Chapter 9: Corporate Insolvency I

Question 1

1 Introduction to corporate insolvency

Answer 1

This section considers the different tests for insolvency and some of the options available to a company in financial difficulties: informal agreements and the new pre-insolvency moratorium, company voluntary arrangements and the restructuring plan.

Question 2

1.1 Corporate insolvency – the law

Answer 2

The principal statute dealing with corporate insolvency is the Insolvency Act 1986 (IA 1986). We
will refer to this statute throughout this topic. IA 1986 has been significantly amended by various legislation including:
* The Enterprise Act 2002 which aimed to promote the rescue of companies and introduced,
amongst other things, a new administration procedure;
* The Small Business Enterprise and Employment Act 2015;
* The Insolvency (England and Wales) Rules 2016; and
* The Corporate Insolvency and Governance Act 2020 (CIGA 2020) which commenced on 26
June 2020.

IA 1986 introduced two key insolvency procedures aimed at achieving the objective of corporate
rescue: company voluntary arrangements (CVAs) and administration. CIGA 2020 introduced the pre-insolvency moratorium and the restructuring plan also aimed at
rescuing the company.

Question 3

1.2 Meaning of ‘insolvency’

Answer 3

The meaning of insolvency is set out in s 122(1)(f) IA 1986 which states that a company may be wound up ‘[…] if it is unable to pay its debts’.
There are four tests for insolvency, which are set out below. The most commonly used are the cash
flow test and the balance sheet test.
(a) The Cash Flow test: An inability to pay debts as they fall due (s 123(1)(e))
(b) The Balance sheet test: The company’s liabilities are greater than its assets (s 123(2))
(c) Failure to comply with a statutory demand for a debt of over £750 (s 123(1)(a))
(d) Failure to satisfy enforcement of a judgment debt (s 123(1)(b))

Question 4

1.3 Directors’ obligations towards companies in financial difficulties

Answer 4

The directors must review the financial performance of a company and recognise when it is facing
financial difficulties. Examples of financial difficulty include the following:

(a) The company has many unpaid creditors who are putting pressure on the company to pay
its bills.
(b) The company has an overdraft facility that is fully drawn and the bank is refusing to provide
further credit.
(c) The company has loans and other liabilities that exceed the value of its assets.

Question 5

1.4 Options for a company facing financial difficulties

Answer 5

Faced with a company in financial difficulty, the directors have options which include the
following:
(a) Do nothing - the directors risk personal liability under IA 1986 and breach of directors’ duties
under the Companies Act 2006.
(b) Apply for a pre-insolvency moratorium – this gives the company some ‘breathing space’.
(c) Do a deal - reach either an informal or formal agreement with the company’s creditors with a
view to rescheduling debts.
(d) Appoint an administrator - this is a collective formal insolvency procedure (a procedure
which considers the interests of all creditors) which aims, if possible, to rescue the company.
Administration will be considered later in this topic.
(e) Put the company into liquidation - this a collective formal insolvency procedure under which
a company’s business is wound up and its assets transferred to creditors and (if there is a
surplus of assets over liabilities) to its members. Liquidation will be considered later in this
topic.

Question 6

1.5 Corporate insolvency procedures

Answer 6

There are a number of different insolvency procedures. The procedures which we will consider in
this topic are set out below.
* Informal arrangements
* Formal arrangements
- Company voluntary arrangement
- Restructuring plan
* Administration
* Liquidation

Question 7

Key Features of Formal Arrangements (CVAs & Restructuring Plans)

Answer 7

A key feature of formal arrangements (CVAs and restructuring plans) is that the directors remain in control of the company and can exercise all their powers in the usual way (with the supervision of an insolvency practitioner), whereas in administration and liquidation the administrators or liquidators respectively take control of the company and the directors are then unable to take
decisions on behalf of the company.

Question 8

1.6 Informal agreements

Answer 8

To avoid the time and cost of formal insolvency proceedings, a company can negotiate informally with its creditors. These types of agreements are not regulated by IA 1986 or CIGA 2020. The difficulty is in getting all of the creditors to agree at the same time. For example, if a company needs to persuade a bank to keep lending money to enable it to keep
trading, the company or its directors could offer the bank to:
(a) Make additional payments or offer the bank additional security;
(b) Reschedule outstanding debts; and/or
(c) Reduce or hold over employees’ salaries for a set period.

Question 9

Standstill agreements

Answer 9

Creditors, including banks, could enter into standstill agreements where they agree not to take
enforcement action for a certain period of time to give the company a breathing space to reach agreement with its other creditors. However, it is anticipated that the use of standstill agreements will decline with the introduction of the pre-insolvency moratorium under CIGA 2020.

Question 10

1.7 Pre-insolvency moratorium (to protect the company from creditors)

Answer 10

CIGA 2020 has introduced a new pre-insolvency moratorium for struggling companies that are not yet in a formal insolvency process. The references below are to IA 1986 as amended by CIGA 2020. A ‘moratorium’ is a period during which creditors are unable to take action to enforce their debts, any existing court proceedings are stayed (ie paused) and the company may not be wound up. It creates a breathing space for the company to attempt to resolve the situation.

Question 11

Pre-insolvency moratorium, 20 business days

Answer 11

The pre-insolvency moratorium lasts for 20 business days but can be extended by the directors
for a further 20 business days. Further extensions are possible with the consent of a requisite majority of creditors and/or court order. The maximum period is one year subject to a court order to extend further.
The moratorium automatically comes to an end when the company enters into a formal arrangement or insolvency procedure (CVA, restructuring plan, administration or liquidation).

Question 12

1.8 Procedure for obtaining the pre-insolvency moratorium

Answer 12

In order to obtain a pre-insolvency moratorium, the directors of the company must apply to court
(s A3 IA 1986). The application must be accompanied by (s A6):
* A statement that the company is, or is likely to become, unable to pay its debts as they fall
due.
* A statement from a licensed insolvency practitioner (a specialist external individual, usually an
accountant), known as a monitor for these purposes, stating that:
- The company is an eligible company (see Sch ZA1), and
- It is likely that a moratorium will result in the rescue of the company.

Question 13

Characteristics of the moratorium

Answer 13

The moratorium comes into force at the time that the documents are filed at the court (s A7(1)(a)). The monitor then has the responsibility to notify the registrar of companies and all the creditors of the company that the moratorium is in force (s A8).
The monitor has a supervisory function during the pre-insolvency moratorium.

Question 14

1.9 Company voluntary arrangement (CVA)

Answer 14

The first formal agreement we will consider, the CVA, is a compromise between a company and its
creditors. CVAs are defined in s 1(1) IA 1986 as ‘a composition in satisfaction of its debts or a
scheme of arrangement of its affairs’.
The essence of a CVA is that the creditors agree to part payment of the debts or to a new timetable for repayment.

The agreement must be reported to court but there is no requirement for the court to approve the arrangement (s 4(6)). The CVA is supervised and implemented by an Insolvency Practitioner (a specialist external individual) but the company’s directors remain in post and are involved in the implementation ofthe CVA. CVAs can also be used together with administration or liquidation, which we consider later.

Question 15

1.10 Setting up a CVA

Answer 15

(a) Provided the company is not in liquidation or administration, the directors draft the written
proposals and appoint a nominee (an insolvency practitioner). If the company is in liquidation
or administration, the administrator or liquidator drafts the proposals.
(b) The directors submit the proposals and a statement of the company’s affairs to the nominee.
(c) The nominee considers the proposals and, within 28 days, must report to court on whether to
call a meeting of company and creditors – s 2(1) and s2(2).
(d) Nominee gives 14 days’ notice of meeting to creditors. A meeting of the members must take
place within 5 days of the creditors’ decision.
(e) Voting – the proposals must be approved by:
- 75% in value of creditors (excluding secured creditors); and
- A simple majority of members.
(f) Nominee reports to court on approval.
(g) Nominee becomes supervisor and implements proposals.

Question 16

1.11 Effect of a CVA

Answer 16

A CVA, once approved by the requisite majorities is binding on all unsecured creditors, including
those who did not vote or voted against it. However, secured or preferential creditors are not bound unless they unanimously consent to the CVA (s 4 IA 1986) – this is a major disadvantage of the CVA procedure.

Question 17

1.12 How are CVAs used?

Answer 17

CVAs are frequently used either alone or within administration in order to attempt to reach a compromise with creditors, particularly landlords to agree a reduction in rent in order to allow the company to attempt to continue trading. This is particularly common for retail businesses.

An advantage of CVAs is that the directors remain in control of the company, and the company
can in theory continue to trade. However, the major disadvantage is that a CVA cannot bind secured or preferential creditors.

CVAs are relatively rarely used. This is largely due to the complexity of the procedure and the fact that secured and preferential creditors are not bound by the proposals. It remains to be seen how the use of CVAs develops in the Coronavirus pandemic. Recent examples of companies which have used CVAs during the Coronavirus pandemic to agree rent reductions with landlords include All Saints, Frankie & Benny’s (owned by The Restaurant Group) and New Look.

Question 18

1.13 Restructuring plan

Answer 18

The second formal agreement to be considered is the restructuring plan (Plan). Introduced by CIGA 2020, the purpose of the Plan is to compromise a company’s creditors and shareholders and restructure its liabilities so that a company can return to solvency.

A Plan, unlike a CVA, can bind secured creditors and it is likely to displace CVAs. The provisions
relating to restructuring plans are set out in Part 26A CA 2006 (as amended by CIGA 2020). A Plan can only be used by companies which have or are likely to encounter financial difficulties.

Question 19

Features of the Restructuring Plan

Answer 19

The features of a Plan are:
* Creditors and members must be divided into classes and each class that votes on the Plan
must be asked to approve it. The Plan must be approved by at least 75% in value of each class
voting.
* The court must sanction the Plan and it will then bind all creditors.
The parties who can apply for to the court for sanction of a Plan are the company, any creditor, any member, the liquidator (if the company is in liquidation), or the administrator (if the company is in administration).

Question 20

1.14 Advantages of restructuring plan

Answer 20

The court can sanction a Plan if it is just and equitable to do so even if:
* One or more classes do not vote to approve the plan;
* It brings about a cross class cramdown – where a class of creditor can force the Plan on another class of creditor who has voted against the Plan;
* It brings about a cramdown of shareholders – this means forcing shareholders to accept the
Plan, diluting equity, creating debt for equity swaps. A Plan is likely to be used by directors following the use of a pre-insolvency moratorium. The
company may apply for the pre-insolvency moratorium to protect itself whilst the arrangements
are made for the implementation of the Plan. The moratorium will end once the Plan receives court sanction.
A Plan can also be used by administrators and liquidators.
A Plan may be better than a CVA because it can compromise the rights and claims of secured creditors and shareholders. A CVA cannot do this.

Question 21

1.15 Summary

Answer 21

• Directors must monitor the financial position of the company and have a range of options available to them when dealing with a company in financial difficulty
• A company can enter into informal agreements with its creditors, such as standstill agreements, with a view to not enforcing rights for a period of time to rescue the company.
• A company can apply to court for a pre-insolvency moratorium which will give the company a temporary breathing space to rescue the company.
• CVAs are arrangements agreed by the company’s creditors and members to achieve an
  agreement in respect of the company’s debts.
• CVAs do not bind secured or preferential creditors.
• CVAs are filed with the court but there is no requirement for court approval.
• A Restructuring Plan is a court-sanctioned compromise between a company and its creditors
  and shareholders to restructure the company’s debts.

Question 22

2 Administration and receivership

Answer 22

This section considers two different procedures:
* Administration, including the objectives, the appointment and powers of the administrator; and
* Receivership.

Question 23

2.1 The objectives of the administrator

Answer 23

Administration is a procedure which aims to rescue a company which is insolvent if at all possible, or to achieve a better result for creditors if not.

It is a ‘collective’ procedure, meaning that the administrator acts in the interests of the creditors as
a whole rather than on behalf of a particular creditor. The outcomes of administration will differ depending on the circumstances: administrators may be able to rescue some companies which will then continue trading, perhaps in a streamlined
fashion (eg Cath Kidston, which went into administration in 2020 resulting in the closure of their high street shops, but the continuation of the online business), but other companies may proceed into liquidation (eg BHS which went into administration in 2016 and ultimately into liquidation).

Question 24

Qualified insolvency practitioners

Answer 24

Administrators are qualified insolvency practitioners who may be appointed by the court or under
the out of court procedure (see below). They are required to perform their functions in the interests of the company’s creditors as a whole and owe duties to both the court and to the creditors collectively.

Question 25

2.2 The statutory objectives of administration

Answer 25

Section 8 and Sch B1 IA 1986 set out the objectives of the administration, stating that an
administrator:
[…] must perform his functions with the objective of:

(a) rescuing the company as a going concern, or
(b) achieving a better result for the company’s creditors as a whole than would be likely if the
company were wound up […],
(c) realising the property in order to make a distribution to one or more secure or preferential creditors

Question 26

2.3 Appointment of administrator – court procedure

Answer 26

There are two different procedures for the appointment of an administrator: the court procedure
and the out of court procedure. We will deal first with the court procedure. The court may appoint an administrator where the company is or is likely to become unable to
pay its debts (Sch B1 para 12) on the application of:
* The company
* The directors
* One or more creditors

The appointment may only be made where the order is reasonably likely to achieve the purpose of the administration (Sch B1 para 11(b)).

Question 27

Key case: AA Mutual International Insurance Co Ltd [2004] EWHC Ch

Answer 27

The applicant was an insurance company which sought an administration order. The court found that it was probable that the applicant would be unable to pay its debts as it had no income. The
administration was also held to be reasonably likely to achieve better results for the creditors as a
whole than winding up, therefore the application was granted.

Question 28

2.4 Appointment of administrator – out of court procedure

Answer 28

The following parties may appoint an administrator using the out of court procedure:

• The company or the directors (Sch B1 para 22 IA 1986); or
• A qualifying floating charge holder (‘QFCH’ - this means the holder of a floating charge created after 15 September 2003 relating to the whole or substantially the whole of the
  company’s property) (Sch B1 para 14 IA 1986). This is often a bank.

The most common method of appointing an administrator is by directors using the out of court
procedure. However, it is important to note that directors cannot use the out of court procedure where a creditor has presented a petition for the winding up of the company. In these circumstances, the directors can apply to court for an administration order or the qualifying
floating charge holder can use the out of court procedure to appoint an administrator.

Question 29

2.5 Role of the administrator

Answer 29

The administrator is an officer of the court and owes its duty to all of the company’s creditors to achieve the purposes of the administration. The directors are unable to exercise any of their management powers without the consent of the administrator. The administrator takes on the running of the business with the aim of achieving the purpose of the administration.

Question 30

8-week limit for administrators

Answer 30

Once appointed, the administrator has up to eight weeks to produce a report setting out proposals for the future of the company’s business. This must be put to all creditors for their approval. If the administrator’s proposals are rejected, the company will usually be put into liquidation.

However, if the administrator’s proposals are accepted, the administrator has several options including restructuring the creditors’ rights by implementing a CVA so that the company exits administration.

Question 31

12-month fixed time limit

Answer 31

There is a 12-month fixed time limit for the completion of administrations, although it is possible to obtain extensions. The administrator must report the outcome of the administration to the court.

Question 32

2.6 Moratorium

Answer 32

One key benefit of administration is that during administration, the company has the benefit of a
moratorium (Sch B1 para 42-44 IA 1986). During this time, all business documents and the company’s website must state that the company is in administration. During the moratorium (except with consent of the court or the administrator in each case):
(a) No order or resolution to wind up the company can be made or passed;
(b) No administrative receiver of the company can be appointed;
(c) No steps can be taken to enforce any security over the company’s property or to repossess
goods subject to security, hire purchase and retention of title;
(d) No legal proceedings, execution or other process can be commenced or continued against the company or its property, and
(e) A landlord cannot forfeit a lease of the company’s premises by means of peaceable re-entry.

Question 33

2.7 Powers of the administrator

Answer 33

Administrators have wide powers under IA 1986 to ‘do all such things as may be necessary for the
management of the affairs, business and property of the company’ (s 14(1) IA 1986). These include the powers to:
* Remove and appoint directors (s 14, Sch 1 and para 61 Sch B1);
* Dispose of property subject to a floating charge (para 70 Sch B1);
* Dispose of property subject to a fixed charge (with the court’s consent) (Para 71 Sch B1)
In addition, the Small Business, Enterprise and Employment Act 2015 (SBEEA 2015) granted additional powers to administrators to allow them to bring proceedings against directors for fraudulent and wrongful trading. We will look at the liability of directors in insolvency in the next
topic

Question 34

2.8 Approach of the court

Key case: Re T & D Industries Ltd [2000] 1 LWR 646

Answer 34

Neuberger J set out the approach that the court should take towards the administration process.
In this case the joint administrators of two connected companies applied for a direction under s 14(3) IA 1986 that no direction of the court was necessary before they could dispose of assets belonging to the companies, even though the proposed sale had not been disclosed to the creditors. The court noted that the intention was that administration proceedings should be a cheaper and more informal alternative to liquidation and therefore the administrators did not require the court’s leave

Question 35

Neuberger J h

Answer 35

Held that although an administrator needs time to obtain the necessary information, this should be done as quickly as possible and administrators should call a meeting of creditors as soon as reasonably feasible.

Commercial decisions are for the administrator and not the court and an application for directions should only be made where there is a point of principle in issue or a dispute as to the appropriate course of action to be taken. Where an administrator needs to make an urgent decision, they should consult the creditors to
the extent possible.

Question 36

2.9 Pre-packaged sales in administration

Answer 36

A pre-packaged administration is where the business of an insolvent company is prepared for sale
to a selected buyer prior to the company’s entry into administration. The agreed sale is carried out by an insolvency practitioner shortly after their appointment. Often the pre-pack purchaser will be one or more of the existing owners or directors of the insolvent company.

Pre-packaged sales are controversial, particularly where the sale is to existing members or management. The concern is that often creditors are given insufficient information to determine whether the sale was in their best interests. This concern led to calls for greater transparency, and
the Association of Business Recovery Professionals issued a Statement of Insolvency Practice (SIP) in 2013, requiring clear, comprehensive and timely explanations to creditors following prepackaged sales.

Question 37

Example: Debenhams

Answer 37

The UK department store group appointed administrators for a second time in May 2020 to
protect itself from its creditors. The administrators were pursuing three strategies; a sale of the business, a restructure of the business and the wind-down of the business. Debenhams had heavy debts of around £600 million.

Debenhams initially closed its Irish division, which had eleven stores, 958 staff and 300 concessions, and also closed its Hong Kong and Bangladeshi subsidiaries. The Debenhams brand was bought by fashion retailer Boohoo for £55 million in January 2021.
The stores reopened to clear stock and then began to close. The last remaining UK stores closed in May 2021. The Debenhams brand continued its operations online as part of the internet-only
fashion retailer Boohoo.

Question 38

Example: Cath Kidston

Answer 38

The fashion and accessories chain appointed administrators in April 2020. Like many fashion retailers, the company had longstanding problems in maintaining sales and profitability. It lost £27 million between 2018 and 2020, resulting in its closing stores and cutting head-office staff. There were 200 stores globally.

In December 2020, Cath Kidston returned to the UK high street with the re-opening of its flagship store in London’s Piccadilly.

Question 39

2.10 Receivership

Receivership as an enforcement proceedure

Answer 39

Whilst administration is a collective procedure; in contrast, receivership is an individual enforcement procedure which benefits only the appointing creditor. There are different types of receivers, but we will only consider the most common type: fixed
charge receivers.

Question 40

Fixed Charge Receiver

Answer 40

Fixed charge receivers are often referred to colloquially in practice as ‘LPA receivers’, although
strictly this is only correct if they have been appointed pursuant to a mortgage. Fixed charge receivers are appointed by the holders of a fixed charge pursuant to the terms of the
security documentation. They are appointed to enforce the security and recover the debt that is owing to their appointor, often a bank.

They owe their duties primarily and exclusively to the appointor; the duty to the chargor is to act in good faith in the course of their appointment. It is a legal anomaly that fixed charge receivers are usually an agent of the chargor. They usually have
extensive powers set out in the security documentation and some limited powers under the Law of
Property Act 1925, these powers typically include the ability to sell, mortgage and collect rents
from property

Question 41

2.11 Summary

Answer 41

• Administration is a collective procedure for the benefit of the creditors as a whole, administrators are insolvency practitioners who may be appointed by the court but are more likely to be appointed using the out of court procedure by either the company/directors or a QFCH.
• The administrator performs their duties in accordance with the statutory objectives.
• Once the administrator is appointed, the directors are unable to exercise any of their powers
  without the consent of the administrator. The administrator has wide powers to manage the
  company and may also bring actions against directors.
• The appointment of an administrator gives rise to a moratorium, protecting the company from hostile actions by creditors.
• Receivership is an enforcement procedure for the benefit of individual creditors.

Question 42

3 Liquidation

This section considers compulsory and voluntary liquidation.

Answer 42

Liquidations are the most common type of insolvency procedure. In 2019 more than 87% of all
company insolvencies were liquidations. You have seen references to ‘liquidation’ earlier in this module, but it is important to understand the meaning of this term.

Question 43

Definition of Liquidation

Answer 43

Liquidation is the process by which a company’s business is wound up and its assets transferred to creditors and (if there is a surplus of assets over liabilities) to its members.

Question 44

Differences between Liquidation & Winding Up

Answer 44

The company will then be removed from the register of companies and dissolved. The terms ‘liquidation’ and ‘winding up’ are used interchangeably. However, it is important to note that it is not only insolvent companies which are wound up or liquidated.

Solvent companies may also be wound up and this is not uncommon. Companies may be wound up simply because the business opportunity has come to an end, due to internal
disputes or where the members wish to move on to new ventures.

Question 45

3.2 Liquidation – an overview

Answer 45

Liquidation is the most basic and oldest of the corporate insolvency procedures. The liquidator’s function is to realise the company’s assets for cash, determine the identity of
the company’s creditors and the amount owed to each of them and then pay a dividend to the
creditors on a proportionate basis relative to the size of their determined claims (creditors of the
same rank are said to rank ‘pari passu’)

Question 46

Liquidation is not a rescue mechanism

Answer 46

Liquidation is not a rescue mechanism, and a liquidator has only very limited powers to carry on
the business of a company. They will usually close a company’s business and dismiss employees very soon after their appointment. They will usually sell assets on a piece-meal basis rather than selling the assets and business as a going concern. The statutory moratorium which applies in a liquidation is very limited.

Go through administration first: For these reasons, it is common for companies to enter into liquidation after having been through a different insolvency procedure (eg administration) first.

Question 47

3.3 Types of liquidation

Answer 47

There are two types of liquidation:
(a) Compulsory liquidation
(b) Voluntary liquidation – which is further subdivided into:
- Members’ voluntary liquidation
- Creditors’ voluntary liquidation.

Question 48

On dissolution, company ceases to exist

Answer 48

Following liquidation, the company’s life is generally brought to an end automatically by dissolution. In the case of a compulsory liquidation, this will be three months after notice by the liquidator to the Registrar of Companies that the winding up of the company has been completed. In the case of voluntary liquidation, dissolution will occur three months from the filing by the liquidator of the final accounts and return. On dissolution, the company ceases to exist.

Question 49

3.4 Compulsory liquidation

Answer 49

Compulsory liquidation is a court-based process for placing a company into liquidation. To begin the process, an applicant presents a winding up petition to the court under which the
applicant requests the court to make a winding up order against the company on a number of statutory grounds.

When the court grants a petition for compulsory liquidation, the order operates in favour of all the creditors and contributories (members and some former members) of the company.

Question 50

Role of the official receiver

Answer 50

The Official Receiver will become the liquidator and continue in office until another person is appointed (s 136(2) IA 1986). The Official Receiver will notify Companies House and all known creditors of the liquidation.

The Official Receiver has the power to summon separate meetings of
the company’s creditors and contributories for the purpose of choosing a person to become the
liquidator of the company in their place (s 136(4)).

Question 51

3.5 Who can apply for a winding up order?

Answer 51

The following persons can apply to the court for the issue of a winding up petition:

(a) A creditor;
(b) The company (acting by the shareholders; this would happen where there are insufficient
assets in the company to fund a voluntary liquidation);
(c) The directors (by board resolution); again, this would happen where there are insufficient
assets to fund a voluntary liquidation;
(d) An administrator;
(e) An administrative receiver;
(f) The supervisor of a CVA; and
(g) The Secretary of State for Business, Energy & Industrial Strategy (on public policy grounds).

Question 52

3.6 Grounds for compulsory winding-up petition

Answer 52

There are a number of grounds on which the court can order a company to be wound up, which
are set out in s 122(1) IA 1986:
* The company is unable to pay its debts.
* It is just and equitable for the company to be wound up.
* The company has passed a special resolution that it is to be wound up by the court.
* The company is a public company and has not issued the requisite share capital and more
than a year has passed since its registration as a public company.
* The company is an old public company within the meaning of the Consequential Provisions
Act.
* The company does not commence its business within a year from its incorporation or suspends its business for a whole year.

Question 53

3.7 Inability to pay debts – s 123 IA 1986

Answer 53

The most common ground for a winding up petition is the company’s inability to pay its debts under s 122(1)(f) IA 1986. This can be evidenced by (s 123 IA 1986):

Question 54

(a) Failure by the company to comply with a creditor’s statutory demand

Answer 54

A statutory demand is a written demand in a prescribed form requiring the company to pay a specific debt. The statutory demand can only be used if the debt exceeds £750 and is not disputed on substantial grounds. The company has 21 days in which to pay the debt, failing which the creditor has the right to petition the court to wind up the company.

Question 55

(a) Failure by the company to comply with a creditor’s statutory demand

Answer 55

(b) The creditor sues the company, obtains judgment and fails in an attempt to execute the
judgment debt

Question 56

(c) Proof to the satisfaction of the court that the company is unable to pay its debts as they fall due (the ‘cash-flow test’).

Answer 56

The cash flow test is usually satisfied by going through the statutory demand process in 1 above but that is not essential.

Question 57

(d) Proof to the satisfaction of the court that the value of the company’s assets is less than the
amount of its liabilities

Answer 57

Taking into account contingent and prospective liabilities (the ‘balance sheet test’) (Re Cheyne Finance plc [2008]).

Question 58

3.8 ‘Unable to pay its debts’ - s 123(2) IA 1986

Answer 58

In this case the Supreme Court considered the meaning of ‘unable to pay its debts’ and particularly the distinction between the cash flow and balance sheet tests. The case arose out of the 2008 collapse of the Lehman Brothers group and concerned the acquisition by the group of a portfolio of mortgage loans funded by loan notes repayable in 2045.

The court held that the cash-flow test must include a consideration of debts falling due in the reasonably near future. What this means will depend on all the circumstances, but especially on the nature of the company’s business. However, once the court has moved beyond the reasonably near future, then the balance sheet test becomes the only sensible test. The burden of proof must be on the party asserting balance-sheet insolvency.

Question 59

3.9 Consequences of winding up order

Answer 59

This includes:
* Disposition of the company’s property;
* Transfer of the company’s shares;
* Altering the status of the company’s members.
Once a compulsory winding up order has been made:
* An automatic stay will be granted on commencing or continuing with proceedings against the
company;
* All employees will be automatically dismissed, and
* The directors lose their powers and they are automatically dismissed from office.

Question 60

3.10 Voluntary winding up

Answer 60

Section 84(1) IA 1986 allows for the company to be wound up without a court order in three
situations:

(a) Where the company’s purpose according to the articles has expired and resolution of the shareholders. This is rare.

(b) Where the company resolves by special resolution to wind up the company. The company
must be solvent. The procedure is MVL.

(c) Where the company resolves that it is advisable to wind up the company due to its inability
to carry on its business. Here the company is insolvent. The procedure is CVL.

Question 61

3.11 Members’ voluntary winding up (MVL)

Answer 61

This method of voluntary winding up may only be used for companies which are solvent.

The directors are required to swear a declaration of solvency stating that they have made a full enquiry into the company’s affairs and they have formed the opinion that the company will be able to pay its creditors in full, together with interest at the official rate, within a period not exceeding 12 months from the commencement of the winding up (s 89(1) IA 1986).

The declaration must also contain a statement of the company’s assets and liabilities as at the latest practicable date before making the declaration.

Question 62

Winding up after special resolution is passed

Answer 62

Any director making a declaration of solvency who does not have reasonable grounds for their
opinion is liable to a fine or imprisonment (s 89(4) IA 1986). If the debts are not actually paid in full
within the specified period it will be presumed that the director did not have reasonable grounds
for their opinion.

The members must then pass a special resolution to place the company into MVL and an ordinary
resolution to appoint a liquidator. The winding up commences when the special resolution is passed (s 84(1) and s 86 IA 1986).

Question 63

3.12 Conversion of MVL to creditors’ voluntary liquidation

Answer 63

On an MVL, if the liquidator considers that the company will be unable to pay its debts in full together with interest within the period stated in the directors’ declaration, they must change the members’ winding up into a creditors’ winding up by going through the procedural conditions in s 95. This involves the liquidator preparing and sending a statement of the company’s affairs to the
company’s creditors.

Question 64

Nominate a person to be a liquidator

Answer 64

The company’s creditors may nominate a person to be liquidator. In most cases this will be the
insolvency practitioner who was appointed to deal with the MVL. The creditors’ voluntary liquidation takes effect from the date of nomination of the liquidator.

Question 65

3.13 Creditors’ voluntary winding up (CVL)

Answer 65

This is a form of insolvent liquidation commenced by resolution of the shareholders, but under the effective control of the creditors who can choose the liquidator. Where a directors’ declaration of solvency has not been made, the liquidation will be a creditors’ voluntary
liquidation. The procedure is for the shareholders to pass a special resolution to place the company into a CVL.

Question 66

Creditors Nominations take precedence

Answer 66

The shareholders may also nominate a person to be liquidator, but in any event within 14 days of the special resolution being passed the directors of the company must ask the company’s creditors to either approve the nominated liquidator or put forward their own choice of liquidator. Where the creditors’ choice of liquidator differs from that of the company’s shareholders, the
creditors’ nomination will take precedence.

Question 67

Statement of Company Affairs

Answer 67

The directors must also draw up a statement of the company’s affairs (setting out the company’s
assets and liabilities) and send it to the company’s creditors.

Question 68

3.14 Role of the liquidator

Answer 68

As noted above, the appointment of a liquidator terminates the management powers of the
company’s directors, and these powers are transferred to the liquidator together with their
fiduciary duties, meaning that liquidators must act in good faith, avoid conflicts of interest and
not make a secret profit (Silkstone and Haigh Moore Coal Co v Edey [1900]).

The liquidator must be either a qualified Insolvency Practitioner (s 230 IA 1986) or the Official Receiver (appointed by the court in the short term) and acts as an officer of the court.

Question 69

Principle Functions of Liquidators

Answer 69

The liquidator in both a CVL and a compulsory liquidation has extensive statutory powers. The principal functions of a liquidator are:
* To secure and realise the assets of the company then distribute to the company’s creditors (s 143 IA 1986); and
* To take into their custody or under their control all the property of the company (s 144 IA 1986).

Question 70

3.15 Liquidator’s powers to manage the company

Answer 70

Include the ability to:
* Sell any of the company’s property;
* Execute deeds and other documents in the name of the company;
* Raise money on the security of the company’s assets;
* Make or draw a bill of exchange or promissory note in the name of the company;
* Appoint an agent to do any business that the liquidator is unable to do;
* Do all other things that may be necessary to wind up the company’s affairs and to distribute
its assets.
* Carry on the business of the company, but only to the extent that is necessary for the
beneficial winding up of the company.
* Commence or defend court proceedings in the name of the company, for example to recover
debts owed to it or dispute debts alleged to be owed by the company.
* Pay debts and compromise claims.

Question 71

3.16 Liquidator’s powers to avoid certain transactions

Answer 71

They are empowered to avoid certain antecedent
transactions in order to maximise the amount of assets available for distribution to creditors as
follows:
* Disclaim onerous property (s178 IA 1986);
* Apply to court to set aside a transaction at an undervalue (s238 IA 1986);
* Apply to court to set aside a preference (s 239 IA 1986);
* Apply to court to set aside, or vary the terms of, an extortionate credit transaction (s 244 IA
1986);
* Claim that a floating charge created for no new, or inadequate, consideration is invalid (s 245
IA 1986);
* Apply to court to set aside a transaction that will defraud creditors (s 423 IA 1986).
Note that many of these powers also apply to administrators.

Question 72

3.17 Summary

Answer 72

Liquidation may be compulsory (court-ordered) or voluntary (members’ or creditors’ voluntary
liquidation).

• A members’ voluntary liquidation applies only to solvent companies where the directors swear
  a statutory declaration of solvency.
• Compulsory liquidation may be ordered by the court on any of the grounds under s 122(1) IA
  1986. The most common ground is that the company will be unable to pay its debts
• The role of the liquidator is to realise the assets of the company and to distribute these in
  accordance with the statutory order of priority.
• Once the liquidation commences, the directors lose their powers, and the liquidator takes
  control of the company.
• Any disposition of the company’s property, transfer of the company’s shares, altering the
  status of the company’s members will be void if commenced after the commencement of the
  winding up.

Question 73

4. The statutory order of priority on winding up

4.1 Introduction

Answer 73

(a) Liquidator’s fees and expenses of preserving and realising assets subject to fixed charges.

(b) Amount due to fixed charge creditor out of the proceeds of selling assets subject to the fixed
charge.

(c) Other costs and expenses of the liquidation.

(d) Preferential creditors (the first tier and then the secondary tier).

(e) Creation of the prescribed part fund (if available) for unsecured creditors.

(f) Amount due to creditors with floating charges.

(g) Unsecured/trade creditors (including payment of the prescribed part).

(h) Interest owed to unsecured creditors.

(i) Shareholders.

Question 74

4.3 Fixed charge assets

Answer 74

It is important to note that the assets are divided into two funds which are applied separately: the
assets subject to the fixed charge, then the remaining assets, which will be those subject to the
floating charge in this example (since we are assuming there is a QFC, which is a charge over the
whole of the company’s assets).

The assets subject to fixed charges are realised first by the liquidator and the proceeds are applied as follows:
(a) Liquidator’s costs of preserving and realising assets subject to a fixed charge
(b) Fixed charge creditors (in respect of assets subject to a fixed charge)

Question 75

Proceeds & Payments

Answer 75

The proceeds of selling assets which are subject to a fixed charge (or mortgage) must first be used
to pay off the debt secured by such charge (or mortgage). The proceeds will be paid net of the liquidator’s costs and associated fees of realising the assets (that is, net of sums falling into the first category of priority above).

If the proceeds are not sufficient to discharge the debt in full, then the creditor must await payment of the balance at an appropriate later point in the order of priority – which will depend on whether or not the same debt was also secured by a floating
charge.

Question 76

4.4 Assets subject to the floating charge (all assets)

Answer 76

In this example we are presuming that there is a QFC therefore all remaining assets of the
company are subject to this. The remaining assets are therefore realised and the proceeds
applied as follows:

Question 77

(c) Other costs and expenses of the liquidation

Answer 77

This includes all other costs and expenses of the liquidation, including the costs of selling assets secured by a floating charge and the costs and expenses incurred in pursuing litigation (such as actions in respect of wrongful trading or voidable transactions). Such litigation will require prior approval from preferential creditors and floating charge holders, or alternatively from the Court, otherwise the liquidator cannot claim the costs of litigation. The reason for this rule is that it is
these creditors who will effectively pay the costs of litigation should it fail.

Question 78

(d) Preferential debts (Schedule 6)

Answer 78

The Enterprise Act 2002 removed the preferential status of certain Crown debts, previously
payable ahead of other creditors, but this has now been reinstated. For insolvencies occurring on
or after 1 December 2020, there will be two tiers of preferential debts.

Question 79

Two Tiers of Preferential Debts

Primary/First Tier

Answer 79

The first tier consists of employees for remuneration due in the four months before the ‘relevant
date’ (generally the date of the winding up resolution or petition), but subject to a maximum of
£800 per employee, plus accrued holiday pay and certain contributions owing to an occupational
pension scheme. If the insolvent company is a bank or building society, certain retail deposits that are insured by the Financial Services Compensation Scheme will also be preferential debts in the first tier.

Question 80

Secondary Tier

Answer 80

The secondary tier consists of debts due within certain periods to HM Revenue and Customs in respect of PAYE, employee national insurance contributions and VAT.

Question 81

(e) Prescribed part fund or the ring fenced fund

Answer 81

The Enterprise Act 2002 introduced the ‘prescribed part’ fund into the IA 1986 to increase the chance that unsecured creditors would get paid something in a liquidation. The prescribed part fund is sometimes referred to as the ‘ring fenced’ fund.

The prescribed part fund is calculated by reference to a certain percentage (the ‘prescribed part’) of the company’s ‘net property’. This is set aside (ring-fenced) for distribution to the company’s unsecured creditors - s 176A. ‘Net property’ means the proceeds of selling property other than that which is subject to a fixed charge, after deduction of the liquidator’s expenses and any
preferential debts.

Question 82

Shared rateably among the unsecured creditors

Answer 82

This pot of money is reserved at this stage to be shared rateably among the unsecured creditors when they are paid (ie at step 7 below). It should be noted that for this purpose, a floating charge holder who suffers a shortfall on floating charge realisations does not share in the prescribed part fund, although the shortfall does constitute an unsecured claim against the company. Note. The ring-fencing provisions only apply to realisations from floating charges created on or
after the Relevant Date.

Question 83

(f) Floating charge creditors

Answer 83

After payment of the general expenses of the liquidation, paying preferential debts and dealing
with the prescribed part, the liquidator then pays any remaining realisations from assets subject
to floating charges to the floating charge holders themselves (according to the priority of their security, if there is more than one floating charge holder).

Question 84

(g) Unsecured creditors

Answer 84

For example:
* Ordinary trade creditors who have not been paid;
* Secured creditors to the extent that the security is invalid or assets subject to the security have
not realised sufficient funds to pay off the secured debt.

All the unsecured creditors rank and abate equally. This is known as the “pari passu” rule. For example, if a company has only two creditors (A and B) and creditor A has a claim against the company of 100 and creditor B has a claim against the company of 50 (making total claims of 150) but the assets available for distribution to the creditors are 75, creditor A will receive 50 and
creditor B will receive 25.

Question 85

(h) Interest on unsecured (including preferential) debts

Answer 85

Interest accruing on unsecured debts from the commencement of the winding up.

Question 86

(i) The shareholders

Answer 86

The shareholders who participate in the equity of the company will rank last. However, their rights, as between themselves, will depend on the rights attributable to their particular class or classes of
shares. This will be written into the Articles of Association. For example, preferential shareholders may have preferential rights to a return of their capital on a winding up in priority to ordinary shareholders.

Question 87

Shareholders are unlikely to receive any value from shares

Answer 87

It is clear that in most insolvent liquidations, the shareholders are unlikely to receive any value
from their shares, since they are the last to be paid in the statutory order of priority. The benefit of fixed charges is also clearly illustrated – fixed charge holders receive their value first and are therefore more likely to receive their money back in a liquidation.