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Corporate insolvency
A company becomes insolvent if it does not have enough assets to cover its debts and/or it cannot pay its debts on the due dates. It is the directors’ responsibility to know whether or not the company is trading while insolvent and they can be held legally responsible for continuing to trade in that situation. The decision to appoint receivers, liquidators and administrators is the responsibility of the appropriate funding bodies (ie banks and lending institutions), creditors, the courts or the company itself, depending on the procedure.
General
Insolvency in the UK is:
governed by Insolvency Act 1986 and Insolvency Rules 1986, SI 1986/1925
subject to the jurisdiction of the High Court and designated county courts
Companies in financial difficulty may be subject to various insolvency procedures:
company voluntary arrangements (CVAs)
administration
administrative receivership
voluntary winding-up (by creditors or members)
compulsory winding-up (by the court)
Company voluntary arrangement (CVA)
A company's directors may propose and negotiate a CVA with its creditors. Once agreed, a CVA:
binds and entitles creditors to repayments of less than the full debt value, over a period of up to 5 years
requires consent from over 75% of creditors, and must have the consent of secured creditors
puts the company’s assets under control of a supervisor
prevents creditors who agreed to the CVA taking action against the company without leave of the court
For small companies, a CVA may be preceded by a moratorium of up to 28 days.
Administration
An administrator may be appointed either:
out of court, either by the directors or by the holder of a debenture created on or after 15 September 2003, or
by the court, on application by the directors or by any creditor
Administration affords protection whilst a recovery scheme is implemented. The objective is to:
rescue the company as a going concern, or
achieve a better result for creditors than if the company were wound up, or
realise property for the benefit of creditors
In administration:
the administrator takes control of the company; the directors' powers are suspended
no proceedings can be taken, or security enforced without leave
business usually continues, but the company must make clear that it is in administration
The administrator:
acts in the interest of creditors as a whole, including unsecured creditors (even where appointed by a secured creditor)
reports on the conduct of the directors preceding insolvency, but
has no power to take proceedings for wrongful trading or misfeasance
Administrative receivership
A secured creditor under a qualifying floating charge created before 15 September 2003 may, on default, appoint an administrative receiver to take possession of the assets to recover the debt. The effect is that:
the directors' powers are suspended
floating charges crystallize
unlike administration, there is no statutory moratorium of proceedings against the company
For floating charges created since 15 September 2003 the power is that of appointment of an administrator. Administrative receivership is consequently becoming less common.
Winding up
Winding up (also known as liquidation) means the dissolution of a company. It may be:
voluntary (by the members), either:
members' voluntary liquidation where the company is solvent, or
creditors' voluntary liquidation where it is not
compulsory (by the court), on one of seven specified grounds, normally that the company is insolvent
Under Insolvency Act 1986 a company is insolvent if:
it cannot pay its debts as they fall due (cash flow test)
its assets are worth less than its liabilities (balance sheet test). Future and contingent liabilities are taken into account
In administration, administrative receivership and liquidation, assets are distributed to creditors in an order prescribed under Insolvency Act 1986.
Insolvency and directors
Directors of insolvent, or potentially insolvent, companies should be aware of the following potential liabilities:
wrongful trading, where they make the position of creditors worse by continuing to trade when they should have stopped. In such a case, directors may be personally liable to contribute to the company's assets. This also applies where they have traded with intent to defraud creditors (fraudulent trading)
transactions at an undervalue, ie those where, in a specified period preceding insolvency, the company receives less in value than it provides. These may be set aside, unless concluded for bona fide business reasons. The period is two years for connected persons (directors and associates, as defined) and six months in other cases
a preference given to the company's creditors or guarantors, ie something done in the relevant period (as above) to put them in a better position, may be set aside
transactions designed to put assets beyond a creditor's reach may be set aside
floating charges created in the relevant period (two years for connected persons and one year otherwise) may not be enforceable
extortionate credit transactions may be set aside
Directors and others found to have acted improperly in running a company may also be subject to disqualification orders. These prevent them from being a director or acting in the management of a company without leave. The court:
must make a disqualification order if a director's conduct makes him unfit to be involved in company management
may make a disqualification order where it orders a contribution to assets in cases of fraudulent or wrongful trading
A director includes a shadow director, ie a person on whose instructions the directors are accustomed to act. Disqualification is normally for between two and fifteen years. If a person acts when disqualified, he commits an offence, and becomes personally liable for the company's debts.
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