A guide to corporate insolvency

What needs to be done and in what order, from understanding whether a formal insolvency procedure is an option for you, to how to file for one of the forms of insolvency and what happens after that.

1. Introduction to corporate insolvency

Insolvency legislation

The law relating to corporate insolvency in England and Wales is primarily found in the Insolvency Act 1986 and the Insolvency Rules 1986.

In Scotland, the legislation for corporate failure contains elements of the Insolvency Act 1986 and the Bankruptcy (Scotland) Act 1985. The primary legislation for Northern Ireland is the Insolvency (Northern Ireland) Order 1989.

When a company is considered to be insolvent

Typically when a company is ‘unable to pay its debts’ it is considered to be insolvent.

In the Insolvency Act 1986 two basic tests are described to help determine when a company is insolvent:

  • the cash flow test deems that a company is insolvent if it currently, or will in the future, be unable to pay its debts when they fall due
  • the balance sheet test deems a company is unable to pay its debts if the value of the company’s assets is less than the amount of its liabilities. This test also takes into account contingent and prospective liabilities

If there is enough evidence to prove that a company fails either one of these tests then it is deemed insolvent, as it does not have enough assets to cover its debts or cannot pay its debts on time.

Insolvency processes

There are 5 main categories of insolvency procedure. The first 2 concern a company that will not be resurrected and will ultimately be dissolved. The final 3 provide potential for the rescue of the company or its business. They are:

  • Compulsory liquidation (CWU)
  • Creditors’ voluntary liquidation (CVL)
  • Administration (ADM)
  • Administrative receivership (ADR)
  • Company Voluntary Arrangement (CVA)

In addition, for solvent companies that are to be wound up and capital returned to creditors, the legislation provides for a solvent liquidation, called a members’ voluntary liquidation (MVL).

The difference between rescuing the company and rescuing the business

Rescuing a company entity itself through the insolvency process is usually done through a CVA, while rescuing the business is usually done through an administration with a licensed insolvency practitioner as administrator who negotiates the sale of the business and its assets to a company.

A CVA is often preceded by an administration. This is because an order of administration will protect the company with a moratorium while it is being rescued through a CVA. A moratorium in the CVA procedure is also available for many small companies under an amendment to the insolvency legislation in 2000.

Alternatively, a rescue of the business may be achieved through an insolvency process where an insolvency practitioner negotiates the sale of the business and its assets.

In this situation, the business and its assets will usually be sold to a new company. The principal difference is that the directors remain in control of the management in a CVA whereas, in administration, the administrator replaces the management, acting as an agent for the company (although he or she can retain the directors to assist).

2. Liquidation

Liquidation is an insolvency process where an Official Receiver or insolvency practitioner (the liquidator) is appointed to realise all assets of the company and distribute them in statutory order to all the creditors.

Introduction to the liquidation process

If a business is insolvent and does not have enough money to pay all of its debts, there is sometimes no other appropriate course of action than for the company to be put into liquidation.

Liquidation is a terminal process and ultimately means the end of a company, although there have been occasions where an insolvency that started as a liquidation has subsequently been converted to a rescue procedure when further information came to light.

There are 2 principal types of insolvent liquidation: compulsory liquidation and creditors’ voluntary liquidation. In addition, a members’ voluntary liquidation can be used to wind up a solvent company. In either case, once a company has been put into liquidation it is very unusual for the company to be resurrected or salvaged.

The liquidator must be a licensed insolvency practitioner and he or she becomes agent for the company. The liquidator is the person who is charged with the winding up of a company and the realisation of its assets for the benefit of its creditors.

Compulsory liquidation

Compulsory liquidation is the process which occurs after the court makes an order to have a company wound up.

This occurs after a creditor petitions the insolvency court with an unpaid debt of £750 or more because the company is unable to pay its debts, or is balance sheet insolvent and the court makes an order to have a company wound-up. Sometimes a petition to wind up may be issued by the Secretary of State (through the Official Receiver) on the basis that it is in the public interest that a company be wound up – eg because it is a vehicle for fraud. The directors may also petition for compulsory liquidation which can be cheaper than paying for a creditors’ voluntary liquidation.

Voluntary liquidation

Voluntary liquidation is the process which occurs after the directors or shareholders of a company agree that the company should be wound up. It is not necessary that the company be insolvent before petitioning for voluntary liquidation.

There are 2 types of voluntary liquidation:

  • members’ voluntary liquidation (MVL)
  • creditors’ voluntary liquidation (CVL)

A members’ voluntary liquidation occurs if the company is able to pays its debts within 12 months (solvent) and the directors swear a statutory declaration of solvency declaring that.

A creditors’ voluntary liquidation occurs when the directors do not swear a statutory declaration of solvency. In this case, a meeting of creditors is usually held on the same day as the shareholders’ meeting formally deciding to wind up the company. The insolvency practitioner chosen by the members convenes the creditors’ meeting which is chaired by a director, but the vote of the creditors determines which insolvency practitioner is the liquidator. The creditors also vote for the basis of remuneration of the liquidator.

Members’ voluntary liquidation notices

As part of the process of a members’ voluntary liquidation, 5 different statutory notices are published in The Gazette.

The 5 different notices are usually published at different stages in the members’ voluntary liquidation:

  • Appointment of Liquidator
  • Resolution
  • Annual Liquidation Meeting
  • Notice to Creditors
  • Final Meeting

Creditors’ voluntary liquidation notices

As part of the process of a creditors’ voluntary liquidation, 6 different statutory notices are published in The Gazette – and this is usually managed by the insolvency practitioner.

The 6 different types of notices are usually published at different stages in the creditors’ voluntary liquidation process:

  • Meeting of Creditors
  • Appointment of Liquidator
  • Resolution
  • Annual Liquidation Meeting
  • Notice to Creditors
  • Final Meeting

3. Administration

Introduction to the administration process

Administration is a more rescue-oriented insolvency process, and occurs when a company asks an ‘administrator’ to come in to try to keep the company going, or a lender seeks the appointment of an administrator to rescue value.

The administrator has the power to do anything necessary or expedient for the management of the business, property and affairs of the company to which they have been appointed.

The cheapest and quickest way of entering administration is for the company, its directors or a secured creditor to appoint an administrator.

However, if the administration is complex, because there are overseas assets for example, the company, its directors or a secured creditor must apply to the court to appoint one.

Administration can only be considered if it will achieve one of the following results which are to be considered sequentially:

  • to promote the rescue of a company or any suitable part of a company (i.e. the corporate entity – this is rare)
  • to achieve a better result for the company’s creditors as a whole than would be likely if the company were wound up (without first being in administration)
  • to realise company property to enable a distribution to one or more preferential or secured creditors

It is common for the administration process to last up to at least a year. If the company cannot come out of administration and resume trading, it will be dissolved if there can be no distribution for unsecured creditors, or may be liquidated so that a liquidator can continue investigations and bring claims or realise and distribute further assets to unsecured creditors.

It’s important to note that, in relation to floating charge created after 15 September 2003, realisations from such a charge are a ‘prescribed part’ of the company’s net property that must be made available for the satisfaction of unsecured debts (to a maximum of £600,000).

Three ways to appoint an administrator

An administrator is appointed to a company as a temporary measure. This usually lasts no more than a year.

An administrator must be a licensed insolvency practitioner and can be appointed by the court, a floating charge holder, the company, or its directors.

There are 3 ways to appoint an administrator:

  • by court order on the application of the company or its directors or one or more creditors of the company or a combination of them
  • by the holder of a floating charge filing a notice at court (Form 2.6B)
  • by the company or its directors filing a notice at court (Forms 2.9B or 2.10B)

Notice must be given to a petitioner if there is a winding up petition on foot and the out-of-court process cannot then be used.

In order for an administrator to be appointed to a company, the company must provide evidence to the court that one of 3 statutory purposes is likely to be achieved:

  • to rescue the company as a going concern; failing which
  • to achieve a better return for creditors as a whole than would be likely if the company were wound-up without having been in administration; failing which
  • to realise property in order to make a distribution to one or more secured or preferential creditors

After the appointment of an administrator

Once a company is placed into administration, no creditor can take action against the company without the administrator’s agreement or court’s permission.

After being appointed to the company, the administrator’s role is to take over and manage the day-to-day activity of the company.

It is the responsibility of the administrator to report to the creditors within 8 weeks of appointment (administrator’s proposals) and set out what has been done so far and the plan going forward – including proposals as to how the purpose will be achieved and present them to creditors to vote on.

Administration notices

As part of the administration process, 3 different statutory are published in The Gazette – and this is usually managed by the insolvency practitioner.

The 3 different notices are usually published at different stages of the administration process:

  • Appointment of Administrators
  • Meeting of Creditors
  • Notice to Members

4. Pre-packaged administration

Pre-packaged administration (‘pre-pack’) is where the sale of the business has been arranged prior to the administration which is then entered into for the administrator to effect the sale.

Pre-packaged administration is considered to be a good way of preserving value for a business and its creditors.

For example, when a business enters into traditional insolvency, it is likely to experience disruption. It may even cease operation and stakeholders could suffer losses.

Pre-packaged administration is used as an accelerated disposal process.

The goal of pre-packaged administration is to allow for a smooth transition for the survival of a business. It is also used to preserve the value of a business, ensure enhanced realisations for its creditors (from the sale proceeds) and rescue jobs (although this is not a statutory administration aim).

In the situation where a company has entered into pre-packaged administration, an insolvency practitioner will assist the company before its sale.

The insolvency practitioner should test the market as thoroughly as possible and obtain the best deal for creditors. They must give good reason if they do not do that (eg urgency, destruction of value) and a thorough audit trail will be visible to creditors through the subsequent compulsory report under SIP16 in which the insolvency practitioner must provide prescribed information. It is important to consider the exit from administration of the company, which may be by dissolution if there will be no dividend for unsecured creditors. Creditors may prefer to seek a liquidation exit to enable claims to be brought against the directors if any are available. The pre-pack sale itself is merely the realisation of the best price for the business.

5. Administrative receivership

When a company borrows money, the company or organisation that lends the money often asks for some security over the company’s assets. This type of lender is called a secured creditor (fixed or floating charge holder).

In the case of a company going into administrative receivership, control of the company is handed over to an administrative receiver, who looks to sell the company’s assets so that the appointing lender can recover money owed to them.

Administrative receivership is different to administration. It is a process initiated by secured creditors who have lost faith in a company’s ability to repay its debts. The administrative receiver owes a duty only to that lender and not to unsecured creditors as a whole – as the appointment holder in administration does.

Unsecured creditors cannot begin the administrative receivership process. They can, however, begin the administration process (as described in section 3).

Administrative receivership was virtually abolished by the Enterprise Act 2002. A holder of a floating charge created after 15 September 2003 may not appoint an administrative receiver of the company with a few exceptions. Instead the holder of a floating charge may appoint an administrator. This section is relevant to such administrative receiverships.

6. Company voluntary arrangement (CVA)

A CVA is an insolvency procedure that allows a company to agree with its creditors about how a company’s debts should be dealt with.

A CVA can be set up when a company is in liquidation or in administration, as well as at any other time. It can be proposed by:

  • the administrator, where the company is in administration
  • the liquidator, when the company is being wound up
  • the directors

A CVA cannot be proposed by creditors or shareholders. It is, in effect, a contract between the company and its creditors, proposed by the company.

When a CVA is proposed, an insolvency practitioner (who acts as the nominee) must report to the court on whether a meeting between creditors and shareholders should be held.

The meeting between creditors and shareholders is to decide whether the CVA should be put forward.

If the meeting of creditors and shareholders’ approves a voluntary arrangement, the nominee (or other insolvency practitioner) becomes the arrangement’s supervisor.

Once the CVA has been concluded and its terms adhered to, the company’s liability to its creditors is cleared. The company can continue trading during the CVA under supervision and afterwards without.

The directors remain in managerial control unlike in administration where that function is carried out by the administrator even if they retain the directors or some of them to assist.