11 - Insolvency Flashcards
What is the primary statute governing corporate insolvency, and how has it been amended?
The Insolvency Act 1986 (IA 1986), which has been significantly amended by various legislation:
- Enterprise Act 2002 (EA 2002): Focused on promoting the rescue of companies.
- Small Business Enterprise and Employment Act 2015
- Insolvency (England and Wales) Rules 2016
Corporate Insolvency and Governance Act 2020 (CIGA 2020): Commenced on 26 June 2020.
The EA 2002 and CIGA 2020 represent the most substantial changes to insolvency law since the introduction of the IA 1986.
What were the key corporate insolvency reforms introduced by the Enterprise Act 2002 (EA 2002)?
Came into force on 15 September 2003 (relevant date):
Aims of the reforms:
- Promote a rescue culture by removing the stigma associated with insolvency and encouraging an entrepreneurial culture.
- Increase entrepreneurship by prioritising collective insolvency procedures (benefiting creditors as a whole) over enforcement procedures (which primarily benefit secured creditors).
Methods of achieving these aims:
- Streamlined the administration procedure to encourage company rescue.
- Restricted the use of administrative receiverships on or after the Relevant Date.
What are the key corporate insolvency reforms introduced by the Corporate Insolvency and Governance Act 2020 (CIGA 2020)?
Introduced two key insolvency procedures to increase the likelihood of companies restructuring their debts and avoiding formal insolvency like administration or liquidation:
- The pre-insolvency moratorium
- The restructuring plan for companies
These procedures aim to help companies successfully restructure and improve their chances of survival.
What is the meaning of insolvency?
The Insolvency Act 1986 (IA 1986) defines insolvency in the context of when a court may make a winding-up order, specifically under s 122(1)(f), which includes a company being unable to pay its debts.
The IA 1986 outlines four situations to determine if a company is unable to pay its debts (s 123):
1. Cash flow test (s 123(1)(e)): The company is unable to pay its debts as they fall due.
2. Balance sheet test (s 123(2)): The company’s liabilities exceed its assets.
3. Statutory demand (s 123(1)(a)): The company fails to comply with a demand for a debt exceeding £750, evidencing cash flow insolvency.
4. Judgment debt enforcement (s 123(1)(b)): The company has not satisfied enforcement of a judgment debt.
The most commonly referenced tests for insolvency are the cash flow and balance sheet tests.
What are directors’ obligations towards companies in financial difficulties?
Directors must actively monitor their company’s financial performance and act appropriately when financial difficulties arise.
This includes:
- Recognising financial difficulties: Indicators include unpaid creditors exerting payment pressure, a fully drawn overdraft with no further credit facility, or liabilities exceeding assets.
- Decision-making: Directors must decide how to address the company’s difficulties while adhering to their duties, responsibilities, and liabilities under the IA 1986 and general law.
- Seeking advice: Directors should obtain guidance on their legal duties and available options under IA 1986, CIGA 2020, and other relevant legislation to resolve the company’s financial challenges and minimise creditor losses.
Properly addressing these obligations is crucial to protecting the company and its creditors.
Director’s may be personally liable under provisions of IA 1986 where the company is insolvent if they do not take the correct steps and in breach of their duties under CA 2006.
What are the options available to directors when a company faces financial difficulties?
Directors have several options to address a company’s financial difficulties, each with specific considerations:
- Do nothing: Directors must consider the risk of personal liability under the Insolvency Act 1986 and potential breaches of their duties under the Companies Act 2006 when choosing inaction.
- Do a deal: Reach an informal or formal arrangement with some or all creditors to reschedule debts, either by reducing the amount owed or extending the time for payment.
- Appoint an administrator: A formal collective insolvency procedure that considers the interests of all creditors.
- Request the appointment of a receiver: A secured creditor may enforce its security by appointing a receiver, who sells the secured assets to repay the creditor (subject to certain prior claims).
- Place the company into liquidation: A formal collective insolvency procedure to wind up the company.
Each option requires careful assessment of legal and financial implications.
Provide a summary of the introduction to corporate insolvency.
- Section 122(1)(f) IA 1986 provides an overall definition of insolvency for companies as an inability pay its debts.
- There are four tests for insolvency, which are set out in s 123 IA 1986. The most important are the cash flow and the balance sheet tests.
Directors must monitor their company’s financial position and there is a range of options available to them if their company is in financial difficulty:
- Do nothing for the present time;
- Do a deal with some or all of the creditors to restructure the company’s liabilities;
- Appoint an administrator;
- Request the appointment of a receiver (where there is a secured creditor); orPlace the company into liquidation.
What are informal agreements in the context of corporate financial difficulties, and what challenges do they present?
Informal agreements allow a company to negotiate with creditors to avoid formal insolvency proceedings, but they come with challenges:
- These agreements are contractually binding but not regulated by IA 1986, CIGA 2020, or other insolvency-related statutes.
- A key difficulty is securing unanimous agreement from all creditors the company wishes to bind.
- Informal agreements are often sought to avoid the time, cost, and potential termination of the company that formal insolvency proceedings might cause.
What steps might a company take to secure creditor agreement in an informal arrangement?
Preliminary Step: Before negotiating an informal arrangement, the company may request creditors to enter a Standstill Agreement, where creditors agree not to enforce their rights or remedies for a specified period. This gives the company time to negotiate a resolution for its financial issues.
Further:
1. Granting new or additional security.
2. Replacing directors or senior employees.
3. Selling failing businesses, subsidiaries, or profitable assets to raise cash.
4. Reducing costs, e.g., through redundancy programmes or closing unprofitable businesses.
5. Issuing new shares to creditors, known as a “debt for equity swap.”
What is the purpose of the pre-insolvency moratorium introduced by CIGA 2020?
The pre-insolvency moratorium is designed to help struggling companies avoid immediate insolvency.
It is a period during which creditors are unable to take action to exercise their usual rights and remedies, thereby creating breathing space for the company to resolve their difficulties.
- It applies to companies not yet in formal insolvency.
The moratorium can be used to:
- Reach an informal agreement with all or some creditors.
- Propose a CVA, restructuring plan, or scheme of arrangement.
What restrictions does the pre-insolvency moratorium place on creditors and proceedings?
The pre-insolvency moratorium restricts creditors and proceedings by:
- Preventing creditors from enforcing security over the company’s assets.
- Imposing a stay on existing legal proceedings and barring new proceedings.
- Prohibiting the commencement of winding-up procedures, unless initiated by the directors, or shareholder resolutions to wind up the company without director approval.
- Disallowing the commencement of administration proceedings, except by the directors.
These measures create a “breathing space” for the company to resolve its financial difficulties.
What is the procedure for obtaining a pre-insolvency moratorium, and how long does it last?
To obtain a pre-insolvency moratorium, a company must file documents at court, including:
- A statement confirming 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 (the Monitor) asserting that it is likely the moratorium will lead to the company’s rescue as a going concern.
The Monitor supervises the company during the moratorium. The initial duration is 20 business days, but it can be:
- Extended by the directors for a further 20 business days.
- Extended beyond this with the consent of a requisite majority of creditors or by a court order, up to a maximum of one year, subject to further court approval for extensions.
The moratorium ends automatically if:
- The company enters liquidation or administration.
- A CVA is approved, or a court sanctions a restructuring plan or scheme of arrangement.
What are pre-moratorium debts, and which of these must still be paid during the pre-insolvency moratorium?
Pre-moratorium debts:
- Have fallen due before or during the moratorium due to an obligation incurred before the moratorium.
- Generally benefit from a ‘statutory repayment holiday’ while the moratorium is in effect.
However, the statutory repayment holiday does not apply to the following pre-moratorium debts, which must still be paid:
- The Monitor’s remuneration or expenses.
- Goods and services supplied during the moratorium.
- Rent for a period during the moratorium.
- Wages, salaries, or redundancy payments.
- Loans under a financial services contract (e.g., bank loans made before the moratorium).
This ensures critical expenses are covered.
What are moratorium debts, and what obligations must a company meet in relation to them?
Moratorium debts are debts that:
- Fall due during or after the moratorium due to an obligation incurred during the moratorium period.
Key points about moratorium debts:
- All moratorium debts must be paid.
- These typically include payment for goods or services ordered by the company during the moratorium.
- In practice, a company must remain ‘cash flow’ solvent to pay its debts as they fall due and maintain its operations during the moratorium period.
What are the main advantages of formal arrangements and what types of formal arrangements exist?
Formal arrangements (using statutory procedures) offer the advantage that, if approved by the requisite majorities of creditors and/or shareholders, they become legally binding, even if:
- Some creditors voted against the arrangement.
- Some creditors did not vote on it.
- Certain creditors did not receive notice of the procedure.
Two types of formal arrangements:
1. Company Voluntary Arrangement (CVA): Defined under ss 1–7 IA 1986.
2. Restructuring Plan: Introduced by CIGA 2020 and found in part 26A CA 2006.
What is a Company Voluntary Arrangement (CVA), and how does it operate?
A CVA is a compromise between a company and its creditors, defined in s 1(1) IA 1986 as: “A composition in satisfaction of its debts or a scheme of arrangement of its affairs.”
It is an arrangement agreed by the company’s unsecured creditors and members to achieve a restructuring of the company’s unsecured liabilities.
Key features of a CVA:
- Creditors agree to part payment of debts and/or a new extended repayment timetable.
- Once approved under IA 1986, the CVA is reported to court but does not require court approval.
- Supervised and implemented by a Supervisor (an Insolvency Practitioner).
- The company’s directors remain in office and manage the company’s affairs under the CVA terms.
- CVAs can be used alongside administration or liquidation.
What is the process for setting up a Company Voluntary Arrangement (CVA)?
Drafting the CVA proposal:
- The directors draft the proposal and appoint a Nominee (an insolvency practitioner).
- If the company is in liquidation or administration, the administrator or liquidator drafts the proposal and acts as Nominee.
Submitting the proposal:
- The directors submit the CVA proposal and a statement of the company’s affairs to the Nominee.
- In practice, the Nominee often drafts the CVA proposal.
Nominee’s report to court:
- The Nominee reviews the proposal and, within 28 days, reports to the court on whether creditors and shareholders should vote on the proposal (s 2(1) and s 2(2) IA 1986).
Voting process:
- The Nominee allows at least 14 days for creditors to vote on the CVA proposal.
- A shareholders’ meeting must occur within 5 days of the creditors’ decision.
Approval criteria for the CVA - The CVA proposal is approved if:
- At least 75% in value (i.e., in value of debts owed) of creditors (excluding secured creditors) voting on the proposal vote in favour.
- If the required majority is achieved, the decision of those creditors will be invalidated if more than half of the total value of creditors voting against the CVA proposal are unconnected to the company (e.g., not a related company, shareholder, or director of the company proposing the CVA).
- A simple majority of shareholders/members vote in favour.
- In practice, creditor approval is decisive. If creditors approve but shareholders reject the proposal, the creditors’ vote always prevails.
Reporting to court: The Nominee reports to court that the CVA has been approved.
Implementation: The Nominee usually becomes the Supervisor responsible for implementing the CVA.
What is the effect of a Company Voluntary Arrangement (CVA)?
A CVA is binding on all unsecured creditors, including those who did not vote or voted against it.
Secured or preferential creditors are not bound unless they unanimously consent to the CVA (s 4 IA 1986), which is a significant disadvantage of the CVA procedure.
Creditors can challenge a CVA within 28 days of its approval being reported to the court on two grounds:
- Unfair prejudice: If the CVA treats one creditor unfairly compared to another.
- Material irregularity: If there is an issue with the procedure followed to seek approval, such as how creditors’ votes were calculated.
- Subject to any challenge, the CVA becomes binding on all creditors at the end of the 28-day challenge period.
The Supervisor’s role includes:
- Agreeing creditors’ claims.
- Collecting unsecured funds to pay dividends to creditors.
- Ensuring the company complies with its obligations under the CVA.
- Sending a final report to all shareholders/members and creditors once the CVA is completed.
How are CVAs commonly used within the retail sector?
CVAs are frequently employed in the retail sector to achieve compromises with creditors, particularly landlords, often to agree on rent reductions to enable the company to continue trading.
- CVAs can be used independently or as part of an administration process.
- During the coronavirus pandemic, companies like All Saints (June 2020) and Clarks (October 2020) utilised CVAs for rent reductions.
- In 2023, Wilko explored a CVA with landlords in May and June, but as of August 2023, entered administration.
What are the advantages and disadvantages of CVAs for companies, trade creditors, and landlords?
Advantages for companies:
- Directors remain in control of the company.
- The company continues trading under the terms of the CVA proposal, aiming to survive as a going concern.
Major limitation of CVAs for companies: Secured or preferential creditors are not bound without their consent.
Advantages for trade creditors: Likely to recover more through a CVA than via administration or liquidation.
Disadvantages for landlords:
- CVAs often result in heavily discounted rents and income loss.
- However, re-letting retail properties is challenging, so landlords may accept reduced rents over having empty properties with no income.
What is a Restructuring Plan, and how does it work?
The Restructuring Plan is a court-sanctioned compromise between a company and its creditors and shareholders to restructure the company’s debts.
Introduced by CIGA 2020, designed to:
- Compromise a company’s creditors and shareholders.
- Restructure liabilities to help the company return to solvency.
- The Plan is a hybrid of a CVA and a scheme of arrangement under CA 2006.
- Unlike a scheme of arrangement, the Plan is only available to companies facing financial difficulty or likely to do so.
- Court approval (a ‘sanction’) is required for the Plan to be binding.
Process:
- Creditors and members are divided into classes, and each class votes on the Plan.
- Approval requires at least 75% in value of those voting in each class to vote in favour.
- The Plan becomes binding only when the court sanctions it.
Effect:
- Once sanctioned, the Plan binds all creditors, including secured creditors.
What makes the Restructuring Plan advantageous?
Exclusion of creditors and shareholders:
- The court can exclude creditors and shareholders from voting on the Plan if they have no genuine economic interest in the company, even if they are affected by the Plan.
Cross-class cram down: The court can sanction the Plan even if a dissenting class of creditors or shareholders votes against it, provided:
- The dissenting class would not be worse off than they would be if the Plan were not approved.
- At least one class of creditors or members who would receive payment or retain a genuine economic interest if the Plan were not approved has voted in favour.
Effect of a cram down:
- One rank of creditor can force the Plan on another class of creditor who voted against it.
- Shareholders can be forced to accept a debt-for-equity swap, allowing creditors to hold new shares in the company in place of their debt claims.
How does the Restructuring Plan compare to a CVA, and what makes it more advantageous?
Advantages over a CVA:
- The Plan can compromise the rights and claims of secured creditors and shareholders, which a CVA cannot do.
- The Plan can bind all creditors even if the requisite majority approval is not obtained in every voting class, provided the court sanctions it.
Usage flexibility:
- The Plan is likely to be used by directors alongside a pre-insolvency moratorium.
- It can also be used by administrators and liquidators to restructure the company.
Provide a comparison of the formal arrangements.
Who can initiate?
CVA: Directors, liquidator, or administrator.
Restructuring Plan: Company, creditor, member, liquidator, or administrator.
Approval requirements:
CVA: At least 75% in value of unsecured creditors, but not more than 50% of unconnected creditors voting against. Over 50% of shareholders.
Restructuring Plan: Sanctioned by the court.
At least 75% in value of each affected class of creditors/shareholders.
Who does it bind?
CVA: Binds all unsecured creditors.
Restructuring Plan: Binds all creditors and shareholders.
Advantages:
CVA: Not court sanctioned, making it quicker and less costly to implement.
Restructuring Plan: Binds all creditors, including dissenting ones, and can bind classes of creditors who do not approve if the court sanctions the plan.
Limitations:
CVA: Preferential and secured creditors are not bound without express consent.
Restructuring Plan: Court process is costly and time-consuming, and it requires consideration of whether creditors are in separate classes for voting.
Provide a summary of formal and informal arrangements.
- A company can enter into informal contractually binding agreements with some or all of its creditors, using standstill agreements where creditors agree to refrain from exercising their rights and remedies whilst terms are negotiated.
- The company can also obtain a pre-insolvency moratorium by filing documents at court. This moratorium gives the company a breathing space in which to seek a longer term solution to its financial problems.
- A CVA is an arrangement agreed by the company’s unsecured creditors and members to achieve a restructuring of the company’s unsecured liabilities.
- CVAs do not bind secured and preferential creditors without their consent and there is no requirement for court approval.
- The Restructuring Plan is a court-sanctioned compromise between a company and its creditors and shareholders to restructure the company’s debts.
What are the objectives of the administrator in an administration?
- Administration is a collective procedure where the administrator acts in the interests of the creditors as a whole, rather than on behalf of a particular creditor.
- Administrators are officers of the court, even if appointed out of court, owing duties to the court and creditors.
- Administration is the second most common insolvency procedure after liquidation.
- Administrators must be licensed insolvency practitioners.
What are the statutory objectives of administration under Sch B1 IA 1986?
Administrators must perform their functions with the aim of achieving one of three objectives, in order of priority:
1. Firstly - Rescue the company as a going concern, if reasonably achievable.
2. Secondly - Achieve a better result for creditors as a whole than would be likely if the company were wound up, if objective (a) is not reasonably achievable.
3. Thirdly - Realise the company’s property to make a distribution to secured or preferential creditors, if objectives (a) and (b) are not achievable.
Objective (b) is most commonly achieved in practice.
These objectives guide the administrator’s actions throughout the process.
What are the two methods for appointing an administrator?
Court Procedure:
- Apply to court.
- Interim period with an interim moratorium.
- Hearing and order for administration.
Out-of-Court Procedure:
Company/Directors:
- File Notice of Intention (NOI) and serve to the Qualifying Floating Charge Holder (QFCH.)
- Wait 5 business days, then appoint administrator and file Notice of Appointment.
QFCH (1st ranking):
- Appoint administrator and file Notice of Appointment.
When might the court appoint an administrator, and who can make this application?
The court may appoint an administrator if the company is or is likely to become unable to pay its debts (Sch B1 para 11(a)).
The application for the administration order can be made by:
- The company
- The directors
- A creditor
- The supervisor of a CVA
- A liquidator
The court must consider that the appointment is reasonably likely to achieve the purpose of the administration (Sch B1 para 11(b)).
What are the key features of the court procedure for appointing an administrator?
Court application criteria: The company must be unable to pay or likely to be unable to pay its debts.
The application can be made by the company, directors, a creditor, a CVA supervisor, or a liquidator.
Court’s consideration: The court must assess that the appointment of an administrator is likely to achieve the administration’s purpose.
Interim moratorium: Upon making an application to the court, a temporary freeze on creditor actions is in place until the administration order is made or the application is dismissed.
Appointments by court order are uncommon, and happen usually where a creditor has begun winding up proceedings against the company, and the directors wish to appoint an administrator before the court has made the winding-up order. Here, the company must apply to court to appoint administrators.
Winding-up proceedings: If a court order is granted, any ongoing or pending winding-up proceedings are automatically dismissed.
How does the out-of-court procedure for appointing an administrator work under Sch B1, Para 22 for the directors or the company?
- The directors (more commonly than the company itself) can appoint an administrator out of court under Sch B1, Para 22.
- The directors must first file a notice of intention to appoint (NOI) at court.
- At least 10 business days later, the directors must file a notice of appointment at court.
- The administrator’s appointment becomes effective when the second notice is filed at court.
- If the company has granted a qualifying floating charge (QFC), the process differs.
How does the out-of-court procedure for appointing an administrator work when a qualifying floating charge holder (QFC) is involved?
- If a company has granted a QFC, the directors must send the NOI to the QFC holder at the time of filing it at court.
- The QFC holder has 5 business days to appoint its own choice of administrator.
- If the QFC holder does not appoint an administrator, the directors can proceed with filing the notice of appointment, and the directors’ choice of administrator will be appointed.
- For a QFC holder to appoint an administrator out of court, it must first enforce its security according to the terms of the QFC.
- The appointment takes effect once the QFC holder files a notice of appointment at court.
- If there are multiple QFC holders, a lower-ranking QFC holder must give two business days’ notice to higher-ranking QFC holders and obtain their consent before proceeding with the appointment.
What are the key roles and powers of an administrator during the administration process?
The administrator is an officer of the court with a duty to act in the interests of all creditors to achieve the purposes of the administration.
Directors remain in office but cannot exercise management powers without the administrator’s consent.
Employees remain employed by the company during the administration.
The administrator’s powers include:
- Carrying on the business of the company
- Taking possession and selling the company’s property (subject to the consent of the fixed charge holder or court)
- Borrowing money
- Executing documents in the company’s name
Administrators generally cannot pay a dividend to unsecured creditors without obtaining court permission.
What is the administrator’s responsibility regarding proposals and what time limits apply to the administration process?
Within eight weeks of appointment, the administrator must produce a report outlining proposals for the conduct of the administration. These proposals may include:
- A scheme of arrangement
- A restructuring plan
- A CVA (Company Voluntary Arrangement)
The report is sent to all creditors for their approval. If the proposals are rejected, the company is usually placed into liquidation.
If the proposals are accepted, the administrator proceeds with them, and if successful, the company exits administration.
Administrations have a 12-month fixed time limit for completion, though extensions can be granted.
What are the key features and benefits of an administrative moratorium during the administration process?
During administration, the company benefits from a full moratorium (Sch B1 para 42-44 IA 1986), and all business documents and the company’s website must state that the company is in administration.
The moratorium prevents the following actions without the court or administrator’s consent:
1. No order or resolution to wind up the company can be made or passed.
2. No administrative receiver of the company can be appointed.
3. No steps can be taken to enforce security over the company’s property or repossess goods subject to security, hire purchase, or retention of title.
4. No legal proceedings, execution, or other process can be commenced or continued against the company or its property.
5. A landlord cannot forfeit a lease of the company’s premises.
Interim moratorium, following a court application to appoint an administrator or the directors filing a NOI, includes the restrictions in points (a), (c)-(e), but only the court can consent to creditors taking such actions. The interim moratorium does not prevent a QFC holder from appointing an administrator.
What powers does an administrator have under the Insolvency Act 1986 to manage the company’s affairs and property?
Administrators have wide powers under s 14(1) IA 1986 to ‘do all such things as may be necessary for the management of the affairs, business and property of the company.’
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.
Specific powers include:
- The power to remove and appoint directors (s 14, Sch 1, and para 61 Sch B1).
- The power to dispose of property subject to a floating charge (para 70 Sch B1).
- The power to dispose of property subject to a fixed charge (with the court’s consent) (Para 71 Sch B1).
- Administrators can bring proceedings against directors for fraudulent and wrongful trading.
What is a pre-packaged sale in administration and what are its benefits?
A pre-packaged administration is when the business and assets of an insolvent company are prepared for sale to a selected buyer before the company enters administration.
The terms of the sale agreement are negotiated and agreed upon prior to the administrator’s appointment, and the administrators complete the sale with the buyer immediately following their appointment.
Benefits of pre-packaged sales:
- The goodwill and continuity of the business are not damaged by the administration.
- Certainty of result for creditors is achieved.
- The sale often involves entities associated with the holder of the QFC, or current shareholders or directors of the company.
