of a petition when he changes his position and who knows of the effect of section 127, can nonetheless rely on a change of position defence. In particular, is, the Bank entitled to rely on the defence of change of position in all the circumstances of the present case? Mr Cherryman relied on the factors which I have already set out in paragraph 28 above to explain why the Bank was, justifiably, not concerned and believed that no money remained owing to it by Tain. He does not suggest, and nor could he, that these factors amounted to an express representation by the Liquidator that he would not pursue the Bank for repayment; rather, he uses them (a) to show that the Liquidator was as much at fault as the Bank and (b) to support the view that the Bank acted in good faith.
47. As to fault, following Dextra, (which I would in any event do, but am probably bound to do in the light of the decision of Moore-Bick J in Niru Battery Manufacturing Co v. Milestone Trading Ltd [2002] EWHC 1425 (Comm)) questions of relative fault do not arise. As to good faith, there is nothing to suggest that the Bank acted other than in good faith, whatever view one might take of the care with which it acted. There is certainly nothing to suggest that the Bank released the charge over Mr Bernard's house believing that there was a debt owing or did so recklessly, not caring whether there was a debt owing or not, The very limited evidence is simply to the effect that the Bank thought that nothing was owing. Mr Prentis submits that the mere knowledge of the facts which gave rise to the restitutionary claim at the time when the charge was released ie that there had been a reduction and eventual elimination of Tain's overdraft after commencement of the winding-up, was enough to constitute bad faith. I do not accept, on the evidence before me, that the Bank acted other than in good faith in the sense that it acted other than in the belief that nothing was owing to it by Tain. That is not, in my judgement, 'bad faith' in the way that Mr Prentis suggests.
48. This point is of some relevance in the present case. Suppose that the Liquidator had made a claim in restitution before the Bank had released its charge over Mr Bernard's house. Suppose that the Bank had nonetheless released the charge – for instance because its overall commercial relationship with Mr Bernard made that a sensible thing for it to do. The Bank could not then, of course, rely on its change of position. But this is not because it acted in bad faith (or even because it did not act in good faith) since it was perfectly entitled to take the action it did; rather, it is because the Bank would not have relied in any sense on the invalid payment to it in acting as it did in releasing the charge.
49. This highlights another point. The wide statement of the general principle of the change of position defence by Lord Goff includes a change brought about by the act of another (eg theft by a thief of the money paid). The Bank's alleged change of position, in contrast, took place as a result of its own act in releasing the charge. It therefore still needs to show that it changed its position 'on the faith of the validity of the receipt'. The defence would fail, for example, if the Bank had taken a decision to release the security in order to preserve its commercial relationship with Mr Bernard or that it deliberately decided to take the risk of invalidity.
50. It is not suggested by Mr Cherryman that the Bank was generally unaware of section 127 The Bank's own evidence is that it had procedures for ruling-off a customer's account on receiving notice of a winding up petition, and a new account is opened if the customer requires continuing facilities. Although section 127 is not mentioned in that evidence, it would be astonishing if the Bank was not well aware of the statutory provisions concerning the invalidity of dispositions post-commencement of a winding up and I infer that it was so aware. There is nothing in the evidence to suggest that the Bank considered, at any time before it released the charge over Mr Bernard's house that section 127 did not, for some reason, apply to the payments into Tain's accounts when overdrawn, there is, for instance, no suggestion that the Bank had addressed the arguments which Mr Cherryman has (unsuccessfully) put forward in support of the submission that there was no disposition to the Bank within section 127 at all.
51. Nor is there any evidence that the Bank simply 'failed to address the position when it had learnt of the Petition. In the absence of such evidence, the presumption, in the case of an informed financial institution such as a bank, must be that it is aware of the well-known consequences of section 127. The Bank must therefore be taken to have known, at that time, that the Liquidator would have a good claim against it at least to the extent of credits to the accounts when they were in overdraft.
52. But even if it is not correct to make that presumption, the Bank must, at the very latest by March 1998 on receipt of the Liquidator's letter, have been aware of possible claims which the Liquidator might make (although Mr Cherryman, of course relied on the correspondence for a different purpose, namely to support his submission that the Bank was reasonable in forming the view that nothing was outstanding by the time it released the charge) It must have been the case, and I so hold that the Bank appreciated, by the end of March 1998, that at the very least it could be vulnerable to attack in relation to payments into Tain's overdrawn accounts. It may well actually have appreciated that the risk was, subject to validation under section 127, a certainty. There is no evidence that the Bank formed the view, after receipt of that letter that the Liquidator did not have a cast-iron claim or that it had received any advice that the claim was doubtful.
53. How then, did the Bank come to release the charge? It says that it assumed that nothing was owing by Tain to the Bank when it released the charge. It can only have believed that nothing was owing in one of two ways: first, because it positively addressed the matters which Mr Cherryman relies on and concluded that it had every reason to believe that no claim would be made by the Liquidator; or second because it simply overlooked the Petition and the effect of section 127. The limited evidence does not explain expressly which of these is the case.
54. I do not think that I should presume that the Bank was careless or negligent. In any event, the onus would be on the Bank to establish a change of position. In the absence of evidence from the Bank that it simply overlooked the Petition and the effect of section 127, I conclude that the Bank reached the conclusion that nothing was owing because of the factors relied on by Mr Cherryman.
55. It follows that the Bank's assumption arose only because of its own interpretation of the actions (or rather lack of action) by the Liquidator since his appointment. I have already held that the Bank, once it had notice of the Petition, must be taken to have known that the Liquidator had a good claim against it; alternatively, I have held that by the end of March 1998 it knew that there was significant exposure to such a claim. In these circumstances, I do not think that the Bank can be said to be relying on the validity of the credits to the overdrawn accounts when they were made. Rather, it has to recognise that it knew that the Liquidator had a good restitutionary claim, alternatively that it knew at least of a significant risk that he had such a claim, and has to accept that it took the view that, as a result of the matters relied on by Mr Cherryman, that claim was not going to be asserted rather than that it never was a good claim. In my judgment, the change of position in releasing the charge was not made in reliance upon the initial validity of the credits to the overdrawn accounts, but was made in reliance on an assumption that no claim would be made to assert that initial invalidity. Without reliance on the initial validity there is no change of position defence to the restitutionary claim.
56. This accords with principle. If A owes B a debt, but thinks it is unlikely to be enforced he may change his position in reliance on his belief. His change of position affords no defence to B's claim even if he has been encouraged in his belief by lack of activity on the part of B. The same should apply where B's claim against A is a restitutionary claim to recover a payment to him eg made under a mistake of fact once A knows of that claim, he cannot then change his position in reliance on the validity of the payment to him, although he can do so in the belief that the claim will not be enforced. That, in my judgment, ought not to afford a defence based on change of position. So, in the present case, the Bank, which must be taken to have known of the initial invalidity of the credits to the overdrawn accounts, or at least of a significant risk that that was so, cannot be heard to say that it relied on the validity of the credits: it knew the credits were open to challenge but formed the view that they would not in fact be challenged, the only justification the Bank could have had for assuming that nothing was owing to it.
57. In my judgment, in the absence of a clear representation by the Liquidator, sufficient to give rise to an estoppel to the effect that no money was owing to the Bank, the Bank is not entitled to rely on the discharge of the charge over Mr Bernard's house as affording a change of position defence. There was, of course, no such representation.
58. If, contrary to the views which I have expressed, it goes too far to say that the Bank did not, in changing its position, rely at all on the validity of the credits to the overdrawn accounts, there is an alternative approach which leads to the same result and which I would adopt. Under this approach, the Bank (although it may have acted in good faith) cannot rely on the change of position as a defence because it took a risk; aware of the risk, it cannot complain when the risk becomes a reality. This risk was that the assumption, based on the conduct of the Liquidator, that no claim would be made against it, was wrong. That risk could have been easily eliminated by the Bank confirming the position with the Liquidator. Of course, as Mr Cherryman said, the Bank would have been unlikely to wish to provoke the Liquidator into action, I suppose that one could say it wished to let that sleeping dog continue its lengthy slumber. But that is simply part of the risk assessment which the risk-taker must take into account.
59. I should not be taken as basing this result on a broad proposition that it is never open to a recipient of money to which there is a valid restitutionary claim to rely on a change of position brought about by his own actions and choice whenever he is aware of a risk that a claim may be made against him. That may be correct: cf the example in footnote 93 on p 834 of Goff & Jones. But the proposition has not been tested before me and it is not difficult to see principled objections to such a broad proposition. However, where the risk taken is not about the validity of the restitutionary claim, if made, but is about whether the claim will be made, the risk, however small, taken by the potential defendant is one in relation to which he alone must bear the consequences.
60. My conclusion is based on my analysis that this is not a case where the Bank could say (and nor did Mr Cherryman submit) that, when it released the charge, it had simply overlooked the Petition and the effect of section 127 altogether. If that had been the position, then the result could well have been different. It could be said that, following my decision that a defence of change of position is, in principle, available and is not altogether excluded by the statutory context, and given the rejection in Dextra of the proposition that relative fault comes into the balance, it follows logically that the Bank, having acted in good faith even if carelessly, had a good defence. I do not propose to express any further view on this aspect.
61. That conclusion makes it unnecessary, strictly, to deal with Mr Prentis' submissions concerning financial detriment to the Bank. I do not think that it would be helpful for me to say anything about this aspect.
62. Accordingly, in relation to the Bank, I propose to make an order validating all payments into the Current Account and the Loan Account on and after 4 February 1997 except the first £31,667 in relation to the Current Account and the first £17,837 in relation to the Loan Account and ordering payment of those sums to the Liquidator by the Bank. In relation to the second respondent, there will be no validating order at all but only an order that she pay the sum of £10,400 to the Liquidator. I will hear Counsel on what, if any, interest should be paid on those sums.