2020-07-21
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Insolvency definition and FAQs

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Posted by Elizabeth Taylor on 21 July 2020

Elizabeth Taylor - Insolvency Lawyer
Elizabeth Taylor Consultant

How do I tell if my company is insolvent?

Insolvency is not defined under the Insolvency Act 1986. However, a company is deemed to be insolvent if its liabilities exceed its assets (the balance sheet test) or it cannot pay its debts as and when they fall due (the cash flow test). A company is insolvent if it satisfies one or other of these tests.

What is a winding up petition?

A winding-up petition is an application the court for a winding up order to be made on the grounds that the company is insolvent and unable to pay its debts. It can be presented by a creditor or the company itself.

What is the difference between a liquidation and an administration?

The role of a liquidator is to realise all the company's assets and divide the proceeds by way of dividend amongst the company's creditors in the prescribed order of priority. It is essentially a burial procedure.  

Administration is intended to be a rescue procedure. A moratorium is created, which prevents any creditor from enforcing its rights during the course of the administration, and the administrator seeks to achieve one of three prescribed statutory purposes. These are:

  1. Rescuing the company as a going concern;
  2. Achieving a better result for creditors as a whole than would be likely in a liquidation; and
  3. Realising property to make a distribution to one or more secured or preferential creditors.

Liquidation results in an immediate cessation of trade, whereas an administrator will sometimes continue to trade the company while he seeks to achieve one of the above purposes.

What is a CVA?

A company voluntary arrangement is a statutory contract between a company and its creditors whereby a company proposes to reschedule its liabilities to creditors by paying in part or in full over an extended period. A company voluntary arrangement must be approved by 75% (by value) of the creditors who vote at the meeting provided that those who vote against it don't represent more than 50% of the unconnected creditors. If the company voluntary arrangement is approved, it binds all creditors including those who opposed it but any creditor who believes that it has been unfairly prejudiced by the company voluntary arrangement can apply to the court to challenge it.

Who can start insolvency proceedings?

Administration

Administrators can be appointed using an out of court procedure by the company, its directors or the holder of a Qualifying Floating Charge (QFC). A qualifying floating charge holder is a lender who holds a debenture over substantially all the company's assets.

It is also possible to make an application to the court for an administration order. The application can be made by one or more creditors, the company, the directors or in limited circumstances the holder of a QFC.

Liquidation    

Liquidation is also known as winding up. A company can enter creditors' voluntary liquidation by convening meetings of its members of creditors and passing resolutions for the company to be wound up and the appointment of a liquidator.

A winding up order can also be made by the court on the petition of one or more creditors, or the company itself.

A Company Voluntary Arrangement (CVA)

A CVA is commenced by convening meetings of the company's members and creditors who then vote on and approve the company's proposals.

Bankruptcy

A creditor can present a bankruptcy petition against an individual in respect of a debt of £5,000 or more. If satisfied that the debt is not disputed the court will make a bankruptcy order.

An individual can make themselves bankrupt by making an online application to an adjudicator. The adjudicator is a government official who sits within the Department for Business, Energy and Industrial Strategy.

I'm a director – do I have personal liability for company debts?

As a general rule, the answer to this question is no. However, there are limited circumstances in which a director can be liable for the company's debts as follows:  

  1. If satisfied that the company has been set up for fraudulent purposes or as a sham, the courts are occasionally willing to "pierce the corporate veil" and find directors liable for the debts of the company.
  2.  Once a company has gone into liquidation or administration the liquidator or administrator can bring proceedings against directors for misfeasance or wrongful/fraudulent trading in which they will seek damages or compensation for losses caused to the company as a result of the conduct of the directors prior to it entering a formal insolvency process.
  3.  When should I stop trading if I think that my company's finances or cashflow have deteriorated?

Directors owe a duty to the company to act in the company's best interests, and therefore if the directors have good reason to believe that the finances can be improved, they should document their plans and do their best to implement them.

If on the other hand, they believe that the company cannot trade out of its difficulties, the directors' primary duties become owed to the company's creditors, and they should take every step to minimise loss to creditors which could involve ceasing to trade.

Any decision to trade on should be carefully documented, and professional advice sought. Failure to take these steps could result in a liability for wrongful trading if the company ultimately goes into liquidation or administration.  

What responsibilities do I owe to the company if administrators/liquidators have been appointed?

Directors remain in office after a company enters administration or liquidation. 

However, in a compulsory liquidation, the directors lose their powers to control the company's affairs or act in the company's name when the winding-up order is made. In a creditors' voluntary liquidation, the same applies when a liquidator is appointed. In administration, a director may not exercise any management power without the consent of the administrator.

Directors are under a statutory duty to co-operate with the insolvency office holder, to deliver up any books, papers and records in his possession and to provide such information as is requested regarding the company's business, affairs and dealings.

The directors also retain all their statutory duties to the company as set out in Section 171 – 177 Companies Act 2006.

Can I buy my insolvent company's business from the liquidator or administrator?

The liquidator or administrator has a duty to sell the business and/or assets of the company for the best possible price, and he will take steps to market the business and assets in order to comply with this duty. There is nothing to prevent the former director(s) from making an offer and ultimately purchasing the business or assets.

Following a pre-pack, can I re-use the old company name or trading style?

There are restrictions of the re-use of company names when a company goes into liquidation. Breach of the relevant rules is a criminal offence, and anyone who was a director of the insolvent company and the purchaser becomes personally liable for the debts of the purchaser.

A pre-pack sale is a sale by an administrator (as distinct from a liquidator) which is negotiated prior to the company entering administration and completed on the date of administration. The restrictions on the re-use of company names do not apply in administrations. 

However, when the purpose of an administration has been fulfilled, it is common for the company to be placed into liquidation, and at this point, the restrictions apply.

There are exceptions to the general prohibition, and it is therefore prudent for a purchaser to take advice on complying with these when buying the business and/or assets from an administrator if it is intended to use the same or similar name to that of the insolvent company.

Are shareholders liable for any company debt?

No. In administration and liquidation, shareholders are only liable to pay the balance of any unpaid share capital.

What is wrongful trading?

In order to be found liable for wrongful trading, the court must make a finding that the director continued to trade the company after the point that he or she ought to have concluded that the company could not avoid going into insolvent liquidation or administration and in so doing the director caused loss to the creditors. If a director is found liable, the court can order the director to compensate the company. 

The level of compensation is calculated by ascertaining the balance sheet position at the date the company ought to have ceased trading and comparing it with the balance sheet position as at the date the company actually ceased trading. Broadly speaking the increase in the deficit position is the sum the court is likely to order the director to pay.

What is fraudulent trading?

Fraudulent trading is trading with the deliberate intention of defrauding creditors. As such, it is necessary to prove dishonesty. Unlike wrongful trading, anyone who was knowingly a party to the carrying on of business in this way can be found liable, not just the directors. Like wrongful trading, the court can order the respondent to compensate the company. Proceedings can be brought by a liquidator or administrator. Fraudulent trading is also a criminal offence, so criminal proceedings can be commenced without the company entering any formal insolvency process.

What is a preference?

A preference occurs where a company makes payment to a creditor within six months or two years depending on the circumstances) of the onset of insolvency and in doing so is influenced by the desire to put that creditor in a better position than he would otherwise be in the event of the company going into liquidation. The company must have been insolvent at the time or become so as a consequence. 

Where the court is satisfied that a preference has occurred, it can order the creditor to repay the amount it received or make such order as it thinks fit for restoring the position to what it would have been had the payment not been made. Corresponding provisions apply in respect of bankruptcy.

What is a transaction at undervalue?

A transaction at undervalue (TUV) occurs where a company makes a gift or enters into a transaction where the consideration it receives is significantly less than the value of the consideration it gave. The transaction must have occurred within two years of the onset of insolvency, and the company must have been insolvent at the time or become so as a consequence. If satisfied that a TUV has occurred the court can make such order as it thinks fit for restoring the position to what it would have been had the transaction not been entered into. Corresponding provisions apply in the case of bankruptcy where the transaction occurred up to 5 years prior to the commencement of the bankruptcy.

I am a director of a company in liquidation, do I still need to file annual accounts and confirmation statements?

No. When a winding-up order is made, or a liquidator is appointed in a creditors' voluntary liquidation, the directors lose their powers to control the affairs of the company or act in the name of the company, and as such, they are not required to file any documents at Companies House.

Can I resign as a director of an insolvent company?

Prior to the company entering a formal insolvency process, the directors have the power to resign. However, once a company becomes insolvent, the directors have a duty to act in the best interests of the creditors and resigning is likely to amount to a breach of that duty which could result in personal liability and disqualification from acting as company director. Instead of resigning a director should remain in office, seek professional advice and act accordingly.

I have received a statutory demand, what should I do?

If you are an individual, you have a period of 21 days from receipt of the demand to pay the debt failing which you will be deemed to be insolvent and the creditor who served the demand is entitled to issue a bankruptcy petition against you. If you dispute the debt, you have a period of 18 days from receipt of the demand to make an application to the court to have the demand set aside.

If you are a company, you have a period of 21 days from receipt of the demand to pay the debt failing which you will be deemed to be insolvent and the creditor who served the demand is entitled to issue a winding up petition against you. There is no procedure for applying to set the demand aside if the debt is disputed. Rather, the company must seek an injunction against the creditor to prevent presentation of a winding up petition.

I supply goods/services to a company in financial difficulty, can I protect myself by obtaining security?

If you supply fresh goods or services to a company you believe to be in financial difficulty on terms that do not require immediate payment or payment upfront, you can take security over the company's assets to secure payment of the debt. However, to the extent that the security purports to include any pre-existing debt, if the company subsequently enters a formal insolvency procedure, the liquidator or administrator is likely to challenge the security on the ground that it contravenes section 239 (preference), or section 245 (invalid floating charge).

What does ROT stand for? 

ROT stands for retention of title. A ROT clause in a contract provides that title to the goods supplied remains with the supplier until the goods have been paid for. If a company goes into liquidation before payment is made, the supplier is entitled to demand the return of its goods from the liquidator. However, where the company enters administration, a moratorium comes into force which prevents a supplier from enforcing its ROT clause without the consent of the administrator or the court.

For a ROT clause to be valid, it must be validly incorporated into the contract, and the supplier must be able to identify its goods by reference to invoices and or delivery notes. Problems can arise where the goods have been incorporated by the customer into its own products such that they cannot be returned.

I advised a company which is now in liquidation. The liquidator/administrator is asking to see my file of papers? Do I have to provide it to them even though I owe my client a duty of confidentiality?

A liquidator/administrator has a duty to investigate the causes of the company's failure and the conduct of its directors. To facilitate the office holder's compliance with this duty, section 236 of the Insolvency Act 1986 provides a mechanism for the office holder to apply to the court for an order requiring. 

  1. a person known or suspected to have in his possession any property of the company, and
  2. any person whom the court thinks capable of giving information concerning the promotion, formation, business, dealings, affairs or property of the company

to appear before the court and provide any books, papers or other records in his possession or under his control relating to the company.

Prior to making such an application, the office holder will ask for voluntary disclosure. If you fail to give voluntary disclosure and the court subsequently makes an order for disclosure, you could be ordered to pay the costs of the application.

Client confidentiality is not of itself a ground to object to compliance with a section 236 request/order. 

The legal privilege may provide a defence to a section 236 request, but this will not be the case where the insolvent client would have been obliged to disclose the information/documentation to the office holder or where the lawyer would have been under an obligation to disclose the information or documentation to the insolvent client

I am the former solicitor of a bankrupt individual; the trustee in bankruptcy has asked to see my file. Do I have to comply? 

Although Section 366 of the Insolvency Act 1986 contains provisions which are virtually identical to those of Section 236, a bankrupt's right to privilege is not an asset that vests in a trustee in bankruptcy and there is no requirement in the IA86 for a bankrupt to waive that privilege. Privilege depends on the nature of the information contained in the documents held by the solicitor, not the documents themselves and therefore the extent to which a solicitor is required to comply with a section 366 request will depend upon the nature of the information contained within the documents.

I have a claim against an insolvent company – can I still pursue my claim?

Administration

No. The moratorium that comes into effect means that no claims can be commenced or pursued against a company in administration.

Compulsory liquidation (winding up by the court)

No. Section 130(2) IA86 states that no proceedings shall be proceeded with or commenced once a winding up order has been made.

Creditors' voluntary liquidation

There is no automatic stay of proceedings, so claims may be commenced or continued. However, the liquidator can apply to court for an order staying proceedings.  

If a judgment is obtained, it cannot be enforced, and you will have to prove alongside the other unsecured creditors for a dividend in the liquidation.

Bankruptcy

There is no automatic stay of existing proceedings after a bankruptcy order is made, but the court has the power to order a stay.

No new proceedings may be commenced without the leave of the court.

About the author

Elizabeth qualified as a solicitor in 1992. She has a wealth of insolvency experience having specialised in the field for over 25 years.

Elizabeth Taylor

Elizabeth qualified as a solicitor in 1992. She has a wealth of insolvency experience having specialised in the field for over 25 years.

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