Chapter 10: Insolvency Flashcards
(107 cards)
1
Q
What is insolvency?
A
Insolvency is a term that indicates that a person or business is unable to pay their debts.
2
Q
What options does a sole proprietor or partner have if they can no longer pay debts when they become due?
A
- negotiating with creditors,
- entering an individual voluntary arrangement,
- applying for bankruptcy
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Q
How can a sole proprietor/partner be forced into bankruptcy?
A
A creditor may present a creditor’s petition for bankruptcy, forcing the debtor into bankruptcy if certain criteria are met.
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Q
What does a sole proprietor/partner negotiating with creditors involve?
A
Asking for debt to be reduced or for extra time to repay.
Creditor might agree if this means they are likely to receive more money than they would if the debtor becomes bankrupt.
Typically not binding on the creditor, as there is no contract consideration given by the debtor to support the creditor’s promise.
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Q
What is an Individual Voluntary Arrangement?
A
An IVA is a negotiated agreement between the debtor + all of their creditors.
The creditors each agree to accept less in payment than is owed to them.
It avoids the enforceability problem of individual negotiation because it is a formal procedure.
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Q
When will an IVA only be suitable?
A
IVA is suitable only if the debtor has enough money, or the prospect of receiving some money, to enable the debtor to make a reasonable offer of payment to their creditors.
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Q
What is the procedure for a debtor agreeing an IVA with their creditors?
A
Need to find an insolvency practitioner.
The insolvency practitioner will draw up proposals and supervise the implementation of the IVA.
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Q
What will the insolvency practitioner do in an IVA?
A
- Have the debtor prepare a statement of affairs,
- Apply to the bankruptcy court for an interim order.
- Prepare a report advising whether there are any realistic proposals to offer to the creditors + whether it is worth calling a meeting of creditors
- They supervise the implementation of the proposals
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Q
What does the interim order granted by the bankruptcy court do in an IVA?
A
Whilst this order is in force, no bankruptcy petition may be presented or proceeded with unless permission to proceed is granted by the court.
Additionally, no other proceedings or executions can be commenced against the debtor.
This gives the insolvency practitioner breathing space to try + work out what assets and liabilities the debtor has, and whether there is any likelihood of a successful IVA.
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Q
What is needed for an IVA to be binding? Who will it be binding on?
A
If a meeting is called and at least 75% in value of the debtor’s unsecured creditors agree to the practitioner’s proposals, the proposals become binding on every ordinary unsecured creditor who has notice of the meeting, even if they did not attend or vote.
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Q
Who will not be bound by an IVA?
A
Preferential creditors - employees owed holiday pay or wages due in the last 4 months - and secured creditors, unless they agree to the proposal.
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Q
What may happen if the debtor fails to comply with the IVA or provided false or misleading information?
A
The supervisor or any creditor who is a party to the IVA may petition for the debtor’s bankruptcy.
This could occur if it is discovered that the debtor tried to put money or assets out of reach of the creditors before the IVA by making transactions at an undervalue or giving preferences, as only the trustee in bankruptcy and not the supervisor of an IVA has the power to apply to court to set aside these transactions
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Q
What is bankruptcy?
A
A judicial process in which the assets of the bankrupt debtor are passed to a third party, the trustee in bankruptcy, who liquidates the assets and uses the money from the liquidation to pay off as many of the debtor’s debts as possible in a strict order set out by legislation.
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Q
What is the effect of an application for bankruptcy?
A
Once an application for bankruptcy is made, the debtor’s creditors must stop chasing after the debtor, and the debtor will be discharged from most of their debts after 1 year
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Q
How can an application for a bankruptcy order be made?
A
Application for a bankruptcy order can be made in 3 ways:
- Debtor can apply online
- One or more unsecured creditors who is/are owed at least £5,000 combined can present a petition for an order of bankruptcy to the bankruptcy court, or
- The supervisor of an IVA can petition
16
Q
How can a debtor apply online for a bankruptcy order?
A
The debtor can apply online to declare themself bankrupt.
The application is head by an adjudicator appointed by the Secretary of State.
The application will be granted if the adjudicator finds the debtor is unable to pay their debts.
17
Q
When can the supervisor of an IVA petition for the debtor’s bankruptcy?
A
If the debtor has breached the terms of the IVA, hidden assets, or given a preference to a creditor.
18
Q
What happens if a bankruptcy order is made?
A
An official receiver is appointed.
The official receiver is a civil servant who will act as the trustee in bankruptcy unless the creditors seek to appoint their own nominee.
19
Q
What must a creditor who applies to have the individual debtor declared bankrupt prove?
A
Must prove that the debtor is insolvent by showing either that:
i. the debt is payable immediately and the debtor doesn’t have the funds to pay, or
ii. the debt is payable in the future and the debtor has no reasonable prospect of being able to pay.
20
Q
What do the various ways a creditor may seek to show that the individual debtor does not have the funds/reasonable prospect of having the funds, to pay a debt relate to?
A
- If the debtor owes a liquidated debt for £5,000 or more,
- IF the debtor owes a future liability of more than £5,000
- If the debtor owes judgment debt of more than £5,000
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Q
How can a creditor show that the individual debtor doesn’t have the funds to pay if they are owed a liquidated debt by the individual debtor?
A
- If the debtor owes a liquidated debt for £5,000 or more,
- The creditor may make a statutory demand for payment,
- If within 3 weeks,
i. the debt is not paid, or
ii. the debtor doesn’t apply to set aside the statutory demand, then - The debtor will be deemed insolvent.
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Q
How can a creditor show that the individual debtor doesn’t have the funds to pay if they are owed a future liability?
A
- If the debtor owes a future liability of more than £5,000,
- The creditor may serve a statutory demand for proof of ability to pay,
- If the debtor does not:
i. show a reasonable prospect of being able to pay the debt when it falls due, or
ii. apply to the court to set aside the statutory demand, - The debtor will be deemed insolvent
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Q
How can a creditor show that the individual doesn’t have the funds to pay if they are owed a judgment debt?
A
- If the debtor owes a judgment debt of more than £5,000,
- The creditor can seek to execute on the judgment, and
- If the attempt fails, the debtor will be deemed insolvent.
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Q
What happens to the bankrupt’s estate?
A
The bankrupt’s estate vests automatically in the trustee in bankruptcy.
The trustee collects in and sells the bankrupt’s assets to raise money which is then used to pay off the creditors.
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What is the bankrupt allowed to keep?
Some assets needed for day-to-day living, such as:
i. furniture, and
ii. any tools required for their job,
iii. their salary
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What is the bankrupt's entitlement to keep their salary subject to?
The bankrupt is entitled to retain any salary they make, subject to the trustee applying for an income payments order, if the salary exceeds the amount needed for the reasonable needs of the bankrupt and their family.
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How long can income payments orders last?
A maximum of 3 years
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What will happen to the Bankrupt's home?
The bankrupt's interest in their home will pass to the trustee, but there may be other legal or equitable interests in the home, e.g:
i. the home could be held in joint names,
ii. a partner/spouse may have an equitable interest arising from a trust,
iii. a spouse may have a right of occupation under legislation,
iv. children under 18 may live in the home, giving the bankrupt and their spouse/partner a right of occupation.
If there are any of the above interests in the home, the trustee cannot sell the home without a court order, and the court will consider all the interests before making an order for sale.
However, after 1 year, the interests of the creditors are paramount, and so will take precedence over any of the other people claiming an interest.
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What restrictions are placed on the bankrupt during bankruptcy?
The bankrupt may not:
i. apply for credit of more than a prescribed amount,
ii. act as a company director,
iii. be a partner, or
iv. trade under another name without disclosure of the bankruptcy
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What is the order of priority for distribution to creditors of a bankrupt?
1. Costs of the bankruptcy,
2. Preferential debts - holiday pay due to employees and wages of employees due in the last 4 months & HMRC in respect of VAT, PAYE, and National Insurance contributions owed,
3. Ordinary unsecured creditors, and
4. Postponed creditors
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What happens if there is not enough money to fully satisfy all the creditors at one level in bankruptcy?
The debts rank and abate equally.
This means all the creditors in that category will receive the same percentage of their original debt.
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When will a bankrupt be discharged?
If the bankrupt complies with the restrictions and has not caused the bankruptcy by their own dishonesty, negligence, or recklessness, then the bankruptcy will be automatically discharged after 1 year
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What is a culpable bankrupt?
A bankrupt who has caused the bankruptcy by their own dishonesty, negligence, or recklessness is considered 'culpable' and can be subject to a court bankruptcy order for up to 15 years.
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What restrictions can be placed on a culpable bankrupt?
This order can extend the restrictions intended to protect the public from the bankrupt so that they continue after the bankruptcy is discharged
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What happens if an individual bankrupt was a partner in a partnership at will?
The partnership will be dissolved on the bankruptcy of the partner.
The trustee in bankruptcy will any money due to the insolvent partner, to be used for the benefit of the partner's creditors.
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What happens if an individual bankrupt was a partner in a partnership not at will?
If the partnership agreement provides that the partnership will not terminate on the bankruptcy of a partner, then the partnership will continue and, usually the remaining partners will purchase the insolvent partner's interest from the trustee in bankruptcy, in accordance with the retirement provisions in the partnership agreement
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What happens if the individual bankrupt was a member of a LLP?
An undischarged bankrupt cannot be a member or take part in the management of an LLP without the agreement of the court.
The trustee in bankruptcy will seek to realise the member's interest for the benefit of his creditors, usually by selling the interest to the remaining in accordance with the retirement provisions in the partnership agreement.
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What happens if all the partners in a partnership are made bankrupt?
The official receiver/insolvency practitioner will:
i. make sure all contracts are completed, transferred, or otherwise ended,
ii. cease the business,
iii. settle any legal disputes,
iv. sell any assets,
v. collect money owed to the partners or partnership, and
vi. distribute any funds to the creditors
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What happens if an LLP is insolvent?
If an LLP were to be made the subject of a winding up order, it would be administered by the official receiver as a limited company.
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What does corporate insolvency law seek to do?
1. Protect the creditors and balance the interests of competing groups of creditors,
2. Promote corporate rescues, and
3. If necessary, control or punish the company's directors.
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What insolvency options are available for companies/LLPs?
1. Receivership,
2. Restructuring plan,
3. Moratorium
4. Administration and CVAs,
5. Liquidation
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What does receivership do?
Enables secured creditors to recover what is owed solely to them
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What does a restructuring plan do?
Allows companies to restructure their debts with the sanction of the court
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What does a moratorium do?
This halts most actions by creditors to enforce their rights
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When does receivership typically arise as an insolvency option?
Although not technically an insolvency procedure, it can often lead to insolvency.
When a company borrows money, a creditor may take security over the company's fixed assets, such as its equipment or plant.
The loan and security agreement between the company + the creditor will set out what comprises a breach.
- It will usually also give the lender the right to appoint an administrative receiver if the company commits a breach.
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What does receivership involve?
In the case of a breach, the receiver takes possession of the asset securing the loan (the 'charged asset') and (usually) sells it to pay the secured lender.
- the sale is not for the benefit of all the creditors.
Once the asset is sold, the receiver has no further role in the company.
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What does a restructuring plan usually involve?
Usually, the plan involves the creditors agreeing to accept less than they are owed but more than they would likely receive in bankruptcy.
The plan must be approved by those owed at least 75% in value of the unsecured debt.
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When may the court approve a restructuring plan?
The court may approve the plan even if one or more classes disagrees with it and dissenting creditors will be bound (known as a cram down).
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What may not be done during a moratorium?
Creditors cannot take action to enforce their financial rights or commence formal insolvency proceedings.
Landlords may not forfeit any lease of the company's premises.
Floating charge holder may not crystallise their floating charge.
50
What does a moratorium give a company?
The corporate entity has a payment holiday in relation to debts, subject to certain exceptions including wages + other amounts owed to staff.
51
What is the purpose of a moratorium?
The purpose is to rescue the company as a going concern + return it to profitable trading through a Company Voluntary Arrangement, a restructuring plan, refinancing, or an injection of new funding.
A moratorium is not a formal insolvency procedure, but is designed to encourage businesses in financial debt to act early to restructure their debt.
52
What is the procedure re a moratorium?
The directors of the company will appoint an insolvency practitioner as 'monitor' to oversee the company's affairs and ensure that it is likely that the moratorium will result in a rescue of the company as a going concern.
To obtain the moratorium, the directors and the monitor file certain papers with the court,
The directors remain in charge of running the business
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When is a moratorium not available?
Not available for companies which are, or have within the previous 12 months been, subject to an insolvency procedure
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What is administration?
A procedure which enables the administrator to run, reorganise, and/or sell the company as a going concern.
Might enable the company to avoid going into the liquidation.
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What is the aim of administration?
The aim of administration is for the administrator to (in order of importance):
i. rescue the company as a going concern,
ii. achieve a better result for the company's creditors than would be achieved if the company were to be wound up, or
iii. realise property to distribute to one or more secured creditors.
The administrator acts in the interests of the creditors as a whole.
56
How can a company go into administration?
By 2 methods:
i. through a formal court hearing, or
ii. by the company, its directors, or the holder of a qualifying floating charge filing certain documents with the court
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If the court method is used to enter administration, what is needed?
The court may make the order only if it is satisfied the company is unable to pay its debts + that the order is likely to achieve a better result for the company's creditors than liquidation.
58
When can the directors and the members appoint an administrator?
Who must they notify?
If no winding up petition has been issued.
They must notify any qualifying floating charge holder who will agree or appoint an alternative administrator.
59
What is a qualifying floating charge?
A charge over the whole or substantially the whole of the company's assets.
It contains a provision empowering the lender to appoint an administrator or administrative receiver if a breach has occurred which allows the lender to enforce its security under the terms of the credit agreement (usually this is non-payment of interest or capital).
60
What is the role of an administrator?
Must be a licensed insolvency practitioner.
They have the power to:
i. take control of the company's property and sell it,
ii. bring or defend legal proceedings on behalf of the company,
iii. carry out the company's business,
iv. remove or replace directors, etc.
Administrator also has power to investigate previous transactions of the company to seek to increase the value of the assets for the creditors + can take action against the directors for wrongful and fraudulent trading.
61
Generally, what is needed for any administrator's proposals?
A majority in value of the creditors must approve the administrator's proposals.
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What is one advantage of administration?
A moratorium is imposed which:
i. restricts the ability of third parties to enforce their rights, and
ii. prevents the commencement of other insolvency procedures, giving the administrator breathing space to try to achieve the sale of the company as a going concern.
63
What is a Company Voluntary Arrangement?
A CVA is similar to an IVA.
It is a compromise between the company and its creditors under which each creditor usually agrees to take less than the full debt owed to them.
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When will a CVA be used?
When the company has a short-term cash flow problem, but is generally financially sound.
Although the creditors might not be paid in full, they are likely to receive more money than if the company went into liquidation.
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What happens if the CVA fails?
The company could still end up in liquidation or administration.
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How is the process for a CVA started?
Started by the directors of the company who make a written proposal to the creditors and nominate an insolvency practitioner to supervise the CVA.
75% or more in value of the unsecured creditors must agree to the CVA in order for it to be implemented.
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What can be granted at the same time as a CVA?
As with an IVA, at least for small companies, it is possible to have a moratorium which restricts the ability of third parties to enforce their rights + prevents the commencement of other insolvency procedures which can give the company a breathing space.
71
What is voluntary liquidation?
A voluntary liquidation can be started by the members or the directors of a company.
There are 2 kinds of voluntary liquidation:
i. members'
ii. creditors'
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What is a Members' Voluntary Liquidation?
In an MVL, the members and directors control the process from start to finish.
It is available only if the company is solvent, but the individuals involved in running the company wish to wind it up, e.g., if it is a small company + the owners wish to retire.
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What is the process of a CVL?
1. The directors resolve that the company is insolvent + should be placed into liquidation, and the members pass a special resolution to start the liquidation.
2. The resolution is advertised in the London Gazette.
3. Within 7 days of the day following the members' resolution, the directors must make out a statement in the prescribed form as to the affairs of the company + send that statement to the company's creditors. The directors also seek a nomination from the company's creditors for a person to be the liquidator.
4. The appointment of the liquidator is advertised in the London Gazette and Companies House is notified
5. The liquidator investigates, reports to creditors + asks for details of all debts
6. The liquidator collects in the assets of the company + distributes funds to the creditors in the statutory order. Final accounts are sent to creditors and members, and the final return is filed at Companies House.
7. The company is dissolved after 3 months.
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What is the procedure for an MVL?
1. The directors must make a statutory declaration of solvency. If the declaration is made without reasonable grounds, they are liable to a fine or imprisonment.
2. The members will pass a special resolution to start the liquidation and an ordinary resolution to appoint a liquidator,
3. The appointment of the liquidator is advertised in the London Gazette, and Companies House is notified.
4. The liquidator investigates, reports to creditors and asks for details of all debts,
5. The liquidator collects in the assets of the company and distributes funds to the creditors in the statutory order. Final accounts are sent to creditors and members, and the final return is filed at Companies House.
6. The company is dissolved after 3 months.
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What is a creditors' voluntary liquidation?
A CVL is started by the directors but then taken over by the creditors/
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What is compulsory liquidation of a company?
A creditor who can show that the company is unable to pay its debts can petition for the company to be wound up.
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What transactions does a liquidator/administrator/trustee in bankruptcy have power to ask the court to ask aside?
1. Preferences,
2. Transactions at an undervalue,
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What will the court consider when deciding when looking at a petition for the company to be wound up?
The court will consider all the relevant factors.
- It doesn't have to accept the petition.
If the company is able to convince the court it may recover financially or that the debt on which the petition is based is disputed, the court may dismiss the petition.
Otherwise, a liquidator will be appointed.
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What is the role of the liquidator?
The liquidator collects in the assets of the company + distributes funds to the creditors in the statutory order and the company is dissolved
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What is the order of priority for distribution to creditors in compulsory liquidation of the company?
1. Where the company enters into liquidation within 12 weeks of the end of a moratorium, certain moratorium debts + priority pre-moratorium debts,
2. Expenses of winding up,
3. Preferential debts,
4. Debts secured by floating charges in order of priority (subject to ring fencing),
5. Unsecured debts, and
6. Shareholders
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What is a preference?
A preference arises when a debtor does something that puts a creditor, surety, or guarantor in a better position on liquidation or administration than they would have been if the event had not occurred.
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What is needed for an event to be a preference?
The company or individual must have desired to prefer the creditor, surety, or guarantor of the company.
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When will the desire to prefer be presumed for a preference?
The desire to prefer is presumed if the preference is in favour of a connected person (such as a director, their spouse, or other close family member or an association of the bankrupt).
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When must an event occur for it to constitute a preference?
It must have occurred within 6 months of the onset of insolvency, or 2 years if the preference was made to a connected person or associate of the bankrupt.
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When is the onset of insolvency for a company compulsory liquidation?
The date of presentation of the petition
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When is the onset of insolvency for a CVL?
The date the company enters liquidation
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When is the onset of insolvency for administration?
The date the company files a Notice of Intention to Appoint an Administrator, or the date when it enters administration, whichever is earliest.
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When is the onset of insolvency for an individual?
The presentation of the bankruptcy petition.
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What is the effect of a preference?
The transaction will be voidable at the discretion of the court.
The court can order that any property be returned, any proceeds of sale be returned, or any security be discharged.
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What is a transaction at an undervalue?
A transaction at an undervalue arises when property that would have otherwise been part of the bankruptcy estate was given as a gift or was sold for significantly less than market value within 2 years of a company's insolvency, or 5 years of an individual's insolvency.
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What are the consequences of an undervalue transaction?
The same as those for a preference.
- Voidable at the discretion of the court.
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What is the insolvency requirement for a transaction to be set aside as an undervalue transaction for a company?
The company must have been insolvent at the time of the transaction or become so as a result.
However, there is a presumption of insolvency if the transaction is to a connected person.
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What is the insolvency requirement for a transaction to be set aside as an undervalue transaction for an individual?
There is no requirement to prove the debtor was insolvent at the time the transaction was made if it was made within 2 years before the petition.
Insolvency is presumed if the transaction was made at any time in favour of a close relative or business associate.
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What is the defence for a transaction at an undervalue?
There is a defence if the transaction was entered into in good faith, for the purpose of carrying on the business, and when it was made there were reasonable grounds for believing it would benefit the company
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What will not be considered a transaction at an undervalue?
Granting a security interest in a company asset is not considered to be a transaction at an undervalue as this doesn't change the value of the company's assets.
However, it may give rise to a preference.
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What is fraudulent trading?
Arises when a director (or any other person who knowingly participates) carries on business of the company with the intent to defraud creditors.
An action can be brought by a liquidator or an administrator.
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What may happen if fraudulent trading is established?
The directors may be liable to make such personal contribution to the company's assets as the court orders.
It is also a criminal offence.
Rarely proved in practice.
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What is wrongful trading?
Wrongful trading is a claim that at some time before a company became insolvent, the directors knew or ought to have known that there was no reasonable prospect that the company would avoid insolvency + failed to take adequate steps to minimise the losses to the company's creditors.
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How does a director's duty shift once they know our ought to know that insolvency is unavoidable?
Once a director knows or ought to know that insolvency is unavoidable, their duty shifts from what is best for the shareholders to what is best for the creditors.
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Who can bring a wrongful trading action?
Liquidator or administrator
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What may happen if a wrongful trading action is successfull?
The court may order the director to contribute to the company's assets as the court deems appropriate
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What is the defence to wrongful trading?
A director can defend the action by showing they took every step with the view to minimising potential loss to the company's creditors after becoming aware that the company had no prospect of avoiding liquidation.
A director should not do nothing if faced with the possibility of insolvency.
At the least they should take (and follow) professional advice.
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When will a floating charge automatically be void?
If the floating charge was created:
1. For no consideration within 12 months ending with the onset of insolvency (or 2 years for a connected person), and
2. At the time the company was insolvent or became insolvent as a result if the charge was given to a person unconnected to the company. However, there is no requirement to show insolvency if the floating charge is to a connected person.
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What is ring fencing?
A liquidator is required to set aside part of the assets subject to a floating lien for the benefit of unsecured creditors.
The amount is 50% of the first £10,000 in value of the property subject to floating charges and 20% on amounts above, up to a maximum ring-fenced fund of £800,000.
