Winding-up petitions and debt collection

Q: My subcontractor has two outstanding invoices and is chasing us for payment. But we anticipate incurring some additional defect rectification costs, so don’t intend to pay the invoices. The subcontractor has threatened to collect the debt by issuing a winding-up petition. Is that just a baseless scare tactic?

A: Despite the reforms that followed Sir Michael Latham’s landmark report Constructing the Team and, more recently, the introduction of the Payment Charter and Prompt Payment Code, payment disputes remain rife, particularly those that relate to late or incomplete payment in the supply chain. Unpaid parties frequently weigh up their options for recovering debts, and one of these is issuing a winding- up petition.

In the recent case Sell Your Car With Us Ltd v Sareen [2019] EWHC 2332 (Ch), the applicant company, Sell Your Car With Us, sought an injunction to restrain the presentation of a winding-up petition. Its primary assertion was that the debt was subject to a genuine and substantial cross-claim, but the judge found that the alleged cross-claim had no prospect of success. The company’s secondary position was that the petition ought to be restrained in any event since it could pay the outstanding amount, and the threat of insolvency proceedings should not be used as a method of debt collection.

Goode on Principles of Corporate Insolvency Law states: "Admittedly, it has been said on more than one occasion that the winding-up procedure in the Companies Court cannot properly be used for the purpose of debt collection. However, if this statement means that it is somehow improper for a creditor to resort to winding-up instead of execution in the hope of inducing the company to pay the debt, then it undoubtedly goes too far.

"Very often that is precisely the reason why the petition is launched, and the courts have emphasised that a petition presented in order to bring pressure on a company to pay a debt [that] is indisputably due is perfectly proper, even where other proceedings are in train for recovery of the debt and even if the winding-up proceedings are being pursued 'with personal hostility or even venom'".

While case law confirms that a valid counter- or cross-claim will amount to a full defence, anticipated costs for possible defects are unlikely to satisfy this threshold. As such, you should consider paying the invoices as soon as possible or reaching a compromise with the subcontractor, rather than take the risk that the petition runs its course.

Although Sell Your Car With Us has caused a stir because it appears to permit winding-up petitions as a form of debt collection, the law is in fact fundamentally unchanged. In the vast majority of circumstances, the debt claim will be subject to an arguable cross- or counter-claim and the petition will fail. As such, other forms of debt collection – such as garnishee orders, which are court orders requiring a third party to pay the judgment creditor – will still be more appropriate in most cases.