Bankruptcy validation orders: the meaning of “value” for innocent third parties and what legal costs are allowed?
Under Section 284 of the Insolvency Act 1986 any dispositions post presentation of a bankruptcy petition are void, unless ratified by a court. (For more information on validation orders, see our earlier bulletin of 1 April 2020.)
Two recent cases have clarified the scope of bankruptcy validation orders. The first deals with the meaning of “value” and the second with the validation of legal fees.
The meaning of “value”
Section 284(4)(a) of the Act provides that if an innocent third party receives the payment or property “in good faith, for value and without notice” of the filing of a bankruptcy petition then that third party may keep the same. The overriding purpose of this section, as a counterbalance to the protection afforded to the general body of creditors, is to prevent unfairness to innocent persons dealing with debtors but unaware of the commencement of bankruptcy proceedings.
In Edwards v Aurora Leasing Ltd and another [2021 EWHC 96 (Ch), decided on 20 January 2021, the court held that “value” should be given its ordinary meaning and should not be fettered by any additional interpretations such as a requirement for full value. Provided some value was given, and the transferee’s receipt was not gratuitous, that was sufficient. In reaching this conclusion the court placed weight on the words used within the section. The phrase “for value” carries no qualifying definition and should be interpreted accordingly. In further keeping within the spirit of protection afforded to innocent third parties, the court also found there is no explicit requirement for the value be received by the estate rather than a third party.
The unfettered definition of “value” under section 284 contrasts with the more detailed definition of “undervalue” circumscribing transactions at undervalue under section 339 of the Act.
Scope of validation of legal fees under section 284
In complex, ongoing bankruptcy proceedings, the court validated payment of the debtor’s legal costs relating directly to his opposition of the bankruptcy petition but disallowed costs in linked proceedings even where those proceedings could potentially assist the debtor’s defence. This was held in State Bank of India v Mallya [2021 EWHC 191 (Ch)], decided on 8 February 2021.
The allowance of costs directly connected to the bankruptcy petition is a reiteration of the long-standing principle, first enunciated in Re Sinclair (1885), that on humanitarian grounds a debtor should be able to defend himself. However, as the court observed in Mallya, that exception was narrow in scope and could not be extended to the costs of related litigation particularly where (a) there was no evidence of benefit to the general body of creditors, and (b) such litigation was in a foreign jurisdiction (India) that necessarily precluded any retrospective scrutiny of costs by a later appointed trustee in bankruptcy. The latter scrutiny is enabled by the insertion of a “Lucas” provision (after National Westminster Bank plc v Lucas, 2013) within the body of a validation order that allows a subsequently appointed trustee to scrutinise the costs incurred.
In the circumstances of this case, the high net worth debtor was subject to a worldwide freezing order and the legal costs allowed were to be funded out of monies paid into court from the proceeds of a property sale arising out of an earlier attempt to restructure the debtor’s finances.