Insolvency Procedures

Question 1

Meaning of “insolvency”

Answer 1

IA 86 defines insolvency on the context of the circumstances when a court may make a winding up order in respect of a company. Under s122(1)(f) IA 1986, one such circumstance is when a companyis unable to pay its debts.

S 123 IA 86 then goes onto describe four situations or tests for when a company is deemed to be unable to pay its debts. They are when a company:

is unable to pay its debts as they fall due (s 123(1)(e)) known as the cash flow test;

has liabilities that are greater than its assets (s 123(2)) known as the balance sheet test;

does not comply with a statutory demand for a debt of over £750 (s 123(1)(a)) , this provides evidence that the company is cash flow insolvent; or

has failed to pay a creditor to satisfy enforcement of a judgment debt (s 123(1)(b))

The IA 1986 refers to one or more of these tests for various purposes. The most important are the cash flow and balance sheet tests.

Question 2

Directors’ obligations towards companies in financial difficulties

Answer 2

The directors must continually review the financial performance of a company and recognise when it is facing financial difficulties. Examples of financial difficulty include:

The company has many unpaid creditors who are putting pressure on the company to pay the amounts paid to them.

The company has an overdraft facility that is fully drawn, and the bank is refusing to provide further credit by increasing the facility.

The company has loans and other liabilities that exceed the value of its assets

It is the directors who need to decide what action to take on behalf of the company. In making that decision, the directors will need advice on their duties, responsibilities and liabilities under the IA 1986 and general law and their options under the IA 1986 and CIGA 2020 (and other legislation) for resolving their companies’ financial difficulties and minimising the exposure of creditors to losses.

Question 3

Options for a company facing financial difficulties

Answer 3

Faced with a company in financial difficulty, the directors have a number of options which we will explore in this topic:

Do nothing - the directors should, when deciding to do nothing, bear in mind the potential risk of personal liability under IA 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 the company has less to pay and/or more time to pay.

Appoint an administrator - this is a collective formal insolvency procedure (( which considers the interests of all creditors) and will be considered later in this topic.

Request the appointment of a receiver - this is an enforcementprocedure where a secured creditor enforces its security by appointing a receiver who then sells the secured assets with a view to paying the sale proceeds (subject to certain prior claims) to the secured creditor.

Place the company into liquidation - this a formal collective insolvency procedure and will be considered later in this topic.

Question 4

Informal agreements

Answer 4

To avoid the time and cost of formal insolvency arrangements or proceedings, a company can negotiate informally with its creditors. These are contractually binding agreements which are not regulated by IA 1986 or CIGA 2020. The difficulty is in getting all of the creditors to agree.

To obtain creditor agreement, the company may have to do one or more of the following:

Grant new or additional security;

Replace directors or senior employees; and/or

Sell failing businesses/subsidiaries or profitable ones to raise cash;

Reduce the workforce or the salary bill

Issue new shares to the creditors (‘debt for equity swap’)

Creditors, including banks, could enter into Standstill Agreements where they agree not to enforce their rights or remedies for a certain period of time to give the company a breathing space to reach agreement with its other creditors.

Question 5

Pre-insolvency moratorium

Answer 5

CIGA 2020 introduced a new pre-insolvency ‘moratorium’ for struggling companies that are not yet in a formal insolvency process. Pre-insolvency moratoriums can be used to achieve an informal agreement or as a preliminary step to proposing a restructuring plan, CVA or a scheme of arrangement.

A ‘moratorium’ is a period during which creditors are unable to take action to enforce their debts, thereby creating a breathing space for the company to attempt to resolve the situation. The actions restricted by the moratorium include:

• 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 (unless commenced by the directors) and no shareholder resolution can be passed to wind up the company (unless approved by the directors); and
• no administration procedure can be commenced in respect of the company (other than by the directors).

Question 6

Procedure for obtaining the pre-insolvency moratorium

Answer 6

A company can obtain a pre-insolvency moratorium by filing documents at court including

• 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 (usually an accountant), known as a Monitor for these purposes, stating that it is likely that a moratorium will result in the rescue of the company. The Monitor has a supervisory function during the pre-insolvency moratorium.

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 will terminate automatically if the company enters liquidation or administration, or at the point that a CVA is approved, or a court sanctions a scheme of arrangement or a restructuring plan.

Question 7

Pre-moratorium debts

Answer 7

The company does not have to pay 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. But the holiday repayment 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 in respect of a period during the moratorium;
• Wages or salary or redundancy payments; and
• Loans under a contract involving financial services. This 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.

Question 8

Moratorium debts

Answer 8

All moratorium debts must be paid. These are debts that fall due during or after the moratorium by reason of an obligation incurred during the moratorium.

This means that in practice companies must be ‘cash flow’ solvent and capable of paying their way during the moratorium period.

Formal arrangements (using statutory procedures)

The main advantage of a formal arrangement is that if the requisite majorities of creditors and/or shareholders vote in favour of it, it is legally binding, even if some of those creditors voted against it or did not vote on it at all.

There are two possible types of formal arrangement that we will consider in detail:

• a Company Voluntary Arrangement under ss 1-7 IA 1986; or
• a Restructuring Plan under CIGA 2020, the provisions of which are contained in part 26A CA 2006.

Question 9

Company Voluntary Arrangement

Answer 9

A 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.

The CVA is supervised and implemented by an Insolvency Practitioner but the company’s directors remain in post and are involved in the implementation of the CVA.

CVAs can also be used together with administration or liquidation, which we consider later.

Question 10

Setting up a CVA

Answer 10

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.

The directors submit the proposals and a statement of the company’s affairs to the nominee.

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).

Nominee gives 14 days’ notice of meeting to creditors. A meeting of the members must take place within 5 days of the creditors’ decision.

Voting – the proposals must be approved by:

• 75% in value of creditors (excluding secured creditors) and a majority in value of unconnected creditors (eg related companies, directors); and
• a simple majority of members.

Nominee reports to court on approval.

Nominee becomes supervisor and implements proposals.

Question 11

Effect of a CVA

Answer 11

A CVA 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.

A creditor can challenge a CVA within 28 days of the CVA’s approval by creditors being reported to the court on the grounds of ‘unfair prejudice’ that is the 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, for example, the way in which the creditors’ votes were calculated. Subject to that, the CVA becomes binding on all creditors at the end of the 28-day challenge period.

The supervisor’s role will be to agree creditors’ claims, collect in the funds to pay dividends to the creditors and 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 members and creditors who are bound by the CVA.

Question 12

How are CVAs used?

Answer 12

CVAs are commonly used within the retail sector 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. CVAs can be used alone or as part of an administration.

Examples of companies which used CVAs during the coronavirus pandemic to agree rent reductions with landlords include All Saints (June 2020), Frankie & Benny’s (owned by The Restaurant Group) and Clarks (October 2020).

From the company’s perspective, CVAs are advantageous as the directors remain in control of the company, and the company can continue to trade. However, the major disadvantage is that a CVA cannot bind secured or preferential creditors.

Trade creditors tend to support CVAs as they are likely to recover more than if the company goes into liquidation. For landlords the company’s ongoing trading means heavily discounted rents so less income. Equally, retail properties are not easy to re-let so a landlord may prefer to receive reduced rents rather than have empty properties.

It is envisaged that the use of CVAs will gradually decline and be replaced by the Restructuring Plan introduced by CIGA 2020.

Question 13

Restructuring Plan

Answer 13

The other formal agreement to be considered is the Restructuring Plan (Plan). Introduced by CIGA 2020, the purpose of the Restructuring Plan (Plan) is to compromise a company’s creditors and shareholders and restructure its liabilities so that a company can return to solvency.

A Plan is a hybrid of CVAs and ‘schemes of arrangement’, which are a type of restructuring mechanism that may be used for solvent or insolvent companies. The Plan, however, can only be used by companies which have or are likely to encounter financial difficulty.

A Plan requires court sanction. Creditors and members must be divided into classes and each class which votes on the Plan must be asked to approve it. The votes needed by the class meetings for approval are similar to those under a CVA, so that the Plan must be approved by at least 75% of each class voting.

The court must sanction the Plan and it will then bind all creditors including secured creditors.

Question 14

Advantages of Restructuring Plan

Answer 14

Novel features of the Plan include:

• The court can exclude creditors and shareholders from voting even if they are affected by the Plan if they have no genuine economic interest in the company;
• The court can sanction a plan which brings about a “cross-class cram down” if it is just and equitable to do so even if one or more classes do not vote to approve the Plan.

A cross class cramdownmeans that one rank of creditor can force the Plan on another class of creditor who has voted against the Plan. A cramdown of shareholders means forcing shareholders to accept the Plan by creating debt for equity swaps.

The Plan is likely to be used by directors alongside the pre-insolvency moratorium but can also be used by administrators and liquidators considered in later topics.

The 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. The other advantage of a Plan is that it can be sanctioned by the court to bind all creditors even where the requisite majority approval is not obtained in every class of creditors and shareholders who voted.

Question 15

The objectives of the administrator

Answer 15

After liquidation, administration is the next most common insolvency procedure. Recent examples of companies that have gone into administration include amongst others, Laura Ashley, Debenhams, Cath Kidston and Carluccios. Administration 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 primary objective of administration is to rescue the company (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). However, if that is not possible, then its secondary objective is to achieve a better result for creditors than a liquidation. In practice, it is this secondary objective that is most likely to be achieved.

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.

Question 16

The statutory objectives of administration

Answer 16

Schedule 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.”

These cascading objectives are extremely important as they guide the actions of the administrator throughout the process. Objective (b) is most likely to be achieved.

Question 17

Appointment of administrator – court procedure

Answer 17

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 11(a)) on the application of: the company, the directors, a creditor, the supervisor of a CVA or a liquidator. The court must consider that the appointment is reasonably likely to achieve the purpose of the administration (Sch B1 para 11(b)). I

An interim moratorium temporarily freezing creditor action comes into effect on the application to court and until the administration order is made.

Appointments by court order are fairly uncommon. The usual case when this happens is where a creditor has begun winding up proceedings against the company and the directors wish to appoint administrators before the court has made a winding up order. In this situation, the out-of-court appointment procedure is not available to the directors and they must apply to court for an order to appoint administrators.

If the court makes an administration order, the pending winding up proceedings are automatically dismissed

Question 18

Appointment of administrator – out of court procedure

Answer 18

· Company/Directors

File NOI &serve QFCH - Wait 5 business days - Appoint and file Notice of Appointment - Administrator**Appointed!

· QFCH (1st ranking)

Appoint and file notice of appointment - Administrator appointed!

Administrator appointed! - Appoint and file notice of appointment

Question 19

Role of the administrator

Answer 19

The administrator is an officer of the court and has a duty to act in the interests of all the 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.

An administrator’s powers include the power to carry on the business of the company, take possession and sell the property of the company, raise money on security and execute documents in the company’s name. Generally, administrators do not have the power to pay a dividend to unsecured creditors without obtaining court permission.

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 under a scheme of arrangement or implementing a CVA so that the company exits administration.

There is a 12-month fixed time limit for the completion of administrations, although it is possible to obtain extensions.

Question 20

Administrative moratorium

Answer 20

One key benefit of administration is that during administration, the company has the benefit of a full 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):

No order or resolution to wind up the company can be made or passed;

No administrative receiver of the company can be appointed;

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;

No legal proceedings, execution or other process can be commenced or continued against the company or its property, and

A landlord cannot forfeit a lease of the company’s premises.

Where the interim moratorium applies on an application to appoint an administrator as mentioned above, items 1, 3-5 above apply, but without reference to the consent of the administrator. In addition, the interim moratorium does not prevent a QFCH from appointing an administrator.

Question 21

Powers of the administrator

Answer 21

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 (see Topic 10).

Question 22

Pre-packaged sales in administration

Answer 22

A pre-packaged administration is where the business and assets of an insolvent company is prepared for sale to a selected buyer prior to the company’s entry into administration. The terms of the sale agreement are negotiated and agreed before the administrators’ appointment and become immediately effective following the appointment.

Pre-packaged sales have the advantage that the goodwill and continuity of the business are not damaged by the administration and certainty of result is achieved for the creditors. Often the pre-pack purchaser will be one or more of the existing owners or directors of the insolvent company.

Pre-packaged sales are controversial, particularly where the sale is to existing members or management. The concern is that often creditors are given insufficient information to determine whether the sale was in their best interests.

The Administration (Restrictions on Disposal to Connected persons) Regulations 2021 come into force in April 2021. The regulations restrict the ability of an administrator to execute a pre-pack where there is a sale to a connected person and, either the administrator has not obtained the approval of the company’s creditors or the purchaser has not obtained an evaluator’s qualifying report. This report must be sent to Companies House and all creditors.

Question 23

Administrative receivers

Answer 23

Administrative receivership is now a rare procedure which allows a secured creditor to appoint an administrative receiver to seek repayment of the secured debt. It is an individual procedure (benefitting only the appointing creditor) rather than a collective procedure which looks to benefit all creditors such as administration. Administrative receivers can only be appointed by QFCH’s: where the charge was created prior to 15 September 2003; or where one of the statutory exceptions applies. Since this procedure is now rare, we will not consider it any further.

Question 24

Fixed Charge Receivers

Answer 24

Fixed charge receivers are the most common type of receivership. They often referred to colloquially in practice as ‘LPA receivers’, although strictly this is only correct if they have been appointed pursuant to a mortgage.

Fixed charge receivers are appointed by the holders of a fixed charge pursuant to the terms of the security documentation. They are appointed to enforce the security and recover the debt that is owing to their appointor, often a bank. They owe their duties primarily and exclusively to the appointor; the duty to the chargor is to act in good faith in the course of their appointment. It is a legal anomaly that fixed charge receivers are usually an agent of the chargor. They usually have extensive powers set out in the security documentation and some limited powers under the Law of Property Act 1925, these powers typically include the ability to sell, mortgage and collect rents from property.

A fixed charge receiver becomes the receiver and manager only of the property charged and is only entitled to deal with that property and not any other property of the company.

A fixed charge receiver cannot be appointed while a pre-insolvency moratorium subsists or if the company is in administration.

Question 25

Court-appointed receivers

Answer 25

Court-appointed receivers are relatively rare at the moment. They are appointed by the court and their powers and duties are set out in the court order.

Appointments are sometimes made where shareholders are locked in dispute. Receivers may also be appointed by the court under the Proceeds of Crime Act 2002 and associated legislation. Given the move towards imposing criminal sanctions for corporate misconduct, such orders are likely to become more common.

The court-appointed receiver’s duty is typically to run the business until the dispute is determined.

Question 26

Liquidation

Answer 26

Liquidation is the most basic and oldest of the corporate insolvency procedures.

The liquidator’s function is to 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 of their determined claims (creditors of the same rank are said to rank “pari passu”).

The ranking of creditors’ claims (that is, the order in which they must be repaid) is set out in the IA 1986, the IR 2016 and by general law.

Liquidation is the end of the road for the company and a liquidator has only very limited powers to carry on the business of a company. They will usually close a company’s business and dismiss employees very soon after their appointment. They will usually sell assets on a piece-meal basis rather than selling the assets and business as a going concern. The stay on legal proceedings which applies in a liquidation is very limited.

For these reasons, it is common for companies to enter into liquidation after having been through a different insolvency procedure (eg administration) first.

Question 27

Compulsory liquidation

Answer 27

Compulsory liquidation is a court-based process for placing a company into liquidation.

To begin the process, an applicant presents a winding up petition to the court under which the applicant requests the court to make a winding up order against the company on a number of statutory grounds.

When the court grants a petition for compulsory liquidation, the order operates in favour of all the creditors and contributories (members and some former members) of the company.

The Official Receiver will become the liquidator and continue in office until another person is appointed (s 136(2) IA 1986). The Official Receiver will notify Companies House and all known creditors of the liquidation. The Official Receiver has the power to summon separate meetings of the company’s creditors and contributories for the purpose of choosing a person to become the liquidator of the company in his place (s 136(4)).

Question 28

Who can apply for a winding up order?

Answer 28

The following persons can apply to the court for the issue of a winding up petition:

a creditor;

the company (acting by the shareholders; this would happen where there are insufficient assets in the company to fund a voluntary liquidation);

the directors (by board resolution); again, this would happen where there are insufficient assets to fund a voluntary liquidation;

an administrator;

an administrative receiver;

the supervisor of a CVA; and

the Secretary of State for Business, Energy & Industrial Strategy (on public policy grounds).

Question 29

Grounds for a winding up order?

Answer 29

The key grounds on which the court can order a company to be wound up, are set out in s 122(1) IA 1986 and include: (1) the company is unable to pay its debts; and (2) it is just and equitable for the company to be wound up.

Inability to pay debts – s 123 IA 1986

The most common ground for a winding up petition is the company’s inability to pay its debts under s 122(1)(f) IA 1986. This can be evidenced by (s 123 IA 1986):

Failure by the company to comply with a creditor’s statutory demand. A statutory demand is a written demand in a prescribed form requiring the company to pay a specific debt. The statutory demand can only be used if the debt exceeds £750 and is not disputed on substantial grounds. The company has 21 days in which to pay the debt, failing which the creditor has the right to petition the court to wind up the company.

The creditor sues the company, obtains judgment and fails in an attempt to execute the judgment debt.

Proof to the satisfaction of the court that the company is unable to pay its debts as they fall due (the “cash-flow test”). The cash flow test is usually satisfied by going through the statutory demand process in 1 above but that is not essential.

Proof to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account contingent and prospective liabilities (the “balance sheet test”)

Question 30

Consequences of winding up order

Answer 30

To prevent an insolvent company from transferring its assets to third parties at the expense of its creditors, under s 127 IA1986 certain dispositions of a company’s property, transfers of its shares and changes to its members will be void if made after the commencement of the winding-up. This means if these dispositions etc were made during the period between the presentation of the winding up petition and a winding up order being made, then they will be void.

Once a court finds that the grounds for a winding up order are satisfied and it makes a compulsory winding up order, the consequences include as follows:

• an automatic stay will be granted on commencing or continuing with proceedings against the company;
• all employees will be automatically dismissed, and
• the directors lose their powers and they are automatically dismissed from office.

Question 31

Voluntary winding up

Answer 31

Voluntary winding up

Section 84(1) IA 1986 allows for the company to be wound up without a court order in 3 situations:

Where the company’s purpose according to the articles has expired and resolution of the shareholders – RARE

Where the company resolves by special resolution to wind up the company. The company must be solvent – MVL

Where the company resolves that it is advisable to wind up the company due to its inability to carry on its business. Here the company is insolvent – CVL

Question 32

Members’ voluntary winding up (MVL)

Answer 32

This method of voluntary winding up may only be used for companies which are solvent.

The directors are required to swear a declaration of solvency stating that they have made a full enquiry into the company’s affairs and they have formed the opinion that the company will be able to pay its creditors in full, together with interest at the official rate, within a period not exceeding 12 months from the commencement of the winding up (s 89(1) IA 1986). The declaration must also contain a statement of the company’s assets and liabilities as at the latest practicable date before making the declaration.

Any director making a declaration of solvency who does not have reasonable grounds for their opinion is liable to a fine or imprisonment (s 89(4) IA 1986). If the debts are not actually paid in full within the specified period it will be presumed that the director did not have reasonable grounds for his opinion.

The members must then pass a special resolution to place the company into MVL and an ordinary resolution to appoint a liquidator. The winding up commences when the special resolution is passed (s 84(1) and s 86 IA 1986).

On a MVL, if the liquidator considers that the company will be unable to pay its debts, they must change the members’ winding up into a creditors’ voluntary liquidation.

Question 33

Creditors’ voluntary winding up (CVL)

Answer 33

This is the most common insolvency procedure and in 2019 almost 80% of all liquidations were CVLs. It is a form of insolvent liquidation commenced by resolution of the shareholders, but under the effective control of the creditors who can choose the liquidator. Where a directors’ declaration of solvency has not been made, the liquidation will be a creditors’ voluntary liquidation.

The procedure is for the shareholders to pass a special resolution to place the company into a CVL and an ordinary resolution to appoint a nominated liquidator.

Within 14 days of the special resolution being passed the directors of the company must ask the company’s creditors to either approve the nominated liquidator or put forward their own choice of liquidator. Where the creditors’ choice of liquidator differs from that of the company’s shareholders, the creditors’ nomination will take precedence.

The directors must also draw up a statement of the company’s affairs (setting out the company’s assets and liabilities) and send it to the company’s creditors.

Question 34

Role of the liquidator

Answer 34

As noted above, the appointment of a liquidator terminates the management powers of the company’s directors, and these powers are transferred to the liquidator together with their fiduciary duties, meaning that liquidators must act in good faith, avoid conflicts of interest and not make a secret profit.

The liquidator must be either a qualified Insolvency Practitioner (s 230 IA 1986) or the Official Receiver (appointed by the court in the short term) and acts as an officer of the court.

The liquidator in both a CVL and a compulsory liquidation have extensive statutory powers. The principal functions of a liquidator in a winding up by the court are:

• To secure and realise the assets of the company then distribute to the company’s creditors (s 143 IA 1986); and
• To take into their custody or under their control all the property of the company (s 144 IA 1986).

Question 35

Liquidator’s powers to manage the company

Answer 35

The liquidator’s powers to manage the company are set out in Part I to III Sch 4 IA 1986 and include the ability to:

• 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 of 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 that may be necessary to wind up the company’s affairs and to distribute its assets.
• Carry on the business of the company, but only to the extent that is necessary for the beneficial winding up of the company.
• Commence or defend court proceedings in the name of the company, for example to recover debts owed to it or dispute debts alleged to be owed by the company.
• Pay debts and compromise claims.

Question 36

Liquidator’s powers to avoid certain transactions

Answer 36

Liquidators have a duty to preserve the company’s property and to maximise the value of the company’s assets available for distribution. They are empowered to avoid certain antecedent transactions in order to maximise the amount of assets available for distribution to creditors as follows:

§ Disclaim onerous property (s178 IA 1986);

§ Apply to court to set aside a transaction at an undervalue (s238 IA 1986);

§ Apply to court to set aside a preference (s 239 IA 1986);

§ Apply to court to set aside, or vary the terms of, an extortionate credit transaction (s 244 IA 1986);

§ Claim that a floating charge created for no new, or inadequate, consideration is invalid (s 245 IA 1986);

§ Apply to court to set aside a transaction that will defraud creditors (s 423 IA 1986).

Note that many of these powers also apply to administrators.

Question 37

The statutory order of priority

Answer 37

In order to make a payment to creditors (known as a dividend), a liquidator will (and an administrator may) be required to distribute the assets of the company to its creditors in a specified order of priority in payment in accordance with complex rules. Inconveniently, these rules have no single source: they are found piecemeal in different parts of the IA 1986, the IR 2016 and general law.

The following (simplified) order of priority in payment summarises the cumulative effect of these rules. This order assumes that that there is a qualifying floating charge (QFC) granted on or after the Relevant Date (15 September 2003).

Administrators may also pay dividends to unsecured creditors if they have court permission to do so and the rules set out below will also apply to them. It should also be noted that the statutory order of distribution can be affected by priority or subordination agreements entered into by creditors under which one class of creditor agrees to rank behind another.

A summary of the statutory order of priority is set out below, followed by a more detailed explanation.

Summary of the statutory order of priority:

Liquidator’s fees and expenses of preserving and realising assets subject to fixed charges.

Amount due to fixed charge creditor out of the proceeds of selling assets subject to the fixed charge.

Other costs and expenses of the liquidation.

Preferential creditors (the first tier and then the secondary tier).

Creation of the prescribed part fund (if available) for unsecured creditors.

Amount due to creditors with floating charges.

Unsecured/trade creditors (including payment of the prescribed part).

Interest owed to unsecured creditors.

Shareholders.

Question 38

1. Fixed charge assets

Answer 38

1. Liquidator’s costs of preserving and realising assets subject to a fixed charge
2. Fixed charge creditors (in respect of assets subject to a fixed charge)

The proceeds of selling assets which are subject to a fixed charge (or mortgage) must first be used to pay off the debt secured by such charge (or mortgage). The proceeds will be paid net of the liquidator’s costs and associated fees of selling the assets (that is, net of sums falling into the first category of priority above eg estate agent fees in selling property).

If the proceeds are not sufficient to discharge the debt in full, then the creditor may be able to recover the balance lower down the order of priority depending on whether the same debt is secured by a floating charge or is an unsecured debt.

Question 39

3. Other costs and expenses of the liquidation

Answer 39

This includes all other costs and expenses of the liquidation, including the costs of selling assets secured by a floating charge and the costs and expenses incurred in pursuing litigation (such as actions in respect of wrongful trading or voidable transactions). Such litigation will require prior approval from preferential creditors and floating charge holders, or alternatively from the Court, otherwise the liquidator cannot claim the costs of litigation. The reason for this rule is that it is these creditors who will effectively pay the costs of litigation should it fail.

Question 40

4. Preferential debts (Schedule 6)

Answer 40

For insolvencies that commence on or after 1 December 2020, there will be two tiers of preferential creditors: a first and secondary tier. The first tier consists of the existing preferential creditors, the main category being employees for remuneration due in the 4 months before the ‘relevant date’ (generally the date of the winding up resolution or petition) but subject to a maximum of £800 per employee plus accrued holiday pay, and for certain contributions owing to an occupational pension scheme.

The secondary tier consists of Crown debts comprising (i) the PAYE and employee national insurance deductions made by companies from employee salaries and wages and (ii) the VAT they have received on supplies they have made and which they are then due to account to HMRC. Note that these Crown debts used to be preferential until the EA 2002 reforms came into force when they were removed from the list of preferential debts. The Government has now restored their preferential status.

Question 41

5. Prescribed part fund

Answer 41

The Enterprise Act 2002 introduced the “prescribed part” fund into the IA 1986 to increase the chance that unsecured creditors would get paid something in a liquidation. The idea is that some money is reserved for the unsecured creditors and does not flow into the pocket of floating charge holders. The prescribed part fund is sometimes referred to as the “ring fenced” fund and applies to realisations from floating charges created on or after 15 September 2003.

The prescribed part fund is calculated by reference to a certain percentage (the ‘prescribed part’) of the company’s ‘net property’. This is set aside (ring-fenced) for distribution to the company’s unsecured creditors - s. 176A. ‘Net property’ means the proceeds of selling property other than that which is subject to a fixed charge, after deduction of the liquidator’s expenses and any preferential debts.

The amount of the company’s net property that will be ring-fenced is 50% of the first £10,000 and 20% thereafter up to a maximum fund of £600,000 for floating charges created before 6 April 2020 and £800,000 for floating charges created on or after that date.This pot of money is reserved at this stage to be shared rateably among the unsecured creditors when they are paid (ie at step 7 below).

It should be noted that for this purpose, a floating charge holder who suffers a shortfall on floating charge realisations does not share in the prescribed part fund, although the shortfall does constitute an unsecured claim against the company.

Question 42

6. Floating charge creditors

Answer 42

After payment of the general expenses of the liquidation, paying preferential debts and dealing with the prescribed part, the liquidator then pays any remaining realisations from assets subject to floating charges to the floating charge holders themselves (according to the priority of their security, if there is more than one floating charge holder).

Question 43

7. Unsecured creditors

Answer 43

For example:

· ordinary trade creditors who have not been paid;

· secured creditors to the extent that the security is invalid or assets subject to the security have not realised sufficient funds to pay off the secured debt.

All the unsecured creditors rank and abate equally. This is known as the “pari passu” rule. For example, if a company has only two creditors (A and B) and creditor A has a claim against the company of 100 and creditor B has a claim against the company of 50 (making total claims of 150) but the assets available for distribution to the creditors are 75, creditor A will receive 50 and creditor B will receive 25.

Note that secured creditors who have not been paid in full from the realisation of assets subject to their security can only claim as unsecured creditors against realisations from unsecured assets, so they are not eligible to any payment from the prescribed part fund.

Question 44

9. The shareholders

Answer 44

The shareholders who participate in the equity of the company will rank last. However, their rights, as between themselves, will depend on the rights attributable to their particular class or classes of shares. This will be written into the Articles of Association. For example, preferential shareholders may have preferential rights to a return of their capital on a winding up in priority to ordinary shareholders.

It is clear that in most insolvent liquidations, the shareholders are unlikely to receive any value from their shares, since they are the last to be paid in the statutory order of priority.

The benefit of fixed charges is also clearly illustrated – fixed charge holders receive their value first and are therefore more likely to receive their money back in a liquidation.

Question 45

IVA - Overview

Answer 45

An IVA has many similarities to a company CVA. It is a contractual arrangement under which a debtor comes to an arrangement with their creditors eg to settle their debts by paying a proportion of the debts. It is a flexible procedure that can be tailored to a debtor’s circumstances. It usually requires the debtor to make funds available to their creditors out of their income or assets, or a combination of both.

If approved by the requisite percentage of creditors (see below), the IVA binds the debtor and all of their creditors to accept the terms of the IVA in settlement of their debt.

An authorised professional (usually an Insolvency Practitioner) supervises the debtor’s implementation and compliance with the terms of the IVA.

An IVA can last any length of time, but three to five years is common in practice.

Question 46

Setting up an IVA

Answer 46

The debtor drafts proposals setting out a statement of their affairs (eg full details of assets and liabilities) usually with the assistance of an Insolvency Practitioner who is known as a nominee at this stage.

The nominee submits a report to the court stating their opinion as to whether the arrangement has a reasonable prospect of being approved and implemented and whether a creditors’ meeting should be called.

A debtor can apply to the court for an interim order. If the court grants the order, it brings about a moratorium, freezing existing or proposed bankruptcy and other proceedings and legal process (including execution, landlord’s right of peaceable re-entry and/or distress for rent) against the debtor, without leave (in any such case) of the court. The interim order (and the moratorium) lasts 14 days which the court can extend.

If the nominee decides to call a creditors’ meeting, creditors holding more than 75% (by value) of the debt must vote to approve the terms of the IVA.

Question 47

Effect of approval of an IVA

Answer 47

If approved, the IVA binds the debtor and all of their creditors (except secured creditors unless they consent to the IVA).

The nominee becomes the supervisor of the IVA and its implementation. They can apply to court for directions and must report to the court periodically. If the debtor fails to comply with the terms of the IVA, the supervisor can usually petition for their bankruptcy.

At the end of the IVA, if the debtor’s payments into the IVA have not been sufficient to pay off their debts in full, the shortfall will usually be written off by the creditors.

Some advantages of an IVA include the following:

• it is an alternative to bankruptcy;
• it can bind all creditors (except secured creditors); and
• a moratorium is available if an interim order is made.

Some disadvantages of an IVA include the following: it may last longer than a bankruptcy eg where income payments are made over a number of years, and it can be an expensive process.

Question 48

Bankruptcy - petition grounds and requirements

Answer 48

Creditors’ Petition

A ground for the petition is that the debtor is unable/has no reasonable prospect to pay its petition debts.

The debt must be for a liquidated sum exceeding £5,000, generally unsecured, and the debtor must usually be domiciled or present in England and Wales.

Debtor’s Petition

The only ground for this petition is that the debtor is unable to pay its debts.

The petition must be accompanied by a statement of affairs setting out the debtors’ assets and liabilities.

Question 49

Bankruptcy - Inability to pay debts and bankruptcy order

Answer 49

The debtor’s inability to pay their debts is evidenced by:

• a statutory demand that has neither been satisfied within three weeks from service of that demand, nor set aside by the court; or
• an unsatisfied execution of a judgment or of another legal process.
• If a court is satisfied that the grounds for a petition and other requirements set out above have been met, the court has discretion to make a bankruptcy order. Upon the making of a bankruptcy order, either a trustee in bankruptcy (‘Trustee’) is appointed or the court will pass the bankruptcy file to the Official Receiver, a government body, who will become the Trustee until an alternative (if any) is appointed by the creditors. If there are insufficient assets, it may be difficult to persuade anyone other than the Official Receiver to become the Trustee.
• On the making of a bankruptcy order, the bankrupt (whilst undischarged) is prohibited from doing a number of things, including acting as a director or being involved in the management of a company, obtaining credit of over £500 without disclosing the bankruptcy, giving gifts and practising in certain professions. They are also deprived of ownership of their property except for their reasonable domestic needs.

Question 50

Trustee - powers and duties

Answer 50

The bankrupt’s estate vests in the Trustee immediately upon their appointment taking effect or the appointment of the Official Receiver. This means that the bankrupt will have to pass their assets (present and future) to the Trustee.

The Trustee has wide statutory powers to sell or otherwise deal with the assets in the estate and generally including the carrying on of the bankrupt’s business and the mortgaging of property as well as statutory duties.

The Trustee will collect in the assets (and may disclaim any onerous property or contracts), including those assets which may be available to swell the estate as a result of challenging certain fraudulent or undervalue transactions or preferences (see below). The Trustee will sell those assets and must distribute the estate in accordance with the statutory provisions. The Trustee will give notice to the creditors who have proved their debts, stating the amount of the sale proceeds of any assets, any deductions that have been made from these proceeds, and the amount of any dividend that they can expect to receive from the bankruptcy estate. The final distribution will take place when the Trustee has sold all the assets that it can, and distributed them in the order of priority set out below.

Question 51

Bankruptcy - order of priority of payments

Answer 51

The bankruptcy order of priority differs from the order of priority in corporate insolvencies and is as follows:

secured creditors (but limited to the value of the security itself and ranking with ordinary unsecured creditors for any excess amount owing);

expenses of the bankruptcy;

specially preferred creditors (training/apprenticeship fees);

preferential creditors (similar to those on corporate winding up);

ordinary unsecured creditors;

statutory interest;

debts of a spouse (must be provable but they are postponed to other creditors); and

finally, any surplus is payable to the bankrupt.

Question 52

Bankrupts’ Duties

Answer 52

A bankrupt has a number of duties to the Trustee. The bankrupt has to provide information and assistance to the Trustee to enable the Trustee to carry out their functions.

Section 333(1) IA86 states as follows:

“The bankrupt shall-

(a) give to a trustee such information as to his affairs;

(b) attend on the trustee at such times, and

(c) do all such other things,

as the trustee may for the purposes of carrying out his functions reasonably require.”

It is a criminal offence for the bankrupt to fail to comply with their obligations under s 333 IA86 and they could face imprisonment for up to two years and unlimited fines. Also, the bankrupt runs the risk of having their automatic discharge suspended (see below).

Question 53

Bankruptcy Discharge

Answer 53

Generally, a bankrupt is automatically discharged from bankruptcy after a maximum period of one year. Discharge means that the bankrupt is released from most of the bankruptcy debts and the personal restrictions eg acting as a director, obtaining credit etc mentioned above.

The Official Receiver or Trustee may apply for an order suspending the automatic discharge if the bankrupt fails to comply with their obligations under IA 1986.

The bankrupt may be discharged in less than a year if the Official Receiver or Trustee files a notice stating that the bankruptcy does not require investigation or stating that they have concluded any such investigation within the one year period.

Question 54

Bankruptcy Restriction Orders/Undertakings

Answer 54

The Secretary of State, or the Official Receiver acting on the Secretary of State’s direction, may apply to the court for a Bankruptcy Restriction Order (“BRO”) if the court considers it appropriate having regard to the conduct of the bankrupt (before or after the bankruptcy order).

Behaviour to be taken into account is listed in Schedule 4A IA86 and includes failure to keep records, entering into preferences or transactions at an undervalue, fraud and incurring a debt without reasonable expectation of being able to pay it. Generally, the application must be made within a year of the start of the bankruptcy.

A BRO will operate for a period of between two and 15 years. For the duration of the order, the bankrupt is unable to act as a director or obtain credit of more than £500 without disclosing that they are subject to a BRO.

Breach of a BRO is a criminal offence punishable by fine and/or imprisonment.

Instead of being subject to court process, a bankrupt can offer the Secretary of State a bankruptcy restriction undertaking (BRU) which, if accepted, will have the same effect as a BRO.