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Insolvencies for dummies

A company is insolvent when it doesn’t have enough assets to cover its debts, or if it is unable to pay its debts as they fall due. Once a company becomes insolvent, several courses of action are open, sometimes resulting in a return to solvency. 

An insolvent company goes into administration, administrative receivership or liquidation, whereas an individual becomes bankrupt. Insolvent individuals and companies alike can enter voluntary arrangements. 

In any insolvency procedure, a licensed insolvency practitioner (IP) takes control of the all of the assets and makes sure that all creditors are treated fairly and equally, in proportion to their claims. In addition, in most company insolvency procedures, the IP must report to the Department for Business, Innovation and Skills (BIS) about the conduct of directors. 

It is the responsibility of company directors to make sure that the finances of a company are properly handled and understood. If directors knowingly cause a company to trade when it is insolvent and when there is no real prospect of improvement in its finances, they are potentially liable to disqualification. 

The aim of any insolvency procedure is to maximise returns to creditors and, in many cases, an IP will attempt to rescue the business. However, the majority of corporate insolvency cases are liquidations in which there may be little to rescue and the IP is likely to be left with little alternative but to sell off the company’s assets on a break-up basis. 

The options for an insolvent company in England, Wales and Northern Ireland vary from less restrictive voluntary arrangements to more structured and restrictive procedures such as liquidation, administration and administrative receivership. 

The lingo

Administration: Administration is a process which places a company under the control of an IP and the protection of the court to achieve a specified statutory purpose. The purpose of administration is to save the company, or if that is not possible, to achieve a better result for creditors than in a liquidation, or if neither of those is possible, to realise assets to enable funds to be distributed to secured or preferential creditors. 

Administration Order: An administration order is a court order placing a company that is, or is likely to become, insolvent under the control of an administrator in order to achieve the purpose of administration, following a petition by the company, its directors, its liquidator or a creditor. 

Administrative Receiver: An administrative receiver is an IP appointed by the holder of a floating charge covering the whole, or substantially the whole, of a company’s property. He/she can carry on the company’s business and sell the business and other assets comprised in the charge to repay the secured and preferential creditors. Sometimes abbreviated to receiver.

Administrative Receivership: Administrative receivership is the term applied when a person is appointed as an administrative receiver. Commonly abbreviated to receivership.

Administrator: An administrator is an IP appointed to manage the affairs of a company to achieve the purpose of administration set out in the Insolvency Act 1986. The administrator will need to produce a plan, known as the administrators” proposals, for approval by the creditors to achieve this. 

Company Directors Disqualification Act (1986): The Company Directors Disqualification Act (1986) is an act concerning the disqualification of persons from being directors or otherwise concerned with a company’s affairs. 

Company Voluntary Arrangement (CVA): A company voluntary arrangement is a procedure whereby a plan of reorganisation or composition in satisfaction of its debts is put forward to creditors and shareholders. There is limited involvement by the court and the scheme is under the control of a supervisor.

Composition: A composition is an agreement between a debtor and his creditors whereby the compounding creditors agree with the debtor and between themselves to accept from the debtor payment of less than the amounts due to them in full satisfaction of their claim.

Compulsory Liquidation: A compulsory liquidation of a company is a liquidation ordered by the court. This is usually as a result of a petition presented to the court by a creditor and is the only method by which a creditor can bring about a liquidation of its debtor company. 

Connected Persons: Connected persons are directors or shadow directors and their associates, and associates of a company. 

Court-appointed Receiver: A court-appointed receiver is a person, not necessarily an IP, appointed to take charge of assets usually where they are subject to some legal dispute. Not strictly an insolvency process, the procedure may be used other than for a limited company, e.g. to settle a partnership dispute. 

Creditors” Committee: A creditors” committee is a committee formed to represent the interests of all creditors in administrations, administrative receiverships and bankruptcies. The exact functions of the committee depend on the type of procedure. 

Creditors” Voluntary Liquidation (CVL): A creditors” voluntary liquidation relates to an insolvent company. It is commenced by resolution of the shareholders, but is under the effective control of creditors, who can choose the liquidator. 

Debenture: A debenture, broadly speaking, is a document which either acknowledges or creates a debt. The expression is commonly used to denote a document conferring a fixed and floating charge over all the assets and undertakings of a company.

Disqualification of Directors: A director found to have conducted the affairs of an insolvent company in an “unfit” manner will be disqualified, on application to the court by BIS, from holding any management position in a company for between two and 15 years. 

Fixed Charge: A fixed charge is a form of security granted over specific assets, preventing the debtor from dealing with those assets without the consent of the secured creditor. It gives the secured creditor a first claim on the proceeds of sale, and the creditor can usually appoint a receiver to realise the assets in the event of default. 

Floating Charge: A floating charge is a form of security granted to a creditor over general assets of a company which may change from time to time in the normal course of business (e.g. stock). The company can continue to use the assets in its business until an event of default occurs and the charge crystallises. If this happens, the secured creditor can realise the assets to recover his debt, usually by appointing an administrative receiver, and obtain the net proceeds of sale subject to the prior claims of the preferential creditors. 

Fraudulent Trading: Fraudulent trading involves a company which has carried on business with intent to defraud creditors, or for any fraudulent purpose. It is a criminal offence and those involved can be made personally liable for the company’s liabilities. 

Going Concern: A going concern is the basis on which IPs prefer to sell a business. Effectively it means the business continues, jobs are saved, and a higher price is obtained. 

Insolvency: Insolvency is defined as having insufficient assets to meet all debts, or being unable to pay debts as and when they are due. If a creditor can establish either test, he will be able to present a winding-up petition. 

Insolvency Act 1986: The Insolvency Act 1986 is the primary legislation governing insolvency law and practice. Nevertheless, many other statutes and statutory instruments are also relevant. 

Insolvent Liquidation: A company goes into insolvent liquidation if its goes into liquidation at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of liquidation.

Law of Property Act 1925: The Law of Property Act 1925 governs transactions in law and property. Contains statutory powers of receivers appointed under a fixed charge. 

LPA Receiver: Law of Property Act 1925 receiver is a person (not necessarily an IP) appointed to take charge of a mortgaged property by a lender whose loan is in default, usually with a view to sale or to collect rental income for the lender. Common in the case of the failure of a property developer, whose borrowings will largely be secured on specific properties.

Licensed Insolvency Practitioner (IP): An IP is a person licensed by one of the Recognised Professional Bodies or the Secretary of State for Trade and Industry and is the only person who may act as an office holder in an insolvency. 

Liquidation: Liquidation is the process whereby a company has its assets realised and distributed to satisfy, insofar as it is able, its liabilities and to repay its shareholders. The term winding up is also used. Liquidation is usually a terminal process, followed by the dissolution of the company. 

Liquidation Committee: A liquidation committee is a committee which receives information from the liquidator and sanctions some of his actions. Usually consists entirely of creditors, but may also comprise shareholders. 

Liquidator: A liquidator is an IP appointed to wind up a company. 

Members” Voluntary Liquidation (MVL): A members” voluntary liquidation is a solvent liquidation where the shareholders appoint the liquidator to realise assets and settle all the company’s debts, plus interest, in full within 12 months.

Misfeasance: Misfeasance is a breach of duty in relation to the funds or property of a company by its directors or managers. 

Mortgage: A mortgage is a transfer of an interest in land or other property by way of security, upon the express or implied condition that the asset shall be reconveyed to the debtor when the sum secured has been paid. 

Nominee: A nominee is an IP nominated in a proposal for an individual or company voluntary arrangement to act as supervisor of the arrangement. 

Office Holder: An office holder is a liquidator, provisional liquidator, administrator, administrative receiver, supervisor of a voluntary arrangement, or trustee in bankruptcy.

Official Receiver (OR): An official receiver (OR) is an officer of the court, civil servant, member of the Insolvency Service (an Executive Agency of BIS) and deals with bankruptcies and compulsory liquidations. 

Preference: A preference is a payment or other transaction made by an insolvent company which places the receiving creditor in a better position than they would have been otherwise. A liquidator or administrator may recover sums which are found to be preferences, if the transactions took place within a period of either two years (where the creditor is a connected person) or six months (in other cases) of the insolvency.

Preferential Debts: Defined in Schedule 6 of The Insolvency Act 1986. They have priority when funds are distributed by a liquidator, administrator or administrative receiver. 

Proof of Debt: Proof of debt is a document submitted by a creditor to the IP or OR giving evidence of the amount of the debt.

Provisional Liquidator: Provisional liquidator is the name usually given to an IP appointed to safeguard a company’s assets after presentation of a winding-up petition but before a winding-up order is made. 

Proxy: A proxy is a document by which a creditor authorises another person to represent him at a meeting of creditors. The proxy may be a general proxy, giving the proxy holder discretion as to how he votes, or a special proxy requiring him to vote as directed by the creditor. A body corporate can only be represented by a proxy. 

Proxy holder: A proxy holder is a person who attends a meeting on behalf of someone else. 

Receiver: The term receiver is often used to describe an administrative receiver, who may be appointed by a secured creditor holding a floating charge over a company’s assets. More accurately, a receiver is the person appointed by a secured creditor holding a fixed charge over specific assets of a company in order to take control of those assets for the benefit of the secured creditor. 

Receivership: A receivership is the general term applied when a person is appointed as a receiver or administrative receiver. 

Recognised Professional Body (RPB): A recognised professional body is an organisation recognised by the Secretary of State for Trade and Industry as being able to authorise its members to act as IPs, e.g. the Law Society and the Institute of Chartered Accountants. 

Secured Creditor: A secured creditor is a creditor with specific rights over some or all of a debtor’s assets. A secured creditor gets paid first out of the proceeds of sale of the security. 

Security: A security is a charge or mortgage over assets taken to secure payment of a debt. If the debt is not paid, the lender has a right to sell the charged assets. 

Shadow Director: A shadow director is a person who is not formally appointed as a director, but in accordance with whose directions or instructions the directors of a company are accustomed to act. However, a person is not a shadow director merely because the directors act on advice given by him in a professional capacity. 

Statutory Demand: A statutory demand is a formal notice requiring payment of a debt exceeding ?750 within 21 days, in default of liquidation proceedings may be commenced without further notice. Cannot be used where the debt is disputed. 

Supervisor: A supervisor is the IP appointed by creditors to supervise the way in which an approved voluntary arrangement is put into effect. 

Transaction at an Undervalue: A transaction at an undervalue can describe either a gift or a transaction in which the consideration received is significantly less than that given. In certain circumstances such a transaction can be challenged by an administrator or a liquidator. 

Unsecured Creditor: An unsecured creditor, strictly, is any creditor who does not hold security. More commonly used to refer to any ordinary creditor who has no preferential rights, although, in fact preferential creditors will almost always also have an element that is unsecured. In any event, they are the last in the queue, apart from shareholders. 

VAT Bad Debt Relief: VAT bad debt relief is the relief obtained in respect of the VAT element of an unpaid debt, available when the debtor becomes insolvent, or where the debt is six months old at the relevant date. 

Winding-up Order: A winding-up order is an order made by the court for a company to be placed into compulsory liquidation. 

Winding-up Petition: A winding-up petition is a petition presented to the court seeking an order that a company be put into compulsory liquidation.

Wrongful Trading: Wrongful trading is a term applied to companies in liquidation where a director allowed the company to continue trading in circumstances where he knew or should have concluded that there was no reasonable prospect that the company would avoid going into insolvent liquidation. The directors involved may be made personally liable to make a contribution to the company’s assets.

John Alexander, a founding council member of R3, is a chartered accountant and has been an IP for over 30 years. He heads Carter Backer Winter LLP‘s corporate recovery and insolvency practice. John can be contacted at [email protected] or on 020 7309 3827.


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