Imagine operating a company, only to find without any warning that the company’s bank accounts have been blocked. The immediate consequence is one of acute disruption and uncertainty. You learn that a winding-up petition has been filed against the company, triggering restrictions that effectively prevent it from carrying out ordinary financial transactions. At that point, a pressing question arises: how is the business expected to continue operating under such constraints?

This situation arises merely because a winding up petition has been filed and is pending against a company. While this situation may appear manifestly unfair, particularly given that it arises in the absence of any court order or any judicial determination on the merits of the winding-up petition, the company is not left without any relief, and an application to unfreeze the company’s bank accounts can be made (validation order), namely an order that validates the payments to be made by the company. This article explains how such circumstances typically arise and examines the role of validation orders as the appropriate form of relief.

Winding-up petition

A winding-up petition constitutes a legal procedure through which a creditor, a contributory, or a competent authority may request the winding up of a company, provided that certain conditions prescribed by law are met. In Cyprus, this procedure is regulated by the Companies Law, Cap. 113, with Part V specifically addressing court-ordered winding-up. A winding-up petition can be made, inter alia, on the ground that it is “just and equitable”, including cases where minority shareholders are oppressed by the majority.1

Once such a petition is filled, it is common practice to serve it on interested parties, such as creditors and banks. Furthermore, a copy of the winding up petition may also be published in the Official Gazette of the Republic. In most cases, as soon as banks are notified, they usually block the company’s bank accounts, while they may exceptionally permit the execution of certain transactions relating to the daily affairs of the company.2 This reaction is based on the combined interpretation of articles 216 and 218(2) of the Companies Law, Cap. 113, aiming to prevent the company’s officers from disposing the company’s assets after the filing of a winding up petition, to preserve those assets for the benefit of the general body of creditors in the event of liquidation.3 It should be noted, however, that it is debatable to what extent the approach of complete freezing of accounts is legitimate and complies with the intention of the legislature and the rationale of the case law. 

Articles 216 and 218(2) read as follows:

“216. In a winding up by the Court, any disposition of the property of the company, including things in action, and any transfer of shares, or alteration in the status of the members of the company, made after the commencement of the winding-up, shall, unless the Court otherwise orders, be void.”

“218(2) (2) In any other case, the winding up of a company by the Court shall be deemed to commence at the time of the presentation of the petition for the winding-up.”

Validation order

In such a scenario, the company can apply for a validation order seeking the court’s authorisation to validate transactions that would otherwise be restricted. In practical terms, such an order is sought to secure the unfreezing of bank accounts or to allow essential payments to be made, thereby enabling the company to meet its operational and financial obligations.

An application of this kind can be made ex parte without an obligation to notify the other party.4 Under Cyprus Law, courts have discretion to issue such an order pursuant to Article 216 of the Companies Law.

It is noted that, according to Article 218(2), the commencement of the winding up of a company by the Court is deemed to begin at the time of the filing of the petition for winding-up.5  

Balance between asset preservation and business continuity

As it is established under Case Law, what is prohibited is the disposition of the company’s property, the alteration of the status of its members, and the transfer of shares, so that the ownership regime of the company as it exists at the time of the filing of the winding-up petition is not affected. The operation of the company as a going concern during the pendency of the winding-up petition is not prohibited.

As is stated in the case, Re Application of Nikos Christofi:6

“It is clear from the judgment, based also on the corresponding provisions of England (section 227 of the Companies Act 1948) and the relevant legal writings, that Article 216 aims at the protection and at “…preventing the company’s officers from disposing of its assets after the filing of a petition for its winding up.” It is not intended to hinder the company’s continued operation as a going concern in the meantime...”

The case of Re New Steriotis Ltd v. Re Michail Fotios & Sons Ltd7 is an illustrative example. The winding up petitioners proceeded to serve the petition on certain banks.

The banks in turn informed the applicants that due to the existence of the petition they had proceeded to freeze their accounts. The court held that if the accounts are not unfrozen, serious issues regarding the company’s survival would arise, since these accounts were used for payments of suppliers abroad, VAT, purchases of machinery, salaries for 40 employees, tax obligations, etc.

In exercising its discretion to issue a validation order, the court performs a balancing exercise. On the one hand, the assets of the company must be maintained in case of liquidation for the protection of creditors, and, on the other, not to hinder the company’s ongoing operational and financial obligations. In carrying out this exercise, the Courts should also take into consideration the potential legal consequences that may arise under civil and criminal law for the company and its officers, as a result of the company’s inability to comply with tax and other legal or contractual obligations.

As the English court stated in Gray’s Inn Construction Co. Ltd [1980] 1 WLR 711:

“The desirability of the company being enabled to carry on its business was often speculative. In each case the court must carry out a balancing exercise.”

Conclusion

In conclusion, a winding-up petition, whether ultimately well-founded or not, can have significant and disruptive effects on a company, particularly where it is employed to exert pressure on the company or its shareholders. To counter this and ensure the continuity of business operations, the issuance of a validation order is an available remedy, providing a necessary breathing space that allows the company to carry out essential transactions and maintain its activities until the winding-up petition is finally determined by the Court. The question that remains to be examined by the legislature is whether certain safeguards should be introduced to the law to prevent the mala fides advancement of winding-up petitions as a means to exert pressure on companies.

Footnotes

1.          In Re Pelmako Development Ltd (1999) 1 Α.Α.Δ. 1369.

2.          Ηοllicourt (Contracts) Ltd v. Bank of Ireland (2001) Ch. 555.

3.          Hellindo Shipping Company Ltd (2003) 1 A.A.Δ. 238, In Coutts & Co v Stock [2000] 2 All ER 56, [2000] 1 WLR 906.

4.          MG Timinis & Sons Ltd, Application No. 76/14, 13/11/2014

5.          MG Timinis & Sons Ltd, and Express Electrical Distributors Ltd v Beavis and others [2016] EWCA Civ 765.

6.          Re Application of Nikos Christofi, Civil Application No. 153/13, dated 09/08/2013.

7.          Re New Steriotis Ltd v. Re Michail Fotios & Sons Ltd, Application No. 69/2019, 14/6/2019.

Iraklis Kyprianou, Advocate/ Associate at Elias Neocleous & Co. LLC.