What is Insolvency?
When financial hardship hits your business, and the possibility of closing down rears its head, working out what to do next can be overwhelming.
Understanding the fundamentals behind what insolvency is, what the process entails and what it means for the future of your business can help you to navigate this complex situation.
What does insolvency mean for your business?
A company becomes insolvent when its liabilities exceed its assets, and the company is unable to pay its creditors.
Individuals can also face insolvency, which is dealt with as bankruptcy.
There are two tests for company insolvency:
1. Balance sheet test for insolvency
With a balance sheet test, a court will place a value on a company’s liabilities (what it owes to creditors). If they conclude that a company is able to meet all its liabilities, then it is not insolvent. If, however, the company can’t fulfil its liabilities and pay its creditors, then it may enter into the insolvency process.
2. Cashflow test for insolvency
A cashflow test takes a different approach to insolvency, deciding whether a company can pay its bills on time, or within a reasonable amount of time. If the company fails this test, then it may begin insolvency proceedings.
What are the options and which is best for your company?
Your company may be entered into formal insolvency proceedings by a director, the company’s shareholders, creditors, or by the court.
There are a number of possible actions, should your company be faced with insolvency, which could involve you seeking to continue trading or your creditors may take action to recover their debts.
Actions could include:
The administration process was introduced in the Insolvency Act 1986, and later revised by the Enterprise Act 2002.
Administrations are used to support and hold together a company while plans are made for one of the following:
- a financial restructuring of the company
- the sale of the company and its assets for the purpose of obtaining a better outcome for the company’s creditors than if the company went into liquidation
Where neither of these outcomes can be reached, administration may also be used to liquidate the company’s assets and pay all secured or preferential creditors.
A secured creditor is usually a bank or some other asset-based lending financial institution. An unsecured creditor may be a supplier, customer, the HMRC or contractors that your company has hired. A preferential creditor is a creditor who, for whatever reason that has been agreed with the company, receives a preferential right to be paid should the company become insolvent.
When a company enters into the administration process, an insolvency practitioner will take control of the company. This individual will be termed the administrator.
While an administrator is in control of your company, creditors will not be able to take legal action against the company for debts owed to them, including the process of compulsory liquidation.
The purpose of the administrator is to attempt to keep the company in business. If they feel that this is not possible, their next purpose is to ensure that the secured and preferential creditors, and hopefully the unsecured creditors, receive payment.
The administrator has 8 weeks to come to this conclusion and communicate their findings to Companies House, company employees and any creditors. All parties will be asked to approve or amend the administrator’s plans for the company at a meeting.
The administrator could come to any of the following conclusions:
- to put in place a Company Voluntary Arrangement (CVA) with company creditors
- to sell the company to another company
- to sell company assets in a Creditors’ Voluntary Liquidation (CVL), pay back any creditors with monies raised, and close the company
- in the case that there is nothing to sell, close the company
The administration of the company will end when the administrator feels that administration has been achieved (e.g. the company is sold to another company or CVAs are successfully agreed with creditors) or when the administrator’s contract ends, a year after the company entered administration. It is possible, however, to renew the administrator’s contract, should administration have not been reached.
b. Informal creditor agreements
It may be possible to draw up an informal agreement with creditors so that the company may repay them on re-arranged terms. This option is useful where a company’s financial problems are temporary.
In this situation, contact should be made with creditors as soon as possible but having firstly checked how the rearranged payments will affect the company’s finances.
Be aware, however, that any informal agreement is not legally binding. Creditors are within their rights to back out of the agreement at a future date.
c. Company voluntary arrangements (CVAs)
Where an informal creditor agreement can be withdrawn from by a creditor at any time, a CVA is a legally binding agreement between a company that is going though a period of financial difficulty and its creditors.
The CVA is intended to arrange payment of all or part of the company’s debts over an agreed time frame.
The company may continue to trade during the period of time that a CVA covers and into the future.
A company’s directors may propose the use of CVAs but any shareholders or creditors do not have the right to do so.
d. Administrative receiverships
A company enters into administrative receivership, when a floating charge holder (usually a bank or other asset-based lender or lenders) appoints an administrative receiver. Generally, there is no court involvement.
The purpose of the administrative receiver is to ensure that the floating charge holder receives any monies owed to them. They are also responsible for the payment of debts to the company’s preferential creditors.
They are not responsible for making any payment of debts to unsecured creditors.
In accordance with the Enterprise Act 2002, any floating charge that was created after 15 September 2003, may only allow the appointment of an administrative receiver if the floating charge is related to:
- public or private partnerships
- utility projects
- financial markets
- finance projects
- registered social landlords
- certain transactions in capital markets
e. Liquidations or ‘winding up’
Liquidation means the end of the company. It ends its business dealings, no longer employs anyone and is removed from the UK Register of Companies at Companies House.
For an insolvent company, liquidation would take place through a creditors voluntary liquidation or a compulsory liquidation.
For a solvent company, where the directors have made the decision to cease trading, the process would be a members voluntary liquidation.
A compulsory liquidation may be carried out by a director of the company in the following situations:
- the director can provide evidence that the company is unable to pay its debts of £750 or more
- sufficient shareholders agree to the liquidation of the company
- the director can provide a strong enough reason to the court why the company should close
A ‘winding up petition’ must be accepted by the court before a company can go into compulsory liquidation. The directors may present the petition to court and apply for compulsory liquidation without shareholder agreement but only if all directors present the petition together (in the case of there being multiple directors).
The fees for this process, as at 2018, are £280 for the court fee and £1,600 for the petition deposit. There may also be expenses incurred when you list the petition and court hearing date in the Gazette.
If the reason that a director wishes to close down a company is because he or she is in disagreement with any other directors, then this will only be possible if the director is a creditor or shareholder.
Any shareholder who wishes the company to enter into compulsory liquidation must provide their reasons why.
Creditors are also within their rights to apply for an insolvent company to enter compulsory liquidation.
If a director or shareholder of a company is also a creditor, they may request the company go into compulsory liquidation. As this application is made as a creditor, the director will not require the agreement of any other directors to the petition.
A shareholder meeting must be held so they have the opportunity to vote on whether the court should wind-up the company. 75% of shareholders (75% by value of shares) must vote for the winding-up of the company to pass a special resolution.
At this point, where the resolution has been passed, or sufficient reasons for why the company should go into compulsory liquidation are in place, a winding-up petition should be completed. A template for this petition can be obtained from the High Court.
Details of what the winding-up petition should include can be found in Rule 7.5 of The Insolvency (England and Wales) Rules 2016.
Along with the petition, a statement of truth should also be provided. For more information on what this should include, refer to Rule 7.6 of The Insolvency (England and Wales) Rules 2016.
Three copies of each document should be produced.
Should the Companies House register show that the company has a paid-up share capital of over £120,000, the petition should be forwarded to:
The High Court
7 Rolls Buildings
If the Company House register shows that the company’s paid-up share capital is less than £120,000, visit this link to find a court that deals with insolvency (you are required to use the court that is closest to your UK company registered office).
Should the court accept the petition, a date will be arranged for the hearing.
If a shareholder applies, they must deliver a copy of the petition to the company and provide proof of this in the form of a certificate of service to the court.
If the company is involved in voluntary liquidation, administrative receivership, an administration order, or a voluntary arrangement, a copy of the petition must be forwarded to the relevant liquidator, administrative receiver, administrator or supervisor.
When the court provides a date for the hearing, an announcement must be made in The Gazette at least 7 working days before the hearing. Details of what you must include in this announcement can be found in Rule 7.10 of The Insolvency (England and Wales) Rules 2016.
A copy of the advertisement, along with a certificate of compliance, must be sent to the court within 5 working days before the hearing.
Find out what to include in the certificate of compliance, in accordance with Rule 7.12 of
The Insolvency (England and Wales) Rules 2016.
Provide a list of all attendees of the hearing to the court.
This list must be produced to the court by 4.30 pm the day before the hearing.
After the hearing, the court will issue a winding-up order, should the petition be successful.
An official receiver will be placed in charge of the liquidation of the company by the court. The receiver will start the process of liquidating the company’s assets, i.e. turning them into money, so that the company’s debts may be paid.
Creditors’ voluntary liquidations (CVLs)
A director can seek the winding-up of a company if it is insolvent (i.e. it can’t pay its debts) and sufficient shareholders have agreed.
A shareholder meeting must take place so that the shareholders may take a vote. For a winding-up resolution to be passed, 75% of the shareholders (that is, 75% by value of shares) must agree to winding-up the company.
Once the resolution has been passed and a statement sent to the company’s creditors, an insolvency practitioner is appointed to take charge of the process of liquidating the company. This appointment is made by the directors, not the court.
The resolution is forwarded to Companies House within 15 days and advertised in the Gazette within 14 days.
At this point, directors lose any control over the company and its assets. They cannot act on behalf of the company and must provide any company information that the liquidator requests from them, along with company assets, paperwork and records. They must make themselves available for interview by the liquidator.
The liquidator will also:
- settle any outstanding legal disputes or contracts
- sell the assets of the company
- use any money to pay creditors
- complete required paperwork within set deadlines and communicate with the relevant authorities
- pay liquidation costs
- pay the final VAT bill
- communicate with creditors to keep them informed
- communicate with creditors when they are required to be part of any decisions the
- liquidator may make
- pay creditors
- arrange for the company to be removed from the companies register
In a creditors voluntary liquidation, the liquidator acts in the interest of the creditors instead of the directors.
How legal advice can help?
The process of insolvency is detailed and complex, so specialist legal advice is essential.
Not only can it steer your company through the process of insolvency (whether you wish to wind-up your company or restore it to health), but based on your company’s individual situation, specialist legal advice can help you decide which path is the right one to take.