Corporate Insolvency Flashcards
Four tests for insolvency
- Cashflow test: unable to pays its debts as they fall due
- Balance sheet test: liabilities that are greater than its assets
- Does not comply with a statutory demand for a debt over £750
- Failed to satisfy a judgment debt
Most important are the cashflow and balance sheet test
Directors’ obligations towards companies in financial difficulties
Directors must continually review the financial performance of a company and recognise when it is facing financial difficulties as it is the directors who need to decide on what action to take.
Examples:
1. Company has may unpaid creditors who are putting pressure on the company
2. Company has an overdraft facility that is fully drawn and the bank is refusing to provide further credit by increasing the facility
3. Company has loans and other liabilities that exceed the value of its assets
Options for directors facing financial difficulty
- Do nothing: but should bear in mind the potential risk of personal liability under Insolvency Act 1986 and a potential breach of their directors’ duties under the Companies Act 2006
- Do a deal: reaching either an informal or formal arrangement with some or all of the company’s creditors with a view to rescheduling debts so that the company has less to pay or more time to pay
- Appoint an administrator: this is a collective formal insolvency procedure
- Request the appointment of a receiver: enforcement procedure where a secured creditor enforces its security by appointing a receiver who then sells the secured asset with a view to paying the sale proceeds to the secured creditor
- Place the company into liquidation: formal collective insolvency procedure
Why must directors ensure that they take urgent and advice and action when a company is in financial difficulty?
Because directors 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
Informal agreements
A good option to avoid the time and costs of formal insolvency arrangements or proceedings (and the potential consequences where they might bring the life of the company to an end).
Involves informal negotiations with creditors.
Contractually binding but not regulated by the IA or CIGA.
Difficulty is getting all the creditors to agree to an informal arrangement.
What might a company have to do to obtain a creditor agreement?
- Grant new or additional security
- Replace directors or senior employees
- Sell failing businesses/subsidiaries or profitable ones to raise cash
- Reduce costs e.g. close unprofitable businesses or begin a redundancy programme
- Issue new shares to the creditors (debt for equity swap)
Standstill agreement
Often a preliminary step to negotiating an informal arrangement with relevant creditors, a company may ask creditors to enter into a Standstill Agreement whereby the creditors agree not to enforce their rights or remedies for a specified period to give the company time to negotiate an arrangement with them to resolve the company’s financial issues.
What is a pre-insolvency moratorium?
A moratorium is a period during which creditors are unable to take action to exercise their usual rights and remedies, thereby creating a breathing space for the company to attempt to resolve the situation.
A pre-insolvency moratorium is for struggling companies that are not in a formal insolvency process.
What use a pre-insolvency moratorium?
Can be used by a company which is not in a formal insolvency process to buy itself some time to reach an informal agreement with all or some of its creditors or as a preliminary step proposing a CVA, restructuring plan or scheme of arrangement.
What actions are restricted by the moratorium?
- no creditor can enforce its security against the company’s assets
- there is a stay of legal proceedings against the company and a bar on bringing new proceedings against it
- no winding up procedures can be commenced in respect of the company and no shareholder resolution can be passes to wind up the company
- no administration procedure can be commenced in respect of the company (other than by the directors)
Procedure for obtaining a pre-insolvency moratorium
Can obtain one by filing documents at court including:
- a statement that the company is likely to become unable to pay its debts as they fall due
- a statement from a licensed practitioner (usually an accountant) known as a monitor for these purposes stating that in their view it is likely that a moratorium will result in the rescue of the company as a going concern.
Monitor has a supervisory function during the pre-insolvency moratorium.
How long does a pre-insolvency moratorium last?
Lasts for 20 business days but can be extended by the directors for a further 20 business days.
Further extensions beyond that 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.
Will automatically terminate if the company enters liquidation or administration or at the point that a Company Voluntary Arrangement (CVA) is approved or a court sanctions a restructuring plan or scheme of arrangement.
Pre-moratorium debts
Company does not have to pre-moratorium debts whilst the pre-insolvency moratorium subsists.
These are debts which have fallen due before or during the moratorium by reason of an obligation incurred before the moratorium except for:
- Monitor’s remuneration or expenses
- Goods and services supplied during the moratorium
- Rent in respect of a period during the moratorium
- Wages or salary or redundancy payments
- Loans under a contract involving financial services - means that a company remains liable to pay all sums due to a bank which made a loan to it before it obtained the moratorium
Moratorium debts
All moratorium debts must still be paid.
These are debts that fall due during or after the moratorium by reason of an obligation incurred during the moratorium.
Usually relates to payment for goods or services ordered by the company during the moratorium period.
Means that in practice a company must be cash flow solvent and be able to pay its debts as they fall due so is capable of paying its way during the moratorium period.
What are formal arrangements?
Statutory procedures:
- Company Voluntary Arrangement
- Restructuring plan
Main advantage of a formal arrangement is that if the requisite majorities of creditors vote in favour of it, it is legally binding on ALL creditors even if some creditors voted against it or did not vote on it at all or did not receive notice of the relevant procedure.
Company Voluntary arrangement
CVA is a compromise between a company and its creditors.
Essence: creditors agree to part payment of the debts owed to them and/or to a new extended timetable for repayment.
CVA proposals once approved in accordance with the Insolvency Act 1986 must be reported to court but there is no requirement for the court to approve the CVA proposal.
Who supervises a CVA?
Supervised and implemented by a Supervisor who is an Insolvency Practitioner.
During the CVA the company’s directors remain in office and will continue to run the company’s affairs subject to the terms of the CVA.
Can also be used together with administration or liquidation.
Setting up a CVA
- Directors draft a CVA proposal and appoint a nominee (who must be an insolvency practitioner) - if in liquidation or administration this will be admin or liquid and they will also draft the CVA proposal
- Directors submit the CVA proposal and statements of the company’s affairs to the nominee (although in practice it is the nominee who drafts it)
- Nominee considers proposal and report to court within 28 days whether company’s creditors and shareholders should be asked to vote on the CVA proposal
- Nominee must allow 14 days for creditors to vote on the CVA proposal. Meeting of shareholders must take place within 5 days of the creditor’s decision.
- Voting - CVA proposal will be approved if:
- 75% in value (of debts) of those voting on CVA proposal (excluding secured creditors) vote in favour
note: decision will be invalid if those voting against include more than half of the total value of creditors unconnected to the company - simple majority of shareholders/members vote in favour
note: if creditors vote in favour but shareholders against the creditors’ vote will prevail
- Nominee reports to court that the CVA has been approved
- Nominee usually becomes the Supervisor and the Supervisor will implement the CVA proposal
Effect of CVA
CVA is binding on all unsecured creditors including those who did not vote in favour.
Secured or preferential creditors are not bound unless they unanimously consent to the CVA.
Challenge to CVA
A creditor can challenge a CVA within 28 days of the CVA’s approval by the creditors being reported to the court on the grounds of ‘unfair prejudice:
- CVA treats one creditor unfairly compared to another; or
- material irregularity relating to the procedure which the company has followed in seeking approval of the CVA.
Subject to this, the CVA becomes binding on all creditors at end of 28 day challenge period.
CVA: supervisors role
- agree creditors’ claims
- collect in unsecured funds to pay dividends to creditors
- generally ensure that the company complies with its obligations under the CVA.
- When a CVA has been completed the Supervisor will send a final report on the implementation of the proposal to all shareholders/members and creditors
CVA; company’s POV
Advantages:
- directors remain in control of the company
- company can continue to trade subject to the terms of the CVA proposal with the hope of the company surviving
Disadvantage:
- cannot bind secured or preferential creditors without their consent
CVA: creditor POV
Trade creditors tend to support CVAs as they are likely to recover more than if the company goes into administration or liquidation.
Landlords - CVA may result in heavily discounted rents and loss of income but also retail properties are not easy to re-let so a landlord may prefer to receive reduced rents rather than have empty properties generating no income at all if CVA proposals are not approved
Restructuring plan
Can only be used for companies which have or are likely to encounter financial difficulty.
Requires court approval. Only becomes binding if the court sanctions it. If the court sanctions it, it binds all creditors including secured creditors.
Creditors and members are divided into classes and need 75% in value in favour in each class.
Advantages of a restructuring plan
- binds ALL creditors
- court can exclude creditors and shareholders from voting even if they are effected by the plan if they have no genuine economic interest in the company
- court can sanction plan which brings ‘cross-class cram down’ - this is where one rank of creditor votes in favour and the plan is forced on a class that votes against it.
Note: - dissenting class must not be any worse off and plan must be approved by at lease one rank of creditors
CVA summary
Initiate:
- directors
- liquidators
- administrators
Approval:
- at least 75% in value of unsecured creditors but without more than 50% of unconnected voting against
- over 50% of shareholders
Binds:
- unsecured creditors
Advantages:
- no court sanction required so can be quicker and less costly to implement
Limitations:
- Preferential and secured creditors not bound without express consent
Restructuring plan summary:
Initiate:
- company, creditor, member, liquidator or administrator
Approval:
- sanctioned by the court
- at least 75% in value of each affected class of creditors/shareholders
Binds:
- all creditors and shareholders
Advantages:
- binds all creditors including dissenting creditors and potentially classes of creditors who do not approve the plan as the court may sanction the plan if even one or more classes do not approve
Limitations:
- Court processes can be costly and time consuming and need to consider if creditors are in separate classes for voting
Objectives of an administrator
Administration is a collective insolvency procedure.
Means that the administrators are required to perform their duties in the interests of the creditors as a whole rather than in the interests of a particular creditor.
Also officers of the court and owe duties to the courts as well as to the creditors of the company.
Must be licensed insolvency practitioners.
Statutory objectives of administration
(a) First, to rescue the company as a going concern, or if that is not reasonably achievable
(b) achieve a better result for the companies creditors as a whole than would be likely if the company were wound up, or if that is not reasonably achievable
(c) to realise the company’s property in order to make a distribution to one or more secure or preferential creditors.
Appointment of administrator: court procedure
Court may appoint an administrator where the company is or is likely to become unable to pay its debts on the application of:
- company
- directors
- a creditor
- supervisor of a CVA
- liquidator
Court must decide whether the appointment is reasonably likely to achieve the purpose of the administration.
Interim moratorium will come into effect on the application to court and will last until order is made or application is dismissed.
Rare but might be made where a creditor has begun winding up proceedings against the company and the directors wish to appoint administrators before the court order has made a winding up order - in this instance out of court appointment is not available.
If court grants the order, winding up proceedings are automatically dismissed.
Out of court appointment of administrators
May be made by:
- directors
- holder of a qualifying floating charge
QFC:
(1) floating charge together with any other security the charger holder holds relates to whole or substantially the whole of the companies property; and
(2) document which creates the charge provides Sch b1 para 14 IA 1986 applies to the charge or that the holder has the power to appoint an administrator/ receiver.
Directors appointing administrator out of court
Directors must file a notice of intention to appoint (NOI) at court.
Notice of appointment must be filed in court within 10 business days of the NOI being filed with the court.
Appointment takes effect once the second notice has been filed.
If the company has also granted a QFC, when filing the NOI at court, must also send NOI to the QFC.
QFC then has 5 business days to appoint its own administrator - if does nothing then company can proceed with its choice.
QFC appointing administrator out of court
1) must first enforce its security in accordance with the terms of the QFC and appointment will take effect when it has filed a notice of appointment at court.
2) where more than one holder of a QFC, if one ranks below others it must first give two business days notice to the holders of a QFC which have priority and can only proceed with the appointment if the higher ranking QFC holders consent to the appointment.
Role of the administrator
- officer of the court
- duty to act in the interests of all the creditors to achieve the purpose of administration
Powers;
- power to carry on the business of the company
- take possession and sell property of the company (with consent of fixed charge holder)
- borrow money and execute documents in the company’s name
- administrators so not have the power to pay a dividend to unsecured creditors without obtaining court permission
Once appointed:
8 weeks to produce a report setting out proposals for the conduct of the administration which may include proposals to restructure liabilities:
- restructuring plan
- scheme of arrangement
- CVA
This is sent to creditors for approval, if rejected usually placed into liquidation
Completion of administration
If proposals accepted, will proceed with proposals.
If achieved, will exit administration.
12 month fixed time limit for the completion of administrations although it is possible to obtain extensions.
Directors and employees during admin
- Directors are unable to exercise any of their management powers without the consent of the administrator but remain in office
- Employees remain employed by the company
Administrative moratorium
Company has benefit of a full moratorium. During this time all business documents and company’s website must state that the company is in administration.
During moratorium:
- no order to wind up can be made or passed
- no receiver can be appointed
- no steps can be taken to enforce security over the company’s property or to repossess good subject to security, hire purchase or retention of title
- no legal proceedings, execution or other processes can be commenced or continued against the company or its property
- landlord may not forfeit the lease of the company’s premises
These can be taken with consent of the court or the administrator.
Powers of the administrator
‘Do all such things as may be necessary for the management of the affairs, business and property of the company.’
Powers to:
- remove and appoint directors
- dispose of property subject to a floating charge
- dispose of property subject to a fixed charge
May also bring proceedings against directors for fraudulent and wrongful trading.
Pre-packaged administration sale
- business and assets of an insolvent company are prepared for sale to a selected buyer prior to entry into administration
- terms negotiated before admin is appointed and sale is completed immediately following their appointment
Adv:
- goodwill and continuity are not damaged by administration
- certainty of result for creditors
Dis:
- sale does not take place at proper price
- creditors are given insufficient information to determine whether sale was in best interests
Not able to enter into sale with directors or shareholders (or persons connected) unless sale has been approved in advance by creditors or qualifying evaluators report has been obtained.
Report must be sent to Companies House and all creditors.
What is receivership
An enforcement procedure which is conducted in the interests of a secured creditor.
Three types:
1. Administrative receivers (rare)
2. Fixed charge receivers
3. Court appointed receivers
Administrative receiver
- Now rare and prohibited in most cases
- If applicable, a secured creditor with fixed and floating charges over all of the company’s assets may appoint an AR.
- AR will take control of secured asset, sell them and use proceeds to repay the debt owed to the secured creditor
- Enforcement procedure rather than a collective procedure such as administration or liquidation.
only licenced insolvency practitioner can be appointed as an AR.
QFC can only appoint where:
- created before 2003 or one of the statutory exceptions applies.
Fixed charge receiver
- most common type
- does not have to be a licensed insolvency practitioner
- appointed by holders of fixed charge under terms of security document.
- they will sell assets and use proceeds to repay debt of appointer
- owes duties primarily to appointer but owes duty to act in good faith to the debtor
- cannot be appointed during a pre-insolvency moratorium or if the company is in administration
Court-appointed receivers
- rare
- court appointed and powers and duties set out in court order
- sometimes appointed when shareholders are locked in a dispute
- usually duty will be to run the business until the dispute is determined
What is liquidation
The process by which a company’s commercial life comes to an end.
- Task of collecting in the company’s assets and selling them.
- identifying the creditors of the company and determining the amounts owed to them and then paying the creditors a dividend out of the funds obtained from the sale of the assets
- if any surplus after creditors claims have been paid in full then surplus goes to the shareholders
Note: solvent companies are also sometimes wound up
Goal/function of liquidation
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 or their determined claims.
Creditors of the same rank are ‘pari passu’ with each other - meaning they share on an equal and proportionate bases in relation to the assets available for distribution to them.
Liquidation overview
Liquidators have very limited powers to carry on the business and dismiss employees very soon after their appointment.
For this reason, they will usually sell assets on a piece-meal basis then sell business as a going concern.
If company is viable it will usually enter administration first.
Types of liquidation
- Compulsory liquidation
- Voluntary liquidation
i. Members’ voluntary liquidation
ii. Creditors’ voluntary liquidation
Dissolution
How the company’s life as a legal person is brought to an end.
Compulsory liquidation: dissolution occurs three months after the liquidator has filed notice with the Companies Registry stating that the winding up of the company has been completed.
Voluntary:
Dissolution occurs three months after the liquidator has filed the final accounts and return with the Registrar of Companies at Companies House.
What is compulsory liquidation?
Court-based process for placing a company into liquidation.
1) applicant presents winding up petition to the court under which the applicant requests the court make a winding up order against the company on a number of statutory grounds
2) if court grants petition the order operates in favour of all of the creditors and contributories
Official Receiver will become liquidator and continue in office until another person is appointed.
Grounds for a winding up petition
in s122(1) IA 1986:
(1) the company is unable to pay its debts; and
(2) it is just and equitable for the company to be wound up
Who can apply for a winding up order?
- A creditor
- The company
- The directors (board resolution) - where insufficient assets to fund voluntary liquidation
- An administrator
- An administrative receiver
- Supervisor of a CVA
- Secretary of State for business, energy and industrial strategy
Inability to pay debts
4 insolvency test would serve as evidence:
- Failure to comply with creditor’s statutory demand for at least £750 - debt of at least £750 and make a written demand in prescribed form for the debt - the company has 21 days to comply.
- Failure to pay a judgment debt
- Proof to the satisfaction of the court that the company is unable to pay debts as they fall due (cash-flow test)
- Proof to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities (balance-sheet test)
Consequences of a winding up order being granted
- automatic stay will be granted on commencing or continuing with proceedings against the company
- all employees will be automatically dismissed
- directors lose their powers and are automatically dismissed from office
Any transfers or dispositions of property during period between petition and order will be void.
3 situations for a voluntary winding up order
- Company resolves by special resolution to wind up the company. Company must be solvent (member’s voluntary winding up)
- Where the company resolves that it is advisable to wind up the company due to is inability to carry on business. Insolvent. (creditors voluntary winding up)
- Where the company’s purpose according to the articles has expires and resolution of shareholders (rare)
Members’ voluntary winding up (MVL)
- Only for solvent companies
- Directors must swear a declaration of solvency:
+ made full enquiries into affairs of the company and formed option will be able to pay creditors in full within period not exceeding 12 months
+ statement of assets and liabilities as at last practicable date
+ if made without reasonable grounds for opinion - liable to fine or imprisonment -Will be assumed where debts are not paid within 12 months - Members pass special resolution to place company into MVL
- OR to appoint liquidator
- Winding up commences when the SR is passed
Creditors voluntary winding up (CVL)
- Most common insolvency procedure
- commenced by resolution of the shareholders but under effective control of the creditors who can choose the liquidator.
- SR to place company into liquidation
- OR to appoint nominated liquidator
- within 14 days of the special resolution being passed the directors must ask company’s creditors to either approve liquidator or put forward their own choice. Creditors choice will prevail if dispute as to choice.
- directors also draw up a statement of the company’s affairs and send it to the company’s creditors
Role of liquidator
Principle functions:
- Secure and realise the assets of the company then distribute to creditors
- take into custody all of the property of the company
Appointment terminates the management powers of the company’s directors whose powers are transferred to liquidator with the fiduciary duties meaning liquidator must act in good faith, avoid conflicts of interest and not make a secret profit
- either qualified Insolvency Practitioner or Official Receiver and acts as an officer of the court.
Liquidators powers
- 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 or 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 necessary to wind up affairs and distribute the assets
- carry on the business of the company (only to extent necessary for beneficial winding up)
- commence or defend court proceedings in the name of the company
- pay debts and compromise claims
Liquidators powers to avoid certain transactions
- disclaim onerous property
- apply to court to set aside a transaction at an undervalue
- apply to court to set aside a preference
- apply to court to set aside or vary the terms of an extortionate credit transaction
- claim that a floating charge created for no new, or inadequate, consideration is invalid
- apply to the court to set aside a transaction that will defraud creditors
Statutory order of priority
- Liquidators fees and expenses of preserving and realising the assets subject to fixed charges
- Fixed charge creditor out of sale of assets subject to fixed charge
- Liquidator’s other remuneration, costs and expenses
- Preferential creditors (1st then 2nd)
- Creation of prescribed part fund for unsecured creditors
- Amount due to creditors with floating charges
- Unsecured/trade creditors
- Interest owed to unsecured creditors
- Shareholders
Preferential creditors
First tier:
- employee claims for unpaid remuneration due in four months before the relevant date (generally subject to £800 per employee)
- occupational pension scheme contributions
Second tier:
- PAYE and national insurance deductions
- VAT
Tier 1 must be paid before tier 2
Prescribed part fund
Ring fenced fund from realisations from floating charges.
Percentage of the company’s net property (property not subject to a fixed charge) is set aside for unsecured creditors.
Note: shortfall for a floating charge does not share in prescribed part fund but still ranks as an unsecured creditor (but fixed charge shortfall can)
