With COVID-19 causing ever increasing financial uncertainty around the globe, we thought it an apt time to provide you with a summary of the various corporate insolvency procedures in the UK applicable to companies facing financial difficulties. Taking each in turn, we will discuss administration, administrative receivership, company voluntary arrangements, schemes of arrangement and liquidation. We will also touch briefly on directors’ duties, rules relating to asset distribution on insolvency and transactions that may be set aside on insolvency or ‘reviewable’ transactions.
This know-how summary also follows in the wake of announcements made by the Department for Business, Energy & Industrial Strategy on 28 March 2020 which aim to help companies undergoing a rescue or restructure process to continue trading and avoid insolvency. In brief, the UK Business Secretary has announced:
- The insolvency framework will be amended to include new features including:
- a moratorium for companies during which time creditors may not enforce debts to allow for space to seek out means of rescue or restructure;
- protection of company’s supplies to enable them to continue trading during the moratorium; and
- a new restructuring plan, binding creditors to that plan.
- A temporary suspension on wrongful trading provisions in the UK’s insolvency framework to allow company directors greater flexibility and assurances to continue trading without the threat of personal liability. Legislation relating to fraudulent trading will continue to regulate director’s execution of their duties. See section 3 below for further background on wrongful and fraudulent trading.
For those terms highlighted in green, please see our ‘breaking down the jargon’ glossary which follows the main text.
1. CORPORATE INSOLVENCY PROCEDURES
Administration is a form of rescue procedure used to reorganise companies or realise their assets. The majority of the time, administration is used for insolvent companies but it may also sometimes be used for solvent entities. A company may enter into administration by way of an application to court by the company, its directors or creditors and a subsequent hearing in court (the court route) or by way of filing certain documents at court by the company or its directors or a qualifying floating charge holder (the out of court route).
Administration provides some protection for an insolvent company by way of a statutory moratorium during which time creditors are prevented from taking enforcement action. At the point the court approves entry into administration, an insolvency practitioner is appointed as the company’s administrator. It is the administrator’s role to take over control of the company with the aim of achieving one of the purposes of administration, being, in order of priority: (i) to rescue the company as a going concern; or (ii) 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 going into administration); or (iii) to realise the property of the company to make a distribution to one or more secured creditors or preferential creditors (para. 3, Schedule B1, IA 1986). In performing its duties, an administrator may do anything necessary or expedient to manage the affairs, business and property of the company to which he is appointed (para. 59(1), Schedule B1, IA 1986).
Unless extended by application to court or consent from a company’s creditors, an administrator’s appointment will automatically cease 12 months from the day that the company entered administration (para. 76(1), Schedule B1, IA 1986). Administration may also end at any time by an application to court by the administrator or creditor (paras. 79(1) and 81(1), Schedule B1, IA 1986) or if the administrator has been appointed by the out-of-court route and achieved its purpose, by a filing at court and with the registrar of companies (para. 80(2), Schedule B1, IA 1986). In certain circumstances, administration may move to a creditors’ voluntary liquidation, company voluntary arrangement, scheme of arrangement or dissolution (see relevant sections below).
Administration – advantages and disadvantages:
- The assets of the company are protected from creditor action and pressure during the moratorium which gives the company space to consider viable long term rescue solutions to its financial difficulties.
- The procedure involves a licensed insolvency practitioner who is acting objectively with both the interests of the company and creditors in mind and who has extensive experience.
- The company may enter into a company voluntary arrangement (CVA) whilst in administration, which offers the possibility of coming out of administration and beginning to repay creditors.
- Potentially very expensive for the company, with the process of administration often lasting longer than a year.
- Potentially negative publicity for the company, as administration is a very public procedure. The company will be required to alert third parties that it is in administration in various ways.
- Control of the company is given up to the administrator notwithstanding the expertise they bring.
- During administration, the administrator is obliged to examine and report on the actions of the directors which may be intrusive.
A ‘pre-pack’ sale has become a process often used in connection with administration whereby an agreement is reached before the appointment of the administrator has occurred to sell the company’s business as a going concern or its assets by themselves or both. Once the administrator is appointed, the pre-pack sale will occur immediately. Pre-pack sales may be beneficial in that they can quickly transfer the business of the company to a new owner which can reduce costs of the administration process and long term effects on the business (including avoiding loss of confidence by all those involved in the business and retaining employees).
However, pre-packs have invariably been criticised as they allow the administrator to agree a sale of the business without first agreeing the approach with creditors and the court. In addition, the speed at which pre-packs occur may mean a lower market value is achieved for the business or its assets than may otherwise have been possible, meaning a reduced return for creditors.
Summary of administration process
b. Administrative Receivership
Administrative Receivership was once a widely used remedy for secured creditors. However, since the Enterprise Act 2002 came into force, secured creditors may not appoint an administrative receiver (‘AR’) other than in certain limited circumstances, being:
- if the creditor holds a floating charge over the whole (or substantially the whole) of the property of the company that was created before 15 September 2003; or
- if the creditor is a qualifying floating charge holder and the transaction falls into one of the statutory exceptions listed in sections 72B to 72G of the IA 1986 which relate to capital markets arrangements, public-private partnerships, utilities and urban regeneration project companies, project financings, companies which certain financial markets criteria apply to, companies whose purpose is as a provider of social housing or which is registered as a social landlord and protected railway companies.
If one of these limited exceptions apply, following a default under the relevant loan agreement, an AR may be appointed by a secured creditor. The AR must be an insolvency practitioner and, once the floating charge has crystallised, the AR is given extensive authority to take control of the charged assets and the run the company’s business, owing its duties to the relevant secured creditor. An AR may not be appointed if the company is subject to administration proceedings.
The AR will immediately notify the company and all known creditors within 28 days of its appointment. The appointment is also advertised. Within 3 months of the AR’s appointment, the AR must report on the company’s financial state to UK Companies House and the company’s creditors (with certain exceptions).
Administrative Receivership ends when the relevant secured creditor has been paid in full or the company no longer has any assets to be sold.
Administrative Receivership is to be distinguished from ‘LPA or fixed charged receivership’ which is used to describe the process by which a receiver is appointed by a secured creditor (holding a fixed charge) to protect its interests through management of the assets secured. The power to appoint a receiver in this instance is usually permitted following a default under the relevant loan agreement and is typically conferred on the secured creditor by a security document though there are also statutory rights to appoint a receiver contained in the Law of Property Act 1925.
In both administrative receivership and receivership, receivers owe their primary duty to the appointor rather than any other creditors, there is no moratorium available and the procedures are usually comparatively cheaper than administration.
Summary of receivership processes
c. Company Voluntary Arrangement (‘CVAs’)
A company voluntary arrangement is a process which involves an agreement or ‘compromise’ between a company and its creditors under Part I of the IA 1986 which aims to avoid terminal insolvency proceedings. To commence a CVA, the directors of a company will draft proposals to address a company’s financial difficulties and submit these, together with a statement of the company’s affairs to an insolvency practitioner who will act as a ‘nominee’ to assist with assessing the proposals and deciding whether to proceed with the same. Alternatively, if the company is already in administration or liquidation, it would be the administrator or liquidator who would submit proposals for a CVA (section 1(3), IA 1986).
Other than in cases of administration and liquidation, the nominee must submit a report to court within 28 days of being given notice of the proposals setting out whether the proposals should be submitted to the creditors and members of the company. In cases of administration or liquidation, the initial report to court is not required. Small companies who meet at least two of the criteria set out in section 382(3) of the CA 2006 may benefit from an optional 28 moratorium at the point the nominee is appointed.
If the nominee recommends proceeding with the CVA, the proposals will be implemented if approval from at least 75% by value of creditors of the company (excluding secured creditors) is obtained following a statutory decision procedure, unless 50% by value of all creditors whose claims are admitted for voting, vote against the proposals (rule 15.34, IR 2016). The nominee must also call a members’ meeting which must take place following the creditor’s decision within 5 business days (rule 2.28, IR 2016) and obtain a simple majority in value to approve the proposals. The insolvency practitioner in its capacity as nominee reports to court on the creditor approval and if such approval is not challenged (which may be on grounds of unfair prejudice or material irregularity), the nominee’s role transitions to a ‘supervisor’ role in order to implement the proposals.
An approved CVA will bind all creditors entitled to vote, whether or not they had notice of such entitlement (section 5(2)(b), IA 1986). Following completion of a CVA, the insolvency practitioner as supervisor submits a report within 28 days to shareholders and creditors.
Unless with express consent, a CVA will not affect the rights of secured creditors to enforce their security.
Company Voluntary Arrangement – advantages and disadvantages:
- Allows directors and shareholders to maintain a degree of control over the company.
- Less costly than other formal insolvency procedures such as administration or liquidation.
- CVAs are less public than other insolvency procedures as there is no requirement for a company to alert its customers as to the CVA.
- Optional moratorium available for certain small companies in certain circumstances.
- Also possible to combine the CVA with administration to benefit from the statutory administration moratorium.
- No automatic statutory moratorium.
- Unless by consent, CVAs will not bind secured creditors.
- A relatively high threshold of creditors (75%) will need to agree to the proposals together with 50% member approval.
- CVAs may adversely affect a company’s credit rating.
Summary of company voluntary arrangement process
d. Schemes of Arrangement
A scheme of arrangement is an arrangement or ‘compromise’ proposed by a company, creditor, member, liquidator or administrator under Part 26 of the CA 2006. Schemes of arrangement may be put in place by solvent or insolvent companies and are between the company and its members and/or creditors and aim to repay the company’s indebtedness in whole or in part over an agreed timeline.
The process involves an application being made to court following which the court decides whether to call meetings of the relevant classes of creditors (section 896(1), CA 2006). Notice of such meetings includes details of the proposed scheme and an explanatory statement. At the meetings, the scheme must attain agreement from a majority in number and at least 75% in value of creditors or members or each class of them. Unaffected creditors will not be asked to vote. If approved, the court will then decide whether or not to sanction the scheme (section 899(1), CA 2006), making its decision based on whether certain criteria have been satisfied such as whether statutory procedures have been complied with, whether classes of creditors have been fairly represented by those attending the meetings and whether the scheme meets a reasonableness test.
- May be possible to write down large amounts of debt.
- The company is able to continue trading.
- Once completed, the scheme of arrangement is legally binding on all creditors.
- The process may be costly, particularly due to it involving a formal court procedure.
- It is uncertain whether countries in the European Union would recognise insolvent schemes of arrangement after Brexit.
Summary of scheme of arrangement process
Liquidation may alternatively be referred to as ‘winding up’ and is a process which involves realising the assets of a company and distribution to creditors, finishing with legally ‘ending’ a company. A company may be liquidated or ‘wound up’ through compulsory liquidation or voluntary liquidation which often follows an administration. The procedure is overseen by a liquidator who is the official receiver or an insolvency practitioner.
Compulsory liquidation begins with a winding-up petition being submitted to court by the company, its directors, any creditor or creditors, contributory or by a liquidator on one of the seven grounds set out in section 122(a) of the IA 1986. A winding up order will be made by the court if it deems that one of the circumstances set out in section 122 of the IA 1986 applies, most commonly, that a company is unable to pay its debts. Once a winding up order is made, the official receiver becomes the liquidator of the company until or unless any other person is appointed liquidator. The functions of the liquidator in relation to the company being wound up are to report to the company’s creditors and ensure the assets of the company are got in, realised and distributed to the company’s creditors and, if there is any surplus, to the persons entitled to such surplus (section 143(1), IA 1986). The liquidator will distribute funds in accordance with the statutory order of priorities (see section 2 below). Final accounts are sent to creditors (section 146, IA 1986) and if there is no objection, the company is liquidated and dissolved three months later.
Alternatively, companies may go into voluntarily liquidation by way of a members’ voluntary liquidation (‘MVL’) or a creditors’ voluntary liquidation (‘CVL’). In order to implement an MVL, the directors of a company must swear a statutory declaration of solvency (section 89, IA 1986) and in both an MVL and CVL, the members must pass a special resolution which sets out that the company should be wound up in order to commence the relevant proceedings (section 84, IA 1986 and section 283, CA 2006). Both MVLs and CVLs will commence on the date the special resolution is passed following which a liquidator will be appointed to collect in and realise the company’s assets. At the end of the liquidation, the company is dissolved. In a CVL, creditors are involved in the appointment of a liquidator and have certain entitlements.
A liquidated company will be removed or ‘struck off’ the UK Companies House register which will mean it ceases to exist. A director of a company that has gone into insolvent liquidation will be prevented from forming a business or company with the same or similar name as the liquidated company for a period of 5 years (subject to certain exceptions).
Summary of liquidation processes
2. ASSET DISTRIBUTION ON INSOLVENCY
In administration or liquidation proceedings, the proceeds of realisations of a company’s assets will be distributed in the following statutory order of priority in accordance with the IA 1986 and the IR 2016:
- First, to holders of fixed charges and creditors with a proprietary interest in assets. The insolvency practitioner will receive its fees relating to realising the assets subject to fixed charges from the proceeds of those assets (rather than the assets available to all creditors).
- Second, to expenses of the insolvent estate which may include costs from continuing to trade the insolvent estate or preserve assets or in certain circumstances, employee salaries. Also includes the insolvency practitioner’s professional fees.
- Third, to preferential creditors (including employees entitled to arrears of wages up to a maximum of £800, and holiday pay and contributions to pension schemes).
- Fourth, to holders of floating charges (with the prescribed part first carved out).
- Fifth, to unsecured creditor
- Sixth, to shareholders.
3. DIRECTORS’ DUTIES – PENALISATION OF DIRECTORS AND OFFICERS
If in the course of the winding up of a company, it appears that a director or officer of the company has misapplied or retained or become accountable for any money or other property of the company or been guilty of any misfeasance or breach of fiduciary duty in relation to the company, the court may compel such person to repay, restore or account for the money or property or any part of it, with interest at such rate as the court deems appropriate or to contribute such sum to the company’s assets by way of compensation (section 212, IA 1986). Such actions may be by way of:
- Fraudulent trading (section 213, IA 1986) – in which case the business of the company has been carried out with the intent of defrauding creditors for any fraudulent purpose.
- Wrongful trading (section 214, IA 1986) – if a director or officer knew or ought to have concluded that there was no reasonable prospect that a company would avoid going into insolvent liquidation, he may be liable to the company if such director has not taken every step with a view to minimising potential loss to the company’s creditors as he ought to have taken.
4. REVIEWABLE TRANSACTIONS OR ‘ANTECEDENT’ TRANSACTIONS
Certain transactions which a company has been a party to may be reviewed or ‘challenged’ if the company is subject to insolvency proceedings. Such transactions may be referred to interchangeably as ‘reviewable’ or ‘antecedent’ transactions and may be disputed by administrators, liquidators or in some cases, creditors. Reviewable transactions include:
- Transactions at an undervalue (section 238, IA 1986) – if the company during the ‘relevant time’ has entered into a transaction with any person at an undervalue, the administrator or liquidator may apply to court to challenge such transaction. A transaction at an undervalue may include a gift being made by the company or the company entering into a transaction for which it receives no consideration or consideration which is significantly less than the value of the consideration provided by the company. The court may make an order as it thinks fit to restore the position to what it would have been if the company had not entered into the relevant transaction. The court will not make an order if it is satisfied that the company had entered into the transaction in good faith for the purpose of carrying out its business and at the time it did so, there were reasonable grounds for believing the transaction would benefit the company.
- Preferences (section 239, IA 1986) – if the company during the ‘relevant time’ has given a preference to any person, the administrator or liquidator may apply to court for an order to restore the position to what it would have been if the preference had not occurred. A company may be deemed as giving a preference to a person if that person is one of the company’s creditors or a surety or guarantor of the company’s debts or other liabilities and the company does anything which has the effect of putting that person into a position which, in the event of the company going into insolvent liquidation, will be better than the position he would have been in if that thing had not been done. The court will not make an order unless the company which gave the preference was influenced in deciding to give it by a desire to produce the effect mentioned in the preceding sentence.
- Avoidance of floating charges (section 245, IA 1986) – if a floating charge is created during the relevant time, it will be automatically invalidated if at the time it was granted, the company was unable to pay its debts or becomes unable to pay its debts in consequence of the transaction under which the charge is created.
For the purposes of transactions at an undervalue and preferences, the ‘relevant time’ is, in the case transactions at an undervalue or preferences which relate to persons connected with the company (other than by reason of employment only), 2 years ending with the onset of insolvency. In the case of preferences relating to unconnected persons, the relevant time is 6 months ending with the onset of insolvency. With regard to the avoidance of floating charges, in the case of a charge created in favour of a person connected with the company, 2 years ending with the onset of insolvency and in the case of a charge created in favour of any other person, 12 months ending with the onset of insolvency.
- Transactions defrauding creditors (section 423, IA 1986) – the court may make an order under this section in relation to a transaction at an undervalue if the purpose of such transaction was to put assets beyond the reach of a person making or who may at some time make a claim against the relevant person or company or to otherwise prejudice the interests of such person in relation to the claim which he/she is making or may make. If the court is satisfied that the relevant criteria apply, it may make an order to restore the position to what it would have been if the transaction had not been entered into and to protect the interests of the person(s) victim of the transaction. Liquidators, administrator or any other person prejudiced by such a transaction may bring a challenge.
Breaking down the jargon…