The threat of insolvency proceedings against a corporate debtor can greatly assist a creditor's primary objective of getting paid, preferably in advance of everyone else. This is particularly so where the debtor is prevaricating but there is no genuine dispute that the sum in question is due and owing. Although the courts decry the use of the winding-up procedure as a means of debt collection, it is often a very effective tool.
Consider the following when faced with a corporate debtor who is refusing, without genuine reason, to settle its debts:
What are the grounds for a creditor's petition?
The Insolvency Act 1986 sets out seven grounds upon which a company may be wound up, the main ones being:
- non-compliance with a statutory demand
- an unsatisfied judgment
- other evidence of inability to pay debts as and when they fall due – practical insolvency: the 'just and equitable' ground
- evidence that the company is balance sheet insolvent – its assets are less than its liabilities, present, contingent and future.
Should I serve a statutory demand first?
Although you can, it is not necessary to serve a statutory demand or to obtain a judgment before winding-up can be threatened. Neither is required under the just and equitable or the balance sheet ground. And so if there have been numerous but empty promises to pay, the threat alone of a winding-up petition can often bring a speedy resolution.
What happens once the petition has been issued?
If no acceptable response is made to the statutory demand, or it is decided to omit that stage, a petition has to be issued in the Companies Court and served on the debtor company. The petition is registered at the Central Index of Petitions (which is searchable) and must then be advertised in the London Gazette not less than seven business days after service on the company. This short period gives the company time to pay the sum demanded or come to some arrangement with the creditor if it wishes, or is able, to do so. Failure to do so enables the creditor to advertise the petition which in turn potentially notifies other creditors that the petition has been issued and when it is to be heard. Advertisement will have a devastating effect on the debtor company in relation to its financial reputation and its ability to continue trading. This is because its bank account will be frozen, as banks monitor the London Gazette closely. At this stage the petition almost becomes self-fulfilling: an inability to access cash will inevitably prevent the company from paying its debts.
What are the debtor company's options?
Options are limited once the petition has been served. It can:
- pay up or come to some arrangement in relation to the debt due
- do nothing if it truly is unable to pay its debts and await the inevitability of the winding-up
- if the debt is disputed, seek an undertaking that the petition will not be advertised or, if that is not forthcoming, seek an injunction restraining its advertisement on the basis that it is an abuse of the court process. It is at this stage that a creditor using the process as a means of debt collection on disputed debts can find itself in trouble. An injunction will be granted if it appears to the court that there is a genuine dispute over the debt and the company has some prospects of defeating the claim against it (this is not, in practice, a particularly high hurdle). Moreover, the court may then order the creditor to pay the debtor's costs of obtaining the injunction on an indemnity basis as it views the use of the petition process in "disputed" cases to be inappropriate and an abuse of the court process. The use of this procedure in such cases is therefore high risk for creditors
- defend the petition at the hearing, but by this stage untold damage may have been done to the company's reputation. In practice, few petitions actually fight at the petition hearing.
What happens after the company is wound up?
The winding-up order is backdated to the date of the presentation of the petition. Any contracts entered into, any dispositions of assets made or any enforcement proceedings completed after that date can be set aside by the liquidator. No action can be commenced or continued against the company without the court's permission. The liquidator then acts as the agent of the company in realising its assets for the benefit of the creditors of the company as a whole and not just the creditor whose petition led to the winding-up. Indeed, unless that creditor is a secured creditor, it will have expended money in bringing about the winding-up for the benefit of all the other creditors.
To wind-up or not to wind-up - the pros and cons
- it undoubtedly brings commercial pressure upon the debtor to pay what is due and owing. No company will want a petition advertised in the London Gazette if it is able to pay its debts and wishes to continue trading
- it can be a quicker and more cost effective procedure than issuing court proceedings if the debt is not disputed and it is quickly settled. Winding-up proceedings are rarely ignored!
- it does not prevent traditional court proceedings being commenced if the petition is not proceeded with, for example if a genuine dispute does arise following service.
- if the debt is disputed and the petitioner does not back down there can be a heavy costs penalty should the court consider it was an abuse of court process to issue the petition
- if a winding-up order is made, unsecured creditors have to share equally in any distribution of funds with all other unsecured creditors and only after secured creditors have been paid. The available pot may be small and an unsecured petitioning creditor may end up with very little while those higher up the "secured" food chain benefit more. Even the cost of the proceedings may not be recovered by the petitioner
- there might be other creditors waiting in the wings who have had notice of the petition and who might step in should the petitioning creditor have been paid off. If so, and the petition is granted, any sums paid to the original petitioning creditor since the petition was issued, may have to be paid back. In practice, this means that once a petition is advertised, it is harder to reach a payment arrangement, as any arrangement effectively needs also to include any supporting creditor.