Unit 7 Insolvency in Companies

Question 1

What is corporate insolvency

Answer 1

A company is insolvent, in that it is deemed unable to pay its debts, when:
1. a creditor has served a statutory demand for an outstanding sum of £750 or more, and the company does not pay or come to an arrangement with the creditor within 21 days of service of the statutory demand;
2. a creditor has obtained judgment against the company, and has tried to enforce that judgment, but the debt still has not been paid in full or at all;
3. it can be proved to the court that the company is unable to pay its debts as they fall due (the ‘cash flow test’) (NOT CONCLUSIVE); or
4. it can be proved to the court that the company’s liabilities exceed its assets (the ‘balance sheet test’)(NOT CONCLUSIVE).

Question 2

What is liquidation

Answer 2

Liquidation/winding up = the process whereby the business stops trading, its assets are sold and the company ceases to exist.

When liquidation proceedings begin, a liquidator is appointed.

Question 3

Liquidation - compulsory liquidation

Answer 3

Commenced by a third party (in nearly all cases a creditor) presenting a winding up petition at court.

The most common ground on which the petitioner will seek compulsory liquidation is on the basis that the company is unable to pay its debts.

Unpaid creditors do not ordinarily have access to detailed, up- to- date financial information about the company. So, it is usually difficult for unpaid creditors to show that a company is unable to pay its debts.
Will usually prove a debtor’s insolvency by issuing a statutory demand and, if the statutory demand remains unpaid after three weeks, issuing a winding up petition against the company. Alternatively, they may obtain a judgment against the company, as the test of whether a company is insolvent is the inability to pay debts as and when they fall due.

Petitioner will be prevented from proceeding with a winding up petition if the company can show that there is a genuine and substantial dispute in relation to the money owed.

If the company indicates that it will be able to pay the debt within a reasonable period of time, the court may adjourn the hearing to a later date.

Question 4

Liquidation - creditors’ voluntary liquidation

Answer 4

Initiated by the company, through discussion and agreement between the company’s directors and shareholders, and the creditors then take over at an early stage.

Usually the directors will feel pressurised to enter into a CVL by the creditors. They will also be conscious of the risk of facing personal claims for misfeasance and fraudulent or wrongful trading if they continue to trade and then the company goes into liquidation.

Question 5

Liquidation - members’ voluntary liquidation

Answer 5

Only available if the company is solvent, and if, during an MVL, the liquidator realises that the company is insolvent, they must convert the MVL to a CVL.

Often used when companies are dormant, for example, where there is a group of companies and some of the companies within the group are no longer used. It is also common procedure when the directors in an owner- managed company all want to retire or cease trading.

For an MVL to take place, the directors must first swear a statutory declaration that the company is solvent.

Question 6

Liquidation - liquidators powers

Answer 6

(a) carrying on the company’s business;
(b) commencing and defending litigation on the company’s behalf;
(c) investigating the company’s past transactions;
(d) investigating the directors’ conduct;
(e) collecting and distributing the company’s assets;
(f) doing all that is necessary to facilitate the winding up of the company.

Question 7

Claims liquidators and administrators can bring - avoidance of certain floating charges

Answer 7

A charge is automatically void where, at the ‘relevant time’ before the onset of the company’s insolvency, a charge was granted without the company receiving fresh consideration in exchange for granting security.

The relevant time means:
* if the charge was created in favour of a person who is connected with the company, during the 2 years ending with the onset of insolvency; or
* if the charge was created in favour of any other person, during the 12 months prior to the onset of insolvency.

Person connected:
* a director or shadow director of the insolvent company; or
* someone who is, in effect, a close relative or business associate of a director or shadow director; or
* an associate of the company – which broadly means a company in the same group as the company or which is controlled by a director of the insolvent company.

If the floating charge was given to someone unconnected with the company, the company must have been insolvent at the time the floating charge was given or have become insolvent as a result.
If given to someone connected with the company, it is not necessary to show this.

Liquidator or administrator will write to the charge holder saying that they believe the charge is invalid. If the charge holder tries to enforce the charge, the liquidator or administrator will seek an injunction.

Question 8

Claims liquidators and administrators can bring - preferences

Answer 8

Can challenge a transaction where the company, at the relevant time, has given a preference to someone else.

Preference = where the company puts the other person in a better position, in the event that the company went into insolvent liquidation or administration, than they would have been in otherwise.

Relevant time =
* if the preference was given to a person who is connected with the company, during the 2 years ending with the onset of insolvency; or
* if the preference was given to any other person, during the 6 months ending with the onset of insolvency.

Company must have been insolvent at the time of the preference, or have become insolvent as a result of giving the preference.

If the preference is proven, the court may order the release of any security given by the company, the return of any property transferred as part of the transaction, or the payment of the proceeds of sale of property forming part of the transaction to the company.

Question 9

Claims liquidators and administrators can bring - transactions at an undervalue

Answer 9

Can challenge any transaction which the company has entered into at an undervalue at the relevant time.

Undervalue = where the company makes a gift to the other person, or enters into a transaction and receives consideration which is significantly lower in value than the consideration provided by the company.

Relevant time = during the 2 years ending with the onset of insolvency.

Company must have been insolvent at the time of the transaction, or have become insolvent as a result of the company entering into the transaction. Insolvency is presumed where the transaction was with a person connected to the company.

Defence = good faith, entered into transaction for the purpose of carrying on the business, and where, when the transaction was entered into, there were reasonable grounds for believing that it would benefit the company.

Question 10

Claims liquidators and administrators can bring - extortionate credit transactions

Answer 10

A liquidator or administrator has the power to challenge an extortionate credit transaction made in the 3 years ending with the day on which the company went into administration or liquidation.

Extortionate = it must require grossly exorbitant payments to be made, or must otherwise grossly contravene ordinary principles of fair dealing.

Claims are rare, because it is very difficult to prove.

Question 11

Claims liquidators and administrators can bring - transactions defrauding creditors

Answer 11

= a transaction at an undervalue which the company entered into in order to put assets beyond the reach of someone making a claim against it, or to prejudice the interests of that person in relation to any claim they might make.

Brought at the discretion of the court.
May be ordered to return any property which was the subject of the transaction to the company, or discharge any security that was given by the company as part of the transaction.

No time limit for bringing a claim.

Often difficult to show intention. Therefore, the claim is usually only made when the liquidator or administrator cannot bring a claim relating to a transaction at an undervalue because the time limit has expired (although the longer the passage of time, the longer such a claim can be to prove).

Question 12

Distributing a company’s assets during liquidation

Answer 12

Liquidators get unsecured creditors to fill in details of debt owed to them = proving the debt.
Small debts under 1k admitted more or less automatically.

Fixed charge holders receive money owed when asset sold.
Then order is:
(a) the expenses of the winding up (the fees payable to the liquidator and their professional advisers);
(b) preferential debts, which rank and abate equally (receive same percentage of the outstanding debt that they are owed);
(c) money which is the subject of floating charges, in order of priority; and
(d) unsecured creditors, who rank and abate equally.

Any money remaining is distributed to the shareholders.

Question 13

Preferential debts

Answer 13

Paid before all other unsecured creditors in insolvent liquidation.

Most common preferential debt is wages/ salaries of employees for work carried out in the four months immediately preceding the date of the winding up order, up to a maximum of £800 per employee. In addition, employees’ accrued holiday pay is a preferential debt.

HMRC is a secondary preferential creditor but only in relation to taxes which companies collect on HMRC’s behalf, such as PAYE and VAT.

Question 14

Ring fencing

Answer 14

= statutory procedure that sets aside a portion of the available money for floating charge holders (where the security was created on or after 15 September 2003) for the benefit of unsecured creditors.

The amount that should be set aside is:
* 50% of the first £10,000 of money received from the property which is subject to floating charges; and
* 20% of the remaining money
up to a limit of £800,000. Note that this limit was increased from £600,000 with effect from 6 April 2020. The previous limit of £600,000 still applies to any charges created before 6 April 2020, unless a floating charge created on or after 6 April 2020 ranks equally or in priority to the pre- April 2020 charge, in which case the limit of £800,000 will apply to both charge holders.

Question 15

6 alternatives to liquidation

Answer 15

(a) administration;
(b) company voluntary arrangements;
(c) schemes of arrangement;
(d) restructuring plans;
(e) a free- standing moratorium; or
(f) informal agreements with creditors

Question 16

Alternatives to liquidation - administration

Answer 16

Administrator (an independent insolvency practitioner) is appointed to run the company and make whatever changes are necessary to improve its financial performance. Alternatively, the administrator will aim to get the company into a position where it can be sold as a going concern.

There is a statutory moratorium - it is not possible for anyone to commence or continue with legal action against the company, enforce a judgment, or issue a winding up petition without the administrator’s consent.

Question 17

Alternatives to liquidation - administration - 2 ways of commencing administration

Answer 17

1. Court route - by court order, following an application to court and a court hearing.
   Court can grant order where it is satisfied that the company is likely to become unable to pay its debts and the order is likely to achieve the purpose of the administration.
2. Out- of- court route - involves the company, its directors or the holder of a qualifying floating charge, or even an unsecured creditor, filing certain documents at court.

Question 18

Alternatives to liquidation - administration - ending administration

Answer 18

Ends automatically one year from the date the administration took effect, but this can be extended.

It can also be ended earlier, including by application to the court if its objective has been achieved or if the administrator believes its objective cannot be achieved, or by application to the court by a creditor. The creditor may then present a winding up petition if that is the wish.

Question 19

Alternatives to liquidation - pre-pack administration

Answer 19

A pre- packaged administration is an arrangement whereby a company goes into administration and the administrator sells its assets and business straight away, often to the management of the insolvent company.

The sale is effectively agreed before the company appoints an administrator, and it is a perfectly legal way of securing a sale of the business as a going concern.

Question 20

Alternatives to liquidation - company voluntary arrangement

Answer 20

= a written agreement/statutory contract which binds all of the parties to it, as long as the statutory procedures are followed. The parties are usually the company and all of its creditors. In a CVA, the company’s creditors usually agree to wait longer to receive what they are owed, or accept payment of only part of the debt, or both.

Generally used when the company’s business is potentially fundamentally sound, but it is undergoing a temporary cash flow difficulty. Its aim is to prevent liquidation.

The proposals put forward for payment of creditors must be approved by:
* 75% or more in value of the company’s creditors; and
* 50% or more of non- connected creditors.

Question 21

Alternatives to liquidation - restructuring plan under CIGA 2020

Answer 21

Court-supervised and is an ‘arrangement’ or ‘compromise’ between the company and all of its secured and unsecured creditors and shareholders. Companies do not need to be insolvent to apply for a restructuring plan but they must have encountered or be likely to encounter financial difficulties.

Implementation of the plan involves two court hearings and creditors can make representations at the first hearing. At the second hearing, the court will decide whether to sanction the proposed plan.

Creditors and shareholders are divided into classes, and each class will be deemed to have approved the plan if 75% by value of that class vote in favour.

Cross-class cram down provision = enables a dissenting class of creditors to be ‘crammed down’ so that they cannot block otherwise viable plans, and it must be sanctioned by the court. The court will only sanction it where it is satisfied that no member of the dissenting classes would be any worse off under the plan than they would be if the court were not to sanction the plan.

Question 22

Alternatives to liquidation - moratorium under CIGA 2020

Answer 22

Company is protected from actions by creditors relating to pre-moratorium debts, but it must pay debts incurred during the moratorium in full.

Directors remain in control, but a qualified insolvency practitioner acts as an independent monitor who has oversight of the moratorium and can terminate it in certain circumstances.

Requirements:
- Company must be unable to pay its debts or likely to become unable to pay its debts.
- A moratorium is not possible if the company has already entered into a moratorium during the previous 12 months.
- Certain companies which are not eligible for the moratorium, including banks, often known as the financial services exception.
- Only available for English companies with no outstanding winding up petitions against them.

To obtain directors must file the relevant documents at court.

Certain debts are excluded from this payment holiday, including employees’ wages.

Moratorium lasts 20 business days beginning with the business day after the moratorium comes into force/the date of filing.

Can be extended for a further 20 business days.
Can be extended by the directors for a period of up to one year if the creditors who are not going to get paid because of the payment holiday consent to this.

Question 23

Options for secured creditors

Answer 23

May be able to appoint a receiver to take possession of the property which is the subject of the charge and deal with it for the benefit of the charge holder.

2 types:
1. Law of Property Act (LPA) receivers
Power to appoint the receiver is usually in the charge document.
To sell property.
2. Administrative receivers
Appointed by floating charge holders.

Question 24

Personal Insolvency - When is a person insolvent?

Answer 24

When:
* A debt is payable now but the debtor does not currently have enough money to pay; or
* A debt is payable in the future and there is no reasonable prospect that the individual will be able to pay.

Question 25

Personal insolvency - Proving insolvency

Answer 25

1. By serving a statutory demand on the debtor for a liquidated sum of £5,000 or more, and waiting three weeks to see whether the debtor pays or applies to court to set aside the statutory demand.
2. By serving a statutory demand on the debtor in respect of a future liability to pay a debt of £5,000 or more, and waiting three weeks to see whether the debtor either:
   a. shows a reasonable prospect of being able to pay the sum when it falls due; or
   b. applies to court to set aside the statutory demand.
3. By obtaining a court judgment for a debt of £5,000 or more, and attempting execution of the judgment without success.

Question 26

Personal Insolvency - Bankruptcy - What is bankruptcy?

Answer 26

= process whereby the debtor’s assets pass to a trustee in bankruptcy, whose job it is to pay as many of the debts as possible to the debtor’s creditors.

Question 27

Personal Insolvency - Bankruptcy - The bankruptcy procedure

Answer 27

Bankruptcy begins by a creditor presenting a petition at court, or by the debtor applying for their own bankruptcy online.

Question 28

Personal Insolvency - Bankruptcy - The Official Receiver and the trustee in bankruptcy

Answer 28

Once a bankruptcy order has been made, the Official Receiver (OR) acts as the trustee in bankruptcy and takes control of the bankrupt’s assets.

OR is an officer of the court.

Possible for the creditors to appoint a private trustee in bankruptcy, but this will only happen when the bankrupt has enough assets to fund the private trustee’s fees.

Question 29

Personal Insolvency - Bankruptcy - The bankrupt’s property

Answer 29

The bankrupt is permitted to keep some assets which are needed for day- to- day living, such as items they need for work (the ‘tools of their trade’) and everyday household items such as clothing and furniture.

If of high value, the trustee can sell them and replace them with a cheaper alternative.

Entitled to salary to meet reasonable needs.
If more than what needed can enter into income payments agreement (‘IPA’) to meet their liabilities.
If can’t agree on amount then court decides - income payments order (‘IPO’).

Question 30

Personal Insolvency - Bankruptcy - The bankrupt’s home

Answer 30

If someone else has a legal or equitable interest in the house, or a right of occupation, the bankrupt cannot be evicted straight away and the trustee needs a court order to sell the house.

Court considers all relevant circumstances.

After 1 year of bankruptcy, the creditors’ interests outweigh those of anyone else living in the house, unless the circumstances are exceptional.

3 years after the bankruptcy order, ownership of the home transfers back to the bankrupt, unless the trustee has:
(a) sold the property;
(b) applied for an order for sale or possession or a charging order over the house; or
(c) entered into an agreement with the bankrupt regarding the home.

Question 31

Personal Insolvency - Bankruptcy - Preserving and increasing the bankrupt’s assets

Answer 31

Trustee can choose to:
(a) disclaim onerous property;
(b) apply to set aside transactions at an undervalue;
(c) apply to set aside preferences;
(d) apply to set aside transactions defrauding creditors; and
(e) avoid extortionate credit transactions

Question 32

Personal Insolvency - Bankruptcy - Preserving and increasing the bankrupt’s assets - Disclaiming onerous property

Answer 32

E.g. unprofitable contracts, land that has the burden of an onerous covenant or a lease which does not have a capital value to be realised for the creditors’ benefit.

Bankrupt’s rights and liabilities for the onerous property come to an end and the trustee is discharged from personal responsibility for the property.

If anyone suffers loss they are an unsecured creditor in bankruptcy.

Question 33

Personal Insolvency - Bankruptcy - Preserving and increasing the bankrupt’s assets - Transactions at an undervalue

Answer 33

Can investigate transactions during the 5 years prior to the presentation of the bankruptcy petition.

Does not have to show that the bankrupt was insolvent at the time of the transaction or as a result of the transaction, unless the transaction was more than two years before the petition.

If transaction with an ‘associate’ and 2+ years prior to petition = rebuttable presumption that insolvent at time of transaction.

Question 34

Personal Insolvency - Bankruptcy - Preserving and increasing the bankrupt’s assets - Preferences

Answer 34

Where an arrangement places a creditor, surety or guarantor in a better position than they would otherwise have been in on bankruptcy, and the debtor intended to do this.

If associate = rebuttable presumption of intention to prefer. Can challenge within 2 years of petition.

Can challenge any potential preferences within the six months prior of the bankruptcy petition.

Bankrupt must have been insolvent at the time of the preference, or must have become insolvent as a result of it.

Question 35

Personal Insolvency - Bankruptcy - Distribution of assets

Answer 35

If the sale of the charged assets does not realise enough money to pay the secured creditor(s) they will join the unsecured creditors.

Distribution order for trustee:
1. The costs of the bankruptcy.
2. Preferential debts (salary of employees for work carried out in the 4 months preceding the date of the bankruptcy, max £800, plus accrued holiday pay)
3. Ordinary unsecured creditors.
4. Postponed creditors, who are the bankrupt’s spouse or civil partner.
In each category rank and debate equally.

Question 36

Personal Insolvency - Bankruptcy - Restrictions on bankrupts - Business restrictions

Answer 36

Bankrupts are allowed to keep items they need for work (the ‘tools of their trade’) and a vehicle if essential.
Criminal offence for a bankrupt to obtain credit of more than £500 without disclosing their bankruptcy.

The bankrupt cannot:
* act as a director of a company
* be involved in the management, promotion or formation of a company, unless the court grants permission
* trade under a different name from the name in which the bankruptcy order was made, without disclosing to anyone they trade with that they are an undischarged bankrupt; or
* continue in partnership, unless the partnership agreement varies the default position in the Partnership Act 1890, which is that the bankrupt will automatically cease to be a partner when they are made bankrupt.

Question 37

Personal Insolvency - Bankruptcy - Restrictions on bankrupts - personal restrictions

Answer 37

Undischarged bankrupts cannot obtain credit of more than £500 without informing the lender.

Cannot practise as a solicitor without the leave of the Solicitors’ Regulation Authority, and there are similar restrictions for other professions.

Question 38

Personal Insolvency - Bankruptcy - Restrictions on bankrupts - Bankruptcy restriction orders and undertakings

Answer 38

Made by the court and last between 2 and 15 years.

Instead, the bankrupt could agree to a bankruptcy restriction undertaking (‘BRU’) instead, which is an agreement having the same effect as a BRO.

(restrictions as above)

Question 39

Alternatives to bankruptcy - IVA

Answer 39

A binding agreement between unsecured creditors, setting out how much each creditor will receive from the bankrupt in settlement of their debts.

Debtor may seek one to avoid bankruptcy or trustee during.

Need help of an insolvency practitioner (nominee).

Procedure:
- Debtor makes statement of affairs.
- Apply to court for an interim order to obtain a moratorium (usually in force for 14 days).
- Nominee prepares report for court stating proposals made.
- Proposal approved if 75% or more of the creditors in value of which at least 50% in value are not associates of the debtor agree.
- If don’t comply or proposals based on misleading info, then can petition for the debtors bankruptcy.

Question 40

Alternatives to bankruptcy - The Straightforward Consumer IVA Protocol (‘the Protocol’) and Negotiation with creditors

Answer 40

• The Straightforward Consumer IVA Protocol (‘the Protocol’)
  Approved by the British Bankers’ Association. Voluntary.
  Aims to balance the need for the consumer to be free of debt with the creditors’ need to recoup as much as possible.
  Contains standard terms.
• Negotiation with creditors
  To enter into formal arrangement.

Question 41

Alternatives to bankruptcy - Debt relief orders

Answer 41

Apply online.
Only for debtors whose assets and liabilities are low in value.

Not available if:
(a) has total unsecured liabilities exceeding £30,000;
(b) has total gross assets exceeding £2,000;
(c) has a car worth £2,000 or more (unless it has been adapted because the debtor has a disability);
(d) has disposable income in excess of £75 per month, after deducting normal household expenditure;
(e) has been subject to a DRO in the preceding six years; or
(f) is subject to another, formal insolvency procedure.
(g) owns their own home.

If accepted, debtor protected from enforcement action.

Same restrictions apply to them as to a bankrupty. May last up to 15 years.

Question 42

Alternatives to bankruptcy - Debt Respite Scheme (‘Breathing Space’)

Answer 42

1. A standard breathing space
   Available to any client with problem debt.
   Gives them legal protection from creditor action for up to 60 days (a moratorium).
2. A mental health crisis breathing space
   Only available to a client who is receiving mental health crisis treatment.
   Some stronger protections than the standard.
   Lasts as long as the client’s mental health crisis treatment, plus 30 days.