RC Brewery Ltd v HM Revenue and Customs

A validation order under section 127 of the Companies Act 1985 is exceptional where a winding-up petition is based on an undisputed debt. The court ordinarily requires there to be no serious risk to creditors, or a real prospect that continued trading will improve their position. Legal costs may be validated where they fund a genuine defence to a petition which, if successful, would establish that the petition should not have been presented. That rationale does not extend to costs incurred merely to obtain time to pay an admitted liability. The court must also consider whether the proposed expenditure is incurred in the ordinary course of the company’s business and its effect on other creditors.

RC Brewery Ltd applied informally for a validation order under section 127 of the Companies Act 1985. The application arose in the context of HMRC’s winding-up petition, presented for unpaid beer duty and penalties exceeding £2 million, later reduced to £1.485 million.

The petition debt was undisputed and the presentation of the petition was accepted to be proper. The company had unsuccessfully sought to restrain advertisement of the petition and sought validation of legal fees already paid, together with future fees, in connection with that application and a proposed appeal. The central issue was whether those payments should be authorised notwithstanding the likely prejudice to other creditors.

1. The application for a validation order was refused. If a winding-up order were made, the company would be unable to pay all its debts, and validating the payments would reduce the amounts available to other creditors.

2. The general approach is that validation orders are made only where there is no serious risk to creditors, or where the court is satisfied that the company is likely to improve creditors’ position by trading at a profit. The court considered the approach stated in Re McGuinness Bros (UK) Ltd (1987) 3 BCC 571.

3. There may be justification for validating legal expenses incurred to advance a genuine defence to a winding-up petition. If the defence succeeded, it could establish that the petition should never have been presented. The court adopted the reasoning of Hoffmann J in Crossmore Electrical and Civil Engineering Ltd (1989) 5 BCC 37, while noting the possible but highly remote mechanism of charging costs to a third party referred to there by reference to Re Bathampton Properties Ltd [1976] 1 WLR 168.

4. That rationale did not apply. HMRC had a clear right to payment, the debt was undisputed, and the proposed expenditure related to an application intended to obtain time to pay the liability. The arguments were weak, the proposed appeal had no prospect of success, and such expenditure was unlikely to have been incurred in the ordinary course of business.

5. The company’s director had agreed to discharge the solicitors’ fees, but that undertaking formed no part of the reasoning or justification for the decision.