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SQE2 - Business Law and Practice > Insolvency > Flashcards

Insolvency Flashcards

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1
Q

Corporate Insolvency

What is corporate insolvency?

What is the test for insolvency under the Insolvency Act 1986 (IA 1986)?

A

A company being unable to pay its debts.

The test:
- A creditor served a statutory demand for £750+ and the company has not paid within 21 days of service (or come to an arrangement);
- A creditor obtained judgment and tried to enforce it, but the debt is still not paid in full.
- The company is unable to pay its debts as they fall due (cash flow test)
- The company’s liabilities exceed its assets (balance sheet test).

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2
Q

Corporate Insolvency

Why do we need to know if a company is insolvent?

A

It is a prerequisite to a creditor commencing insolvency proceedings.

It also makes certain remedies available.

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3
Q

What are the possible outcomes for an insolvent company?

What further options are available to secured creditors?

A
  • Liquidation
  • Administration
  • Company Voluntary Arrangement (CVA)

Secured creditors can appoint:
- an LPA receiver
- an administrator
- an adminstrative receiver (only for securities created before 15 September 2003).

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4
Q

Corporate insolvency: Liquidation

What is liquidation and what are its effects?

A

The company ceases to exist: the business ceases to trade and the assets are sold. Also known as winding up.

Effects: directors’ powers cease. Liquidator runs the company to obtain more money for creditors. Once assets are distributed, the company is dissolved at Companies House within a few months.

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5
Q

Corporate insolvency: Liquidation

What are the three types of liquidation?

A
  • Compulsory Liquidation
  • Creditor’s Voluntary Liquidation (CVL)
  • Member’s Voluntary Liquidation (MVL)
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6
Q

Corporate insolvency: Compulsory Liquidation

What is the process for compulsory liquidation?

How is this usually established?

A
  1. A third party (‘the petitioner’) presents a petition at court on the basis that the company is unable to pay its debts.
  2. The court orders that the company is wound up.
  3. The Official Receiver (OR) automatically becomes the liquidator.

By a creditor issuing a statutory demand and issuing the petition if unpaid after three weeks.

The creditor may alternatively obtain judgment against the company. This would also show insolvency.
The OR may appoint a private insolvency practitioner if sufficient assets available to pay.

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7
Q

Corporate insolvency: Compulsory Liquidation

How can the company prevent the petitioner from proceeding with their petition?

When might the court adjourn the hearing?

A

By showing that there is a genuine and substantial dispute about the money owed.

If the company indicates that it can pay the debt within reasonable time.

Note: if the creditor already obtained judgment, it would be difficult to argue there is a dispute. However, the court retains discretion.

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8
Q

Corporate Insolvency: Liquidation - CVL and MVL

What is CVL?
What is MVL?

A

CVL: process initiated by the company after pressure from the creditors. The creditors take over at an early stage.

MVL: The shareholders put the company into liquidation when it is solvent (i.e. enough assets to pay all debts). The director must make a statutory declaration of solvency.

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9
Q

Corporate Insolvency: Liquidation

What are the liquidator’s powers when taking over the company?

A
  • carry on the business;
  • commence and defend litigation;
  • investigate past transactions;
  • investigate directors’ conduct;
  • collect and distribute assets.
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10
Q

Corporate Insolvency: Liquidation - order of distribution

What is the order of distribution?

A
  1. Fixed charge holders
  2. Winding up expenses
  3. Preferential debts (abate equally)
  4. Floating charges (in order of priority)
  5. Unsecured creditors (abate equally)
  6. Remainder to shareholders

Abate does not mean in equal amounts, it means they receive the same percentage of outstanding debt owed.

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11
Q

Corporate Insolvency: Liquidation - order of distribution

A company in liquidation has 2 creditors. One is owed £10,000, the other is owed £5000. Only £7500 is available. How much does each creditor receive?

A

Creditor 1: 10,000/15,000 = 2/3 of debt due therefore he receives £5,000.

Creditor 2: 1/3 of debt = £2,500.

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12
Q

Corporate Insolvency: Liquidation - order of distribution

What are the most common preferential debts?

A
  • Wages/salaries of employees in the four months preceding the winding up (up to £800 per employee).
  • HMRC, in relation to taxes collected on HMRC’s behalf (PAYE and VAT).

Holiday pay is also included.
HMRC is not a preferential debtor in relation to corporation tax.

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13
Q

Corporate Insolvency: Liquidation - order of distribution

Explain ring-fencing.

How much is set aside?

A

A portion of money owed to floating charge holders is ring-fenced for the benefit of unsecured creditors.

  • 50% of the first £10,000 of money received from the charged asset;
  • 20% of the remainder up to £800,000.

Only relates to assets charged on or after 15 September 2003.

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14
Q

Corporate Insolvency: Administration

What is administration?
What is its advantage?

A

A process whereby an administrator is appointed to run the company or sell it as a going concern.

Main advantage: there is a statutory moratorium preventing anyone from commencing proceedings without the administrator’s consent.

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15
Q

Administration

What are the objectives of the administrator?

A
  1. To rescue the company as a going concern; or
  2. If not possible, to achieve a better result for the creditors than liquidation.
  3. If not possible, sell assets to pay the secured or preferential creditors.
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16
Q

Administration

How is administration commenced?

A

Court route: if the company is likely to be unable to pay its debts and the order is reasonably likely to achieve one of the three objectives.

Out-of-court route.

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17
Q

Administration: out-of-court route by company or directors

What is the procedure for the out-of-court route instigated by the company or its directors?

A
  1. File a Notice of Intention with the court
  2. Serve the Notice on any qualifying floating charge holder and lender entitled to appoint an administrative receiver.

The moratorium comes into effect when notice of intention is filed at court.

Directors must also file a statutory declaration at court that the company is unable to pay its debts and is not in liquidation.

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18
Q

Administration: out-of-court route by QFCH

What is a QFCH?

What is the procedure for the out-of court route instigated by a QFCH?

Qualifying Floating Charge Holder

A

A floating charge holder with the power to appoint an administrator or administrative receiver. The charge must relate to substantially the whole of the company’s property.

The lender files a notice of appointment at court, including a statutory declaration that:
- the lender is a QFCH
- the floating charge is enforceable; and
- the appointment complies with the IA 1986, Sch B1.

The charge document must also state that para.14 of B1, IA 1986 applies

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19
Q

Administration: process

Once administration commences, a moratorium takes effect. What will the administrator do next?

How will these be approved?

A

Put forward proposals to creditors.

  • By majority in value of creditors present and voting.
  • Those voting against the proposals must not constitute more than 50% of unconnected creditors to the company.
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20
Q

Adminstrator’s powers and duties

What are the administrator’s statutory powers?

A
  • remove and appoint directors
  • pay creditors (with court’s permission if unsecured creditor)
  • call a meeting of creditors or shareholders
  • deal with property subject to floating charge
  • deal with property subject to fixed charge (with permission of the court)
  • investigate and apply to have past transactions set aside.
  • commence fraudulent or wrongful trading proceedings.
  • do anything necessary or expedient for the company’s management.
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21
Q

End of administration

When does administration end?

A

One year after administration took effect, or

Earlier if:
- its objective has been achieved;
- the administrator believes its objective cannot be achieved; or
- application to the court by creditor.

The administrative period can also be extended.

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22
Q

Pre-pack administration

What is a pre-pack administration?

Why are there more onerous requirements on pre-packs?

A

The company goes into administration and the administrator sells its assets and business straight away.

Unsecured creditors are not consulted and are unlikely to receive much of the debts owed.

The sale is effectively agreed before the company appoints an administrator. More jobs are likely to be saved.

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23
Q

Liquidator and Administator Claims

What are the key potential claims that liquidators/administrators can make on behalf of the company (for the payment of creditors)?

A
  • Avoiding certain floating charges
  • Preferences
  • Transactions at an undervalue
  • Transactions defrauding creditors
  • Extortionate credit transactions
24
Q

Liquidator and Administator Claims: Avoidance of floating charges

When can a floating charge be automatically voided under s 245 IA 1986?

A

If it was granted without fresh consideration before the onset of the company’s insolvency.

  • If created in favour of a connected person, the charge must have been created within two years of the onset of insolvency,
  • For any other person, the charge must have been created within one year before the onset of insolvency.

Onset of insolvency

Compulsory liquidation: date of the winding-up petition,
CVL: date of liquidation
Administration: notice to appoint an administrator

25
Q

Liquidator and Administator Claims: Avoidance of floating charges

If the floating charge was given to an unconnected person, what is required to be shown?

A

That the company was insolvent at the time of giving the floating charge or became insolvent as a result.

Need not be shown for a connected person.

26
Q

Liquidator and Administator Claims: Avoidance of floating charges

Who is considered ‘connected’ with the company under ss 249 and 435 IA 1986?

A

A person connected with the company includes:

  • A director or shadow director.
  • A close relative or business associate of a director or shadow director.
  • An associate of the company (e.g. another company controlled by a director of the insolvent company).
27
Q

Liquidator and Administrator Claims: Preferences

What constitutes a preference under s 239 IA 1986?

What conditions must be met?

A

A company, at the relevant time, puts another person in a better position than they would otherwise have been in during insolvent liquidation or administration.

  • There must be a desire to put the creditor in a better position.
  • The company must have been insolvent at the time of the preference or become insolvent as a result.

Desire to prefer is presumed if to a connected person.

But note: no presumption of insolvency if preference given to a connected person (c.f. transactions at an undervalue).

Examples
- Where one creditor is paid before other creditors.
- Where an unsecured creditor is given security.

28
Q

Liquidator and Administrator Claims: Preferences

What is the relevant time for preferences under s 239 IA 1986?

A
  • Connected persons: two years before the onset of insolvency.
  • Any other person: six months before the onset of insolvency.

Note: For connected person it’s always 2 years (for each claim). For other persons, the time limit is shorter for preferences than for floating charges.

29
Q

Liquidator and Administator Claims: Transactions at an undervalue

What is a transaction at an undervalue under s 238 IA 1986?

What condition must be met?

What presumption might be relevant?

What defence may be available?

A

The company makes a gift or receives consideration significantly lower than the value provided by the company within two years of the onset of insolvency.

The company must have been insolvent at the time of the transaction or become insolvent as a result.

Insolvency is presumed if transaction was to a connected person (unlike preferences)

Defence: transaction entered in good faith and there were reasonable grounds to believe it would benefit the company.

E.g. of the defence: company could not find a buyer for property at full price and had to sell quickly to a buyer showing interest.

30
Q

Liquidator and Administator Claims: extortionate credit transactions

What is an extortionate credit transaction under s 244 IA 1986?

A
  • grossly exorbitant payments or a transaction grossly contravening ordinary principles of fair dealing.
  • made within three years before the company went into administration or liquidation.

Rare.

31
Q

Liquidator and Administrator Claims: transaction defrauding creditors

What defines a transaction defrauding creditors under s 423 IA 1986?

What is the time limit for bringing a claim?

A

A transaction at an undervalue made to put assets beyond the reach of a claimant or to prejudice their interests.

No time limit for bringing a claim.

Challenging to prove intent.
Usually only made if the time limit to make a claim for a transaction at an undervalue has expired.

32
Q

Company Voluntary Arrangement

What is a CVA?

When is it used?

What are the advantages of a CVA?

A

A written agreement binding all parties to it (the company and its creditors), in which the company puts forward proposals to pay the creditors.

Generally used when the business is fundamentally sound but undergoing temporary cash flow difficulties.

Advantages
- Cheaper and simpler than liquidation/administration.
- Creditors likely to be paid more.

33
Q

Company Voluntary Arrangement

The proposals must be approved by:

Once approved, it is binding on…

A
  • 75% or more in value of the creditors; and
  • 50% or more of non-connected creditors.

Unsecured creditors in relation to past debts only (not future debts).

Secured creditors are not allowed to vote (apart from in relation to any of their unsecured debt). Note: their rights, along with preferential creditors, are unaffected by the CVA.

34
Q

Restructuring under CIGA 2020

What is the CIGA 2020 Restructuring Plan?

On what condition can a company apply for this?

What is the key feature of the plan?

A

A court-supervised arrangement between the company, its creditors and shareholders, whereby the court will decide whether to sanction a proposed plan of the directors.

It must have encountered or be likely to encounter financial difficulties.

Classes of creditors/members who vote against a proposal are prevented from blocking the proposed plan, if they would be no worse off under the restructuring plan than they would otherwise be.

35
Q

Secured creditors: power to appoint a receiver

What is an LPA receiver?

What is the aim of appointing an LPA receiver?

A

A receiver appointed by a fixed charge holder.

To repay the creditor by selling the charged property.

Note: administrative receiver is for secured creditors of floating charges, but these are hardly relevant now as they only apply to charges created before September 15 2003.

36
Q

Personal Insolvency

When is a person insolvent?

A
  • A debt is payable now but the debtor doesn’t have enough money to pay.
  • A debt is payable in the future and there is no reasonable prospect that he will be able to pay.
37
Q

Personal Insolvency

How can personal insolvency be proven?

A
  • Serving a statutory demand for a liquidated sum of £5000 or more and not being paid after three weeks.
  • Serving a statutory demand for a future liability to pay £5000 or more and the debtor shows no reasonable prospect of paying the sum due.
  • Obtaining a court judgment for a debt of £5000 or more and attempting execution without success.
38
Q

Personal Insolvency

What are the debtor’s options if they are insolvent?

A
  • Negotiate with creditors
  • Apply for their own bankruptcy
  • Enter an individual voluntary arrangement
  • Apply for a debt relief order

Additionally: the Debt Respite Scheme may be available, giving the debtor 60 days’ breathing space.

39
Q

Personal Insolvency: Bankruptcy

What is the bankruptcy procedure?

A

The creditor:
- proves insolvency (as above) and presents a petition at the debtor’s local county court hearing centre.
- personally serves the petition on the debtor, and provides a witness statement confirming they have done so.
- Once a bankruptcy order is made, the OR acts as trustee in bankruptcy and takes control over the assets.

If the debtor is avoiding the agent, the creditor can seek to obtain a court order for substituted service.

A debtor can also apply online for their own bankruptcy.

40
Q

Personal Insolvency: bankrupt’s property

What property is the bankrupt entitled to keep?

What is the bankrupt’s salary potentially subject to?

A

Tools of their trade and household items (unless high value, in which case the trustee can sell and replace with a cheaper alternative).

An income payment agreement, if the salary is more than sufficient to meet reasonable needs.

If the bankrupt and trustee cannot agree to the IPA, the trustee can apply to court for an income payments order.

The IPA/IPO last for three years from the date of the order/agreement.

41
Q

Personal insolvency: bankrupt’s home

A bankrupt has asked for general advice about his home. Advise.

A

His interest passes to the trustee. The home transfers back to the bankrupt three years after the bankruptcy order unless the trustee has:
- sold the property;
- applied for an order for sale, possession or a charging order; or
- entered into an agreement with the bankrupt.

42
Q

Personal insolvency: bankrupt’s home

What is the position if someone else has an interest in the property?

A

The trustee would need a court order to sell the house.

The court will weigh up:
- relevant circumstances
- creditor’s interests
- conduct and need of current or former spouse
- needs of any children.

After one year of bankruptcy, the creditor’s interests outweigh anyone else’s interests unless there are exceptional circumstances.

43
Q

Personal insolvency: trustee in bankruptcy

What are the trustees options following investigation of transactions and assets?

A
  • disclaim onerous property
  • apply to set aside transactions at an undervalue
  • apply to set aside preferences
  • apply to set aside transactions defrauding creditors
  • avoid extortionate credit transactions

Note: defrauding creditors is exactly the same as for corporate solvency.

44
Q

Personal insolvency: bankruptcy - disclaiming onerous property

What is the effect of disclaiming onerous property?

Provide examples of onerous property.

A

The bankrupt’s rights and liabilities for that asset come to an end and the trustee is discharged from personal reposnibility.

Anyone suffering loss as a result may make a formal claim to be an unsecured creditor.

  • unprofitable contracts
  • a lease with no capital value for the creditor
  • land subject to an onerous covenant.
45
Q

Personal insolvency: bankruptcy - transactions at an undervalue

What are the requirements to establish a transactions at an undervalue?

Does the trustee need to show the bankrupt was insolvent at the time of the transaction?

A
  • A transaction for which the bankrupt received consideration significantly lower than that which they provided.
  • made within 5 years of the petition.

Insolvency need not be shown unless the transaction was more than two years before the petition. If the transaction was made to a relative or associate, there is a presumption of insolvency.

46
Q

Personal insolvency: bankruptcy -preferences

What is a preference in relation to a bankrupt?

What are the requirements for a preference to be established in relation to personal insolvency?

A

An arrangement placing a creditor, surety or guarantor in a better positoin than they would otherwise be in the bankruptcy process.

  • The bankrupt had intention to prefer (presumed if in favour of an associate)
  • The preference was made within 6 months of the petition; or 2 years if in favour of an associate.
  • The bankrupt was insolvent at the time or became insolvent as a result.
47
Q

Personal insolvency: bankruptcy - extortionate credit transactions

What are the requirements for a extortionate credit transaction to be established?

A
  • The bankrupt obtained credit in the three years prior to the order.
  • The credit is ‘grossly exorbitant’ or ‘grossly contravenes fair dealing’

Effect is that trustee can vary or set aside the credit.
Example may be: bankrupt receiving loans on very unfavourable terms but no case law.

48
Q

Personal insolvency: bankruptcy distribution

What is the order of distribution once the trustee has finished realising the assets and challenging transactions?

A
  1. Secured creditors can sell charged assets.
  2. Costs of bankruptcy
  3. Preferential debts
  4. Ordinary unsecured creditors
  5. The spouse (postponed creditors)

Preferential debtors are (1) employees within four months of bankruptcy up to £800 and (2) HMRC

49
Q

Personal insolvency: bankruptcy discharge

When is the bankrupt discharged and what is the effect?

What might the discharge be subject to?

A

After one year unless suspended. The bankrupt is released from previous debts. Property is not returned to the bankrupt, other than the matrimonial home in some cases.

A bankruptcy restriction order (BRO) or undertaking (BRU).

50
Q

Personal insolvency: restrictions on bankrupts

What are the business restrictions on undischarged bankrupts?

A

Cannot:

  • obtain credit of more than £500 without disclosing their bankruptcy (while undischarged)
  • act as a director
  • be involved in management, promotion or formation of a company (without court’s permission)
  • trade under a different name
  • continue in partnership (unless partnership agreement varies default position)
51
Q

Personal insolvency: restrictions on bankrupts

What is the effect of a BRO/BRU?

Who does it apply to and for how long?

A
  • Prevents bankrupt, for the duration of the BRO/BRU from being a director or obtaining credit over £500 without disclosing the BRO/BRU.
  • Applies to a bankrupt who was dishonest, negligent or reckless.
  • Lasts anywhere between 2 - 15 years.

Personal restrictions: cannot act as solicitor without consent of SRA.
BRO is an order of the court. BRU is an agreement by bankrupt, out of court.

52
Q

Personal Insolvency: Alternatives to bankruptcy

What are the main alternatives to bankruptcy?

A
  • IVA
  • Negotiation
  • Debt Relief Order
53
Q

Personal Insolvency: IVA

What is an IVA?

What is the procedure?

A

A binding agreement between unsecured creditors, setting how much eich will receive in settlement of their debts.

Procedure:

  1. Debtor appoints nominee to act with them.
  2. Debtor prepares a statement of affairs for nominee to consider.
  3. Debtor applies to court for an interim order to obtain a moratorium (usually in force for 14 days)
  4. Nominee prepares a report for court stating whether it supports the debtor’s proposals (on the basis that the proposals are reasonable)
  5. The IVA is approved by at least 75% of creditors, of which at least 50% are not associates.

Trustee may seek an IVA during a bankruptcy or debtor may seek one to avoid bankruptcy.

The nominee is an insolvency practitioner.

IVA not binding on preferential and secured creditors unless they agree.

54
Q

Personal Insolvency: IVA

Advantages and disadvantages of an IVA:

A

Advantages
- low cost
- potentially greater returns for creditors
- debtor avoids stigma of bankruptcy and disqualifications.

Disadvantages
- creditor relies on bankrupt honouring the IVA. If not, creditor needs to petition to court for bankruptcy.

55
Q

Personal Insolvency: Debt Relief Orders

What is a DRO?
When can a debtor apply online for a DRO?

A

Relief for debtors with low assets and liabilities. The debtor is protected from enforcement action and will usually be free of debt for 12 months, providided cooperation with the OR.

  • Owes less than £50,000 in total
  • Has savings or valuable items worth less than £2,000 in total
  • Owns a vehicle worth less than £4,000.
  • Insufficient money at the end of the month to make debt repayments
  • Not subject to any formal insolvency procedure.
  • Not had a DRO in the last 6 years
56
Q

What are the two types of breathing space under Debt Respite Scheme?

A
  • standard = 60 day moratorium
  • mental health = as long as treatment + 30 days)

SQE2 - Business Law and Practice (9 decks)

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