Corporate Insolvency

Question 1

What is corporate insolvency? When is a company insolvent?

Answer 1

Insolvency is the inability of a company or an individual to pay their debts

A company is insolvent when:

• Creditor has served a statutory demand for an outstanding sum of £750 or more, and company does not pay or come to an arrangement within 21 days of service; or
• Creditor has obtained judgment against the company + has tried to enforce it, but the debt hasn’t been paid; or
• It can be proved the court the company cannot pay debts as they fall due (cash flow test); or
• It can be proved to the court that the company’s liabilities exceed its assets (balance sheet test) - look at net liabilities and net assets figures
• A court is convinced that it is just and equitable to wind them up

Question 2

What are some of the key directors’ duties when a company is insolvent and how do they apply?

Answer 2

1) S172 is the first main duty – duty to promote success of company

• S172(3) requires that the interests of the creditors take precedence over the members when a company becomes insolvent
• The creditors interests become a paramount consideration in director’s decision making when the company is irretrievably insolvent
• When the company is insolvent or borderline insolvent, but not faced with inevitable liquidation, the paramountcy of creditors’ interests depends on how serious the financial difficulties are

2) S174 is the second main duty – duty to exercise reasonable care, skill and diligence

• Important to avoid claims of fraudulent/wrongful trading or misfeasance

Question 3

What are the potential outcomes for an insolvent company (in overview)?

Answer 3

Company can go into, or creditors may force/encourage, these processes:

• Liquidation
• Administration
• Company voluntary arrangement

Secured creditors may be able to:

• Appoint an LPA receiver
• Appoint an administrator out of court; or
• Appoint an administrative receiver (for security created before 15 Sep 2003)

Corporate Insolvency and Governance Act 2020 created 2 new insolvency rescue regimes:

• Moratorium
• Restructuring plan

Question 4

In overview, what is liquidation? What are the 3 different types?

Answer 4

AKA winding up

Business stops trading, assets sold, and company ceases to exist

Liquidator appointed who runs the company – directors’ powers cease

• They try to obtain more money that can be paid to the company’s creditors
• They distribute assets to creditors in a statutory order
• Company later dissolved at Companies House

3 types of liquidation

• 1) Compulsory liquidation – 3rd party commences insolvency proceedings
• 2) Creditors’ voluntary liquidation (CVL) - commenced by the company itself when it is insolvent
• 3) Members’ voluntary liquidation (MVL) - commenced by a solvent company when it wishes to cease trading

Question 5

Give an overview of the initial stages for compulsory liquidation

Answer 5

Commenced by a 3rd party petitioner presenting a winding up petition at court

• They must prove one of the 4 insolvency tests above (cash flow test/balance sheet test etc)
• Winding up petition is the 1st stage

Unpaid creditors have limited access to a company’s current financial records, so they often issue a statutory demand, which, if left unpaid for 21 days, allows them to make a winding up petition

• Prevented from proceeding with a petition if the company can show there is a genuine and substantial dispute in relation to the money owed

If a company can pay its debt within a reasonable time, the court may adjourn the hearing to a later date

If the company is ordered to be wound up, the Official Receiver (OR) will automatically become the liquidator

Question 6

Give an overview of CVL

Answer 6

Process initiated by the company and then the creditors take over the process at an early stage – usually directors feel pressured to enter CVL by creditors

• Risks of misfeasance, fraudulent/wrongful trading if they continue to trade and company goes into liquidation

Question 7

Give an overview of MVL

Answer 7

Only available if company is solvent – must be converted to CVL if liquidator realises, they are insolvent during MVL

• Directors must swear a statutory declaration that the company is solvent for MVL to begin
• Often used by dormant companies

Question 8

After the liquidator is appointed, their role is similar, if not identical, for each type of liquidation.

What is the broad process of liquidation, once the liquidator is appointed?

Answer 8

Liquidation terminates directors’ powers

• They also terminate directors’ appointments – compulsory liquidation only

Liquidator takes over the running of the company and their powers include:

• Carrying on the business
• Commencing and defending litigation
• Investigating company’s past transactions
• Investigating directors’ conduct
• Collecting and distributing company’s assets
• Doing anything necessary to facilitate the winding up of the company

After everything + preparing final accounts, liquidator applies to be released

• Registrar dissolves company 3 months later

The main two liquidator functions are:

1) Preserving and increasing company assets

2) Distributing those assets to creditors

Question 9

Liquidators and administrators have a duty to maximise assets available to creditors.

There are various claims they can bring to aid this duty. In overview, what are they?

Answer 9

They can bring several claims to do this

The claimant is the company and any money awarded to the company is used to pay to creditors

Key potential claims:

• (a) avoidance of certain floating charges;
• (b) preferences;
• (c) transactions at an undervalue;
• (d) transactions defrauding creditors; and
• (e) extortionate credit transactions

Question 10

In summary, what is the claim for ‘avoidance of certain floating charges?’

Answer 10

Deals with invalid floating charges, which are automatically void

Charge is automatically void where, at the relevant time before the onset of the company’s insolvency, a charge was granted without the company receiving fresh consideration in exchange for security

• Consider if the loan and charge granted at the same time

Question 11

What is meant by the ‘relevant time before the onset of insolvency’ in relation to the avoidance of certain floating charges?

Answer 11

Relevant time

• Charge created in favour of a person connected with the company = during the 2 years ending with onset of insolvency
• Charge created in favour of anyone else = during the 12 months prior to onset of insolvency

Onset of insolvency

• Compulsory liquidation – date of presentation of winding up petition
• CVL – date company formally enters liquidation
• Administration – when company files notice of intention to appoint an administrator or actual administration date (if earlier)

Question 12

Who is a connected person, in relation to the avoidance of floating charges?

Answer 12

Connected person

• Director/shadow director
• Close relative or business associate of director/shadow director
• Company in the same group

If charge given to unconnected person – company must have been insolvent at the time or became insolvent as a result

If charge given to connected person – not necessary to show that

Question 13

In summary, what is the claim against ‘preferences’ that liquidators and administrators can make?

Answer 13

Can challenge a transaction where the company, at the relevant time, has given a preference to someone else

Preference = company puts them in a better position, in the event the company goes into liquidation or administration
* Puts a creditor, surety, or guarantor in a better position on insolvency and the company desired this

Relevant time

• Preference to a connected person – during the 2 years ending with onset of insolvency
• Preference to anyone else – during the 6 months ending with onset of insolvency

Company must have been insolvent at the time of the preference or because of giving it – no presumptions of insolvency

Must be a desire to prefer the other party, rather than just an intention to prefer them

• Presumed for a connected person, but can be rebutted
• Desire not present if the preference is a response to ordinary commercial pressure

Question 14

If a claim to challenge a transaction giving a preference succeeds, what are the possible consequences?

Answer 14

If preference proven, court could order:

• Release of any security given by the company
• The return of any property transferred as part of the transaction
• The payment of the proceeds of sale of property

Question 15

In summary, what is the claim to challenge transactions at an undervalue?

Answer 15

Can challenge transactions which the company entered at an undervalue at the relevant time

• Undervalue = where the company makes a gift to the other person or enters a transaction and receives significantly lower consideration than what the company provides
• Relevant time = during the 2 years ending with onset of insolvency

Company must have been insolvent at time of transaction or because of it

• Insolvency presumed where transaction was with a connected person, but this can be rebutted

Defence if transaction was entered into in good faith, for the purpose of carrying on the business and there were reasonable grounds for believing it would benefit the company

Question 16

In summary, what is the claim to challenge extortionate credit transactions?

Answer 16

Can challenge an extortionate credit transaction made in the last 3 years ending with the day administration or liquidation started

Extortionate transaction = must require grossly exorbitant payments or otherwise grossly contravene ordinary principles of fair dealing

• Rare to claim this

Question 17

In summary, what is the claim to challenge transactions defrauding creditors?

Answer 17

Occurs where a company makes a transaction at an undervalue to put assets beyond the reach of someone making a claim or to prejudice any claim they might make

• Challenges to transactions defrauding creditors are brought at the discretion of the court

No time limit for a claim, but difficult to prove

• Usually only made by a liquidator or administrator when they can’t bring a claim for transaction at undervalue due to expiry of time limits
• Creditors can also bring a claim like this

Question 18

Once the liquidator has investigated the financial affairs of the company and challenged any transactions, they will begin to distribute the assets to creditors.

What group of creditors will be paid first?

Answer 18

Fixed charge holders will receive the amount they are owed when the charged asset is sold, with surplus paid to liquidator.

• If there is a shortfall, they will become an unsecured creditor for the remainder

Question 19

After valid fixed charges are paid, there is a set statutory order to how other groups of creditors will be paid. What is the statutory order?

Answer 19

After valid fixed charges paid, liquidator makes payments in the following order:

• Expenses of winding up (liquidators’ fees etc)
• Preferential debts, which rank and abate equally
• Money subject to floating charges, in order of priority; and
• Unsecured creditors, who rank and abate equally
• Remaining money distributed to shareholders

Question 20

How do unsecured creditors show what they are owed?

Answer 20

All unsecured creditors fill in a form with details of the debt owed to them – process called proving the debt

• Liquidator then accepts or rejects the claims – small debts of £1000 or less are automatically admitted

Question 21

Preferential debts and unsecured creditor debts ‘rank and abate equally.’ What is meant by this (with an example)?

Answer 21

Rank and abate equally means they get the same percentage of the outstanding debt they are owed

Example – UC1 is owed £10k and UC2 is owed £5k, with £7500 available for UCs

• UCs will receive £7500/£15,000 (total debt) = £0.50 for every pound they are owed
• UC1 will get £5000 and UC2 will get £2500

Question 22

Who will be the main 2 preferential creditor/have preferential debts?

Answer 22

Most common is salaries of employees of the company for work carried out in the 4 months before the winding up order, up to a maximum of £800 per employee

• Accrued holiday pay is a preferential debt too
• Remaining salary owed becomes an unsecured debt with the other unsecured creditors

HMRC is a secondary preferential creditor behind employees for taxes they collect on HMRC’s behalf (PAYE + VAT)

Question 23

What is ‘ring-fencing?’

Answer 23

Procedure to set aside a portion of available money for floating charge holders for the benefit of unsecured creditors

Can set aside:

• 50% of first £10k of money received from the property subject to floating charges; and
• 20% of remaining money

Up to a £800,000 limit

Question 24

Give a summary of the compulsory liquidation process

Answer 24

• Petition filed at court and served on company – start of winding up
• Company cannot dispose of assets
• Petition advertised in Gazette
• Court hearing; if winding up order made, OR appointed as liquidator and directors’ powers cease
• OR advertises order in the Gazette and notifies Registrar of Companies
• Liquidator investigates and reports to creditors
• Creditors may appoint alternative liquidator if the majority are in favour
• Liquidator collects in assets and sells if necessary and distributes in statutory order
• Final accounts sent to creditors and/or members
• Final return filed with court and Registrar of Companies
• Company dissolved after 3 months

Question 25

Give a summary of the creditors' voluntary liquidation process

Answer 25

* Directors agree by a majority that the company is insolvent and needs to be placed into liquidation * Special resolution to liquidate company and may consider nominating a liquidator. Directors’ powers effectively cease – **start of winding up** * Petition advertised in Gazette * Directors **must, before the end of 7 days beginning with the day after the day the company passes a resolution for CVL**: * (a) make out a statement in the prescribed form as to the affairs of the company * (b) send the statement to the company’s creditors * (c) seek nomination from the company’s creditors for a person to be the liquidator * Creditors considering the appointment of a liquidator must hold a virtual meeting/seek approval by the new deemed consent procedure. There is no physical meeting unless it is requested by the creditors * Once the resolution to wind up the company has been passed by the shareholders, the liquidator must file a copy at Companies House and it must be advertised in the Gazette. * Liquidator investigates and reports to creditors * Creditors may appoint alternative liquidator if the majority are in favour and a resolution is passed to that effect * Liquidator collects in assets and sells if necessary and distributes in statutory order * Final accounts sent to creditors and/or members * Final return filed with Registrar of Companies * Company dissolved after 3 months

Question 26

Give a summary of the members' voluntary liquidation process

Answer 26

* Directors make statutory declaration of solvency * Special resolution to start liquidation and ordinary resolution to appoint liquidator. Directors’ powers cease – **start of winding up** * Petition advertised in Gazette * Once the formalities of the meeting are concluded, appointment published in Gazette and Registrar notified * Liquidator investigates and reports to creditors * Creditors may appoint alternative liquidator if the majority are in favour and a resolution is passed to that effect * Liquidator collects in assets and sells if necessary and distributes in statutory order * Final accounts sent to creditors and/or members * Final return filed with Registrar of Companies * Company dissolved after 3 months

Question 27

What are the alternatives to liquidation?

Answer 27

1) Administration 2) Company voluntary arrangement (CVA) 3) Schemes of arrangement * Can happen at any time in a company’s life + require two court hearings and meetings of creditors and shareholders 4) Restructuring plans * Like schemes of arrangement as company proposes a plan to members or creditors 5) Free-standing moratorium * Apply to court and gives breathing space to rescue the company 6) Informal agreements with creditors * Not binding, so not a recommended option

Question 28

In overview, what is administration?

Answer 28

Process where an administrator (independent insolvency practitioner) is appointed to **run the company and make necessary changes to improve its financial performance** * They might also get it ready to be sold as a going concern **Whilst administration is ongoing, a statutory moratorium in place**, meaning it isn’t possible for anyone to commence or continue with legal action against the company, enforce a judgment or issue a winding up petition, without administrator consent

Question 29

What are the main duties and objectives of an administrator?

Answer 29

They must perform their duties in the **interests of all the company’s creditors as a whole** 1) Their primary objective is to **aim to rescue the company as a going concern** 2) If not possible, they **must try to achieve a better result for the creditors** than would be likely if the company were wound up 3) If this is also not possible, they **must sell property to pay secured or preferential creditors**

Question 30

In overview only, what are the 2 routes to commencing administration?

Answer 30

1) Court route – by court order, after application to court and court hearing 2) Out of court route – involves the company, directors, holder of qualifying floating charge (**QFCH**), or an unsecured creditor, filing certain documents at court

Question 31

What is the court route for commencing administration?

Answer 31

Court can make an administration order only if it is **satisfied that the company is likely to become unable to pay its debt** and the **order is reasonably likely to achieve one of the 3 purposes of administration** * Rescue company as going concern, better result than winding up, sell assets for secured/preferential creditors ASAP after applying, **applicant must notify any person who has appointed or is entitled to appoint an administrative receiver** of the company * They must also notify any qualifying floating charge holder (QFCH) who is entitled to appoint an administrator

Question 32

How does the out-of-court route work when the company or its directors seek to appoint an administrator?

Answer 32

1st stage – serve notice of intention of administration on: * The court; and * Any QFCH; and * Any lender entitled to appoint an administrative receiver Directors must also file at court a statutory declaration that the company is unable to pay its debt and is not in liquidation * Cannot use out of court route if a compulsory winding up petition has been presented at court Moratorium starts as soon as notice of intention to appoint is filed at court

Question 33

How does the out-of-court route work when a qualifying floating charge holder seek to appoint an administrator?

Answer 33

QFC = charge document says paragraph 14 of schedule B1 to the IA 1986 applies to the floating charge and: * The charge document purports to **empower the holder to appoint an administrator or an administrative receiver**; and * The charge document relates to the **whole or substantially the whole of the company’s property** Allows lenders with floating charges to easily appoint administrators * Must notify a fellow QFCH holder with priority in advance to give them the chance to appoint the administrator instead Lender must file notice of appointment at court, which includes a statutory declaration stating: * Lender is a QFCH in relation to company property * Floating charge is enforceable; and * Appointment complies with IA 1986, Sch B1

Question 34

Who do administrators, administrative receivers and receivers owe their duties to?

Answer 34

Administrator has a duty to all company’s creditors Receivers have a duty only to the party who appointed them Administrative receivers have a primary duty to appointer + secondary duties to others

Question 35

What is the process and effect of administration once it begins?

Answer 35

After documents filed at court or administration order made by court, a moratorium comes into effect Administrator puts its proposals to the creditors, who can suggest amendments * They are approved if a **majority in value** of the creditors, present and voting, are in favour Company managed by administrator, who controls company assets and carries out approved proposals Directors remain in office, but their powers cease

Question 36

What powers and duties does an administrator have?

Answer 36

Removing and appointing directors Paying creditors (with court permission for unsecured creditors) Calling a meeting of creditors or shareholders Dealing with property subject to floating charges and (fixed charges – with court permission) Investigating and applying to have company’s past transactions set aside or challenged Commencing fraudulent or wrongful trading proceedings against directors Administrators have the power to do anything necessary or expedient for the management of the affairs, business and property of the company

Question 37

When does the administration end?

Answer 37

**Ends automatically one year from the date the administration took effect**, but this can be extended * Can be ended earlier by court application, if objective achieved, if they believe it cannot be achieved or by creditor application

Question 38

What is pre-pack administration?

Answer 38

Pre-packaged administration is an arrangement where a company goes into administration and the administrator sells the assets and business immediately Secures sale of business as a going concern and is more likely to save jobs

Question 39

A company voluntary arrangement is a further alternative to liquidation and administration. What does a CVA entail?

Answer 39

Written agreement which **binds all parties to it**, if all statutory procedures followed * Written agreement is sometimes called ‘statutory contract’ * Parties are usually the company and all creditors **CVAs aim to prevent liquidation**, so are used when there is a temporary cash flow problem Proposals put forward for payment of creditors must be approved by: * 75% or more in value of the company’s creditors; **and** * 50% or more of non-connected creditors * Secured creditors cannot vote **Once proposals approved, it is binding on all unsecured creditors for past debts, not future ones** * Does not affect rights of secured and preferential creditors, unless they agree to proposals Insolvency practitioner supervises the arrangement of the CVA and monitors it

Question 40

What does a restructuring plan under CIGA 2020 entail?

Answer 40

This is court-supervised and is an arrangement between the company and all secured + unsecured creditors and shareholders * Only need to have or be likely to have financial difficulties; **don’t need to be insolvent** Directors usually prepare plan and ask for court approval to call meetings of creditors and shareholders Implementation of plan involves 2 court hearings * Creditors make representations at the 1st * Court decides whether to sanction proposed plan at 2nd 75% in value of each class (creditor class and shareholder class) must vote in favour to approve plan

Question 41

What does a moratorium under CIGA 2020 entail?

Answer 41

Company protected from actions by creditors relating to pre-moratorium debts, but it must pay debts incurred during the moratorium period in full * Company must be unable to pay or be unlikely to pay debts to enter it * Not available if they’ve had a moratorium in the previous 12 months * Financial services clients like banks not eligible * Only available to companies with no outstanding winding up petitions against them Directors must file relevant documents at court + qualified insolvency practitioner, as independent monitor of moratorium, must confirm it will rescue the company as a going concern **Lasts for 20 business days**, from date of filing at court or court order, but can be extended by another 20 business days by filing more documents or up to 1 year if creditors agree

Question 42

What other options do secured creditors specifically have?

Answer 42

Secured creditors may be able to **appoint receivers** to take possession of charged property and deal with it for their benefit (usually sell it) * Once sold, receiver has no further interest in it Normal trigger for receivership is breach of loan agreement Charging document will state when a receiver can be appointed + company does not need to be insolvent **2 types of receivers** to consider

Question 43

What does a Law of Property Act receiver do to assist a secured creditor?

Answer 43

Appointed by a **fixed charge holder**, by power in charging document Usually appointed to sell property * If shortfall, they become an unsecured creditor for remainder * If surplus, this is returned to the company for other creditors

Question 44

What does an administrative receiver do to assist a secured creditor and how are they appointed?

Answer 44

Appointed by **floating charge holders**, when the floating charge is over the company’s whole undertaking Only used for floating charges created **before 15 Sep 2003** * Newer charges use the administration route Appointment: * Loan agreement will list the events which trigger the lender being able to appoint an administrative receiver * AR runs the company and sells the charged assets, using the proceeds to pay their own costs and what the charge holder is owed