Chapter 9: Corporate Insolvency I Flashcards
1 Introduction to corporate insolvency
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.
1.1 Corporate insolvency – the law
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.
1.2 Meaning of ‘insolvency’
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))
1.3 Directors’ obligations towards companies in financial difficulties
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.
1.4 Options for a company facing financial difficulties
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.
1.5 Corporate insolvency procedures
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
Key Features of Formal Arrangements (CVAs & Restructuring Plans)
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.
1.6 Informal agreements
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.
Standstill agreements
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.
1.7 Pre-insolvency moratorium (to protect the company from creditors)
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.
Pre-insolvency moratorium, 20 business days
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).
1.8 Procedure for obtaining the pre-insolvency moratorium
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.
Characteristics of the moratorium
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.
1.9 Company voluntary arrangement (CVA)
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.
1.10 Setting up a CVA
(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.
1.11 Effect of a CVA
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.
1.12 How are CVAs used?
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.
1.13 Restructuring plan
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.
Features of the Restructuring Plan
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).
1.14 Advantages of restructuring plan
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.
1.15 Summary
- 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.
2 Administration and receivership
This section considers two different procedures:
* Administration, including the objectives, the appointment and powers of the administrator; and
* Receivership.
2.1 The objectives of the administrator
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).
Qualified insolvency practitioners
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.
2.2 The statutory objectives of administration
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
2.3 Appointment of administrator – court procedure
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)).
Key case: AA Mutual International Insurance Co Ltd [2004] EWHC Ch
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.
2.4 Appointment of administrator – out of court procedure
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.
2.5 Role of the administrator
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.
8-week limit for administrators
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.
12-month fixed time limit
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.
2.6 Moratorium
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.
2.7 Powers of the administrator
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
2.8 Approach of the court
Key case: Re T & D Industries Ltd [2000] 1 LWR 646
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
Neuberger J h
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.