Corporate Insolvency

Question 1

when is a company considered insolvent? (4 tests)

Answer 1

1. cash flow test = unable to meet debts as they fall due
2. balance sheet test = company’s assets are greater than its liabilities
3. statutory demand = fails to comply with a statutory demand for payment of debt over 750 GBP within 21 days from the order
4. failure to satisfy a judgement debt when a creditor applies to court

Question 2

what are a company’s options when it faces financial difficulties?

Answer 2

1. do nothing but directors risk personal liability and breach their duties
2. reach an informal arrangement with the creditors to reschedule debt
3. reach a formal arrangement with creditors to reschedule debt (CVA or restructuring plan)
4. pre-insolvency moratorium
5. administration (appoint administrator)
6. a creditor can appoint a receiver (company can request they do this)
7. put the company into liquidation

Question 3

what must the director do if a company is in financial difficulties?

Answer 3

1. directors must continually review the financial performance of the company and recognise when it is facing financial difficulties (e.g., unpaid creditors are putting pressure, overdraft is fully drawn, liabilities exceed assets)
2. directors must decide whether to take action on behalf of the company
3. they must have regard to their duties (promote success of the company and act with reasonable care, skill and diligence)
4. recognise when company is insolvent as they will then owe their duties to the creditors not the shareholders

Question 4

what is the order of priority?

Answer 4

1. liquidator/administrator’s costs in realising assets taken from proceeds of fixed charge assets
2. fixed charge creditors from proceeds of fixed charge assets
3. other costs and expenses including cost of selling remaining assets and pursuing proceedings against directors or for voidable transactions
4. preferential creditors are paid:

• employees first: 4 months salary subject to £800 per employee, and accrued holiday pay
• HMRC payments (PAYE, VAT, etc)

5. Prescribed part fund: a portion of money from proceeds of floating charge assets is ring fenced for unsecured creditors
6. floating charge creditors are paid from whatever is left of floating charge assets proceeds (but not prescribed part fund)
7. unsecured creditors are paid from the prescribed part fund (ordinary trade creditors, shareholders with preference cumulative shares, employees if not paid in full)

• if anything is left pay outstanding amount to fixed and floating charge holders who rank as unsecured creditors

8. interest on unsecured debts
9. shareholders: rank based on articles (preference shareholders rank above ordinary shareholders), and pari passu for shareholders in the same class

Question 5

what informal agreements can companies facing financial difficulties enter into (5)? what are the advantages and disadvantages of this?

Answer 5

companies can enter into informal agreements with creditors and negotiate with them to reschedule debt and creditors agree not to enforce their rights or remedies for a certain period (‘standstill agreement’)

what can company negotiate with creditors:

• grant further securities
• replace directors or senior employees
• sell a failing business or a profitable business to raise cash
• reduce workforce or salary
• issue new shares to the creditors - debt for equity swaps

advantages:

• avoids costs of an informal procedure
• ideal if all creditors agree
• gives the company breathing space to regain solvency which is ideal if the company knows it will be profitable soon

disadvantages:

• all creditors may not be willing to agree

Question 6

how long does the pre-insolvency moratorium last?

Answer 6

• 20 business days
• can be extended by directors for another 20 business days
• automatically ends if company enters liquidation, administration, an approved CVA, or an approved restructuring plan

Question 7

what is the procedure for a pre-insolvency moratorium? (2 steps)

Answer 7

2 documents must be filed at court:

1. statement that the company is or likely will be unable to pay its debts as they fall due
2. a statement from a licensed insolvency practitioner (MONITOR) stating that the moratorium will likely result in the rescue of the company

Question 8

what actions are restricted during a pre-insolvency moratorium? How does this benefit the company?

Answer 8

• creditors cannot enforce securities over company assets
• existing legal proceedings against company are stayed
• new legal proceedings cannot be brought
• no winding up or administration proceedings can be brought (except by directors)
• no appointment of receiver

benefits = gives the company breathing space to ensure it does not become insolvent - ideal when the company knows it will become profitable soon

Question 9

what debts does the company have to pay / not have to pay during the pre-insolvency moratorium?

Answer 9

do not have to be paid = pre-moratorium debts do not have to be paid

must be paid =

• all obligations incurred during the moratorium
• monitor’s expenses
• rent and wages due during the moratorium
• goods supplied during the moratorium
• loans incurred before and during the moratorium

Question 10

what is a company voluntary arrangement and what is a restructuring plan (same)

Answer 10

CVA and restructuring plan = a formal agreement - a compromise between a company and its creditors to restructure debt, pay less, or change repayment timetables

Question 11

is it possible to have a CVA / plan when the company is in administration or liquidation?

Answer 11

yes - the administrator and liquidator can enter into a CVA / plan with the creditors

Question 12

what is the approval threshold needed for a CVA?

Answer 12

1. majority of shareholders (over 50%)

and

2. creditors holding 75% of the unsecured debt

BUT: if over 50% in debt value held by unconnected creditors vote against it, the CVA cannot pass (not a related company, SH or D of company proposing the CVA)

Question 13

Who does a CVA bind?

Answer 13

• binds all unsecured creditors (even those not voting for it)
• does not bind secured creditors - only binds them if they unanimously agree

Question 14

what are the advantages (3) and disadvantages (1) of a CVA?

Answer 14

advantages:

• not court sanctioned like a restructuring plan so quicker and less costly
• directors remain in control of the business (unlike in administration)
• binds unsecured creditors who did not vote for it

disadvantages:

• secured creditors and preferential shareholders are not bound by it so they may still demand repayment

Question 15

what is the procedure for a CVA? (8)

Answer 15

1. nominee appointed by company, liquidator, or administrator
2. directors / administrator / liquidator submits proposals for helping the company and statement of affairs to nominee
3. nominee considers proposals and reports to court within 28 days on whether the creditors and SH should be asked to vote on it
4. Nominee gives 14 days for creditors to vote on it
5. shareholder meeting takes place within 5 days of the creditor meeting and shareholders vote
6. nominee reports to court
7. creditor has 28 days to challenge a CVA
8. nominee becomes supervisor and implements proposals under CVA

Question 16

who can initiate a CVA?

Answer 16

• directors
• liquidator
• administrator

Question 17

who can initiate a restructuring plan?

Answer 17

• directors
• administrators
• liquidators
• shareholders
• creditors

Question 18

what is the approval threshold for a restructuring plan?

Answer 18

• sanctioned by the court
• approved by 75% in value of each affected class of creditors
• approved by 75% of shareholders (as its own class)

Question 19

advantages and disadvantages of a restructuring plan

Answer 19

advantages =
- binds ALL creditors including dissenting creditors (via cross-class cramdown by court)
- directors remain in control of the business (unlike in administration)

disadvantage = court sanction is required so this is costly and time consuming especially if company is already in financial difficulties

Question 20

What is administration? what is its aim?

Answer 20

a procedure by which an administrator is appointed to run the company in order to either rescue the company as a going concern or, if this is not possible, to achieve a better result for creditors than if the company were to be wound up

Question 21

what are the powers of an administrator?

Answer 21

• the administrator has wide powers to carry on trading to achieve the administration’s aims
• it can sell assets, dismiss directors, bring proceedings for wrongful trading, etc.

Question 22

what is the out of court procedure for administration? (4)

Answer 22

by QFCH

1. only appoint administrator and file notice of appointment

by company:

1. file notice of intention to appoint administrator in court and serve on QFCH
2. wait 5 business days = QFCH may approve administrator or choose their own
3. appoint administrator and file notice of appointment

then

1. administrative moratorium in place when administrator is appointed
2. administrator has 8 weeks to produce a report with proposals for the company business
3. administrator has 12 months to complete administration

Question 23

what is the court procedure for administration?

Answer 23

creditors, liquidator, CVA supervisor, company (rare - used to block winging up petition)

1. apply to court
2. interim moratorium available
3. must show the court that the company is likely unable to pay its debts
4. administrative moratorium in place when administrator is appointed
5. administrator has 8 weeks to produce a report with proposals for the company business
6. administrator has 12 months to complete administration

Question 24

what is prohibited during an administrative moratorium? (5)

Answer 24

• securities cannot be enforced
• proceedings are stayed and prevented
• no winding up
• no appointing a receiver
• landlord cannot forfeit leases

Question 25

what effect does administration have on employees, directors, and trading?

Answer 25

• employees remain employed
• directors can remain in office but cannot exercise management powers
• company can continue trading if administrator allows in order to fulfil administration aims

Question 26

what is a qualifying floating charge holder? what are the benefits?

Answer 26

• a QFCH holds a floating charge over the whole or substantially the whole of the company’s assets
• the main benefit is that they can appoint an administrator using the out of court procedure (cheaper and quicker)
• also, if the company wants to appoint the administrator using the out of court procedure they must serve a notice on the QFCH and wait 5 business days for the QFCH to challenge this or choose their own administrator

Question 27

how long does the administrator have to complete administration?

Answer 27

12 months - but the administration ends when:
- administrator succeeds in restructuring the debts via plan, scheme, or CVA
- company is returned to solvency and handed back to directors
- company enters liquidation

Question 28

What is receivership?

Answer 28

An individual enforcement procedure which benefits only the appointing creditor with regards to assets they only have a charge over

Question 29

what are the 3 types of receivers?

Answer 29

1. administrative receivers (rare and not used)
2. fixed charge receivers (LPA receivers)
3. court appointed receivers

Question 30

what is a fixed charge receiver? (4 points)

Answer 30

• holders of a fixed charge can appoint a receiver under the debenture to enforce the security and recover the debt owed to the charge holder
• receivers owe duties to the charge holder but is technically an agent of the chargor company
• they have extensive powers to sell, mortgage, and collect rents from the property subject to a fixed charge
• cannot be appointed during a pre-insolvency moratorium or administration

Question 31

what is liquidation?

Answer 31

• process by which a company’s business is wound up and its assets are realised and distributed to creditors
• the company is ceases trading and is disolved

Question 32

what are the liquidator’s role and duties?

Answer 32

• secure and realise assets on a piece meal basis and distribute assets to company creditors according to the order of priority
• vast powers to manage the company for these purposes
• owed fiduciary duties to the creditors
• duty to preserve and maximise assets = court application to void antecedent transactions, claims against directors for wrongful/fraudulent trading
• can enter CVA or restructuring plan with creditors

Question 33

what are the 2 types of liquidation? who can commence each?

Answer 33

1- compulsory liquidation = creditor, company, administrator, administrative receiver, CVA supervisor

2- voluntary liquidation =

• member’s voluntary liquidation
• creditor’s voluntary liquidation

Question 34

what is the process of compulsory liquidation? (4)

Answer 34

• applicant applies to court for a winding up petition
• on the grounds that = the company is unable to pay its debts (on any of the 4 insolvency tests) OR it is just and equitable to wind up
• if the court grants the winding up order, the OFFICIAL RECEIVER becomes the liquidator until another is appointed by the creditors
• Official receiver will notify CH and all creditors

Question 35

what is the consequence of a winding up order? (3)

Answer 35

• employees and directors are automatically dismissed
• stay on commencing or continuing proceedings against the company
• any dispositions of company assets or changes to membership will be VOID

Question 36

what is a member’s voluntary liquidation, when can it be used, and what is the procedure? (3)

Answer 36

MVL is where the company resolves to wind it up

company must be solvent

Procedure:

• directors must swear a declaration of solvency stating that they believe the company will be able to pay its creditors in full within 12 months from winding up and a statement of assets and liabilities
• members must pass a special resolution to put the company into MVL
• members must pass an ordinary resolution to appoint a liquidator

Question 37

what is a creditors voluntary liquidation? what is the procedure? (5)

Answer 37

• company is insolvent
• Started by the company under the influence of creditors (who choose the liquidator)
• Shareholders pass a special resolution to put the company into CVL
• Shareholders pass an ordinary resolution to appoint a liquidator which the creditors have 14 days to approve of or nominate their own
• directors produce a statement of company affairs and send it to creditors

Question 38

what are a creditor’s options if the company has not paid it? (8)

Answer 38

1. enter into informal agreements with the company (demand more securities, etc.)
2. appoint a fixed charge receiver if holder of fixed charge and allowed under the terms of the debenture
3. initiate a restructuring plan
4. appoint an administrator using the court procedure OR using the out of court procedure if QFCH
5. enforce the debt against the company in court
6. issue a statutory demand for payment
7. if the company does not comply with the judgement OR statutory demand not met within 21 days and debt is over £750 OR company is balance sheet or cash flow insolvent: bring a winding up petition OR pressure the company to enter creditors voluntary liquidation
8. enforce any security against the company