Insolvency is a term used for both companies and individuals. As an individual, it’s more popularly known as Bankruptcy, but for a company it’s known as Corporate Insolvency. Different terminology and more importantly, different rules.
In England and Wales going Bankrupt involves an application to the court which anyone can make including individuals, sole traders and members of a partnership. For your company however, different rules apply because Corporate Insolvency lies within UK Company Law.
Your company will be considered to be insolvent under English law if it is unable to pay its debts.
Basically, this means that the company has gone bust.
There are two tests to determine whether your company is insolvent:
- The cash-flow test: are your company’s current debts, or future debts, unable to be paid as they fall due?
- The balance sheet test: is the value of your company's assets less than the amount of its liabilities, taking into account the present uncertain circumstances and future liabilities?
If the answer is YES to either of these two tests, then your company would probably be deemed to be insolvent under English law.
Your company is deemed unable to pay its debts if:
- A Court Order or other judgment has not yet been sorted out (or paid) by you; OR
- One of your creditors (whom you owe more than £750) has served a formal demand for an undisputed sum at your company's registered office and the debt has not been paid for three weeks.
What is the Insolvency procedure?
Your company can be placed into a formal Insolvency procedure by you (as a director) or its shareholders, creditors or the court.
As your company nears Insolvency, there are four main procedures by which your company could potentially be rescued or wound down and its assets distributed:
- Company Voluntary Arrangement
- Administrative Receivership
Whichever it is for your company, it will be run under the control of an appointed Insolvency Practitioner who will be professionally qualified and licensed to carry out the Insolvency procedure.
What is a Company Voluntary Arrangement?
A Company Voluntary Arrangement, also known as a CVA, is a binding agreement between your company and its creditors.
You (as a director) and your fellow directors may instigate the CVA but if already appointed, an administrator or liquidator can also propose it.
Under the CVA your creditors will likely agree to a reduced (or rescheduled) debt arrangement in return for a commitment by your company to restructure its business' affairs under a new business development strategy.
The procedure will take place under the supervision of an appointed Insolvency Practitioner where your directors will submit a report on your company's finances together with a proposal for reducing the debt. For example, you and your fellow directors might propose that each creditor accepts 50 per cent of the money owed to each of them, and to spread repayments out over a number of months or years.
This procedure and agreement will be legally regulated and should allow your company to carry on trading.
What is Administration?
Administration is a company rescue procedure under which your company's assets will be protected by stopping any form of creditor action. But this is done for the benefit of all of your creditors, not you.
With this procedure, a qualified Insolvency Practitioner (known as the Administrator) will replace you (as a director) and the entire board of directors.
The Administrator then has a public duty to:
- Rescue your company in the interests of all its creditors;
- Must not act so as to 'unfairly harm' a creditor's interests;
- Achieve a better result for creditors;
- Exercise good business judgment;
- Carry out his/her functions as quickly and efficiently as is reasonably practicable;
- If nothing can be done to rescue your company, the Administrator can effect an orderly winding up and distribution of assets.
Essentially, this means that your Administrator will have a wide discretion to do whatever they think is best. They could decide to save your company (allow it to continue and trade on), sell the business, or wind it down.
Your Administrator will do the following:
- Design a restructuring proposal;
- The restructuring proposal will then be given to the registrar and unsecured creditors within 8 weeks;
- A creditor vote will follow to approve the proposal, where a simple majority is required.
If your creditors do not approve the proposal then the court may make an order.
What is Administrative Receivership?
Due to a change in the law, Administrative Receivership (AR) has been mostly superseded by Administration.
Nonetheless, AR is a procedure available for some companies where the holder of a floating charge against your company which pre-dates 15 September 2003 (this could be a secured creditor such as your company’s bank) appoints an Administrative Receiver (Insolvency Practitioner) to sell your company's assets for maximum value in order to pay off its secured debt.
The good news, if there is such a thing in these circumstances, is that Administrative Receivers have no authority to pay your unsecured creditors. Doing this will usually require a Liquidation.
What is Liquidation?
Liquidation is the process used to close down your company (stop trading) by converting all of its assets into cash value. This means your company's assets are broken up, sold off and then distributed to the following:
- Shareholders if your company is solvent; or
- Creditors if your company is insolvent.
If your company is insolvent and Company Voluntary Arrangement, Administration, Administrative Receivership procedures are not used then your company will be Liquidated, and a Liquidator will be appointed.
When your company is placed into Administration or Liquidation the following creditors will be repaid, depending on the amount of cash available:
- Fees and expenses relating to the administration or liquidation;
- Fees of the Insolvency Practitioner/Liquidator;
- Preferential creditors' claims - including employee claims;
- Prescribed part - this is an amount which is set aside by the Administrator or Liquidator for the benefit of unsecured creditors. The amount will depend on the value of the assets, but can be up to a maximum of £600,000.
- Fixed charge stuff - secured creditors' claims; (floating charge realisations);
- Unsecured creditors' claims – usually distributed by a Liquidator;
What’s the upshot of Insolvency?
As with Bankruptcy, it’s likely that your case will be unique. But there are some general consequences of Corporate Insolvency that could apply to you and your company:
- Customers and suppliers may take protective measures under contracts with your company. For example, they may terminate their contracts with you because Insolvency will very likely entitle the other party to trigger this event. You may wish to check the termination clauses in the contracts your company has with customers and suppliers;
- Transactions can be reviewed and reversed going back two years from Insolvency;
- Increased risk of personal claims against you and the possibility of being disqualified as a director;
- A lender (such as your company’s bank) will be entitled to enforce any security it holds because a formal Insolvency procedure will be considered an event of default;
- A winding-up petition may be issued against your company by a creditor who has served a statutory demand for payment of a debt your company owes. This means your company may be placed into Compulsory Liquidation;
- If a winding-up petition has been presented and your company wishes to continue to sell goods (or make payments for supplies) while a winding-up petition is in progress, it will have to obtain authorisation from the court.
How can an Insolvency Lawyer help?
An Insolvency Lawyer will be able to advise you on all the legal issues which are likely to arise in your Corporate Insolvency circumstance, including advice about:
- Appointment of an Insolvency Practitioner;
- Recovering assets and realising assets including business and asset sales;
- Trusts and other equitable rights;
- The validity of a lender’s security (if applicable).
For Bankruptcy (personal Insolvency) we recommend you take a look at our Bankruptcy page.
With Insolvency, there are a number of options that may be available to you, and they all need to be carefully considered. It’s likely that you may already have strong connections with a legal professional, as well as access to further guidance. It’s well worth having a chat with someone who specialises in this area, to get the best advice for your particular situation.
Published on 25th January 2013
(Last updated 26th November 2013)