Corporate Insolvency Procedures
Whilst insolvency is something that no business ever wants to experience, it is vitally important to know just what the process entails. Many businesses and corporations have thought themselves ‘too big to fail’ and have subsequently failed. They then find themselves in an alien world with unfamiliar procedures and restrictions, wondering just what happened. Since the Enterprise Act 2002 amended the Insolvency Act 1986, the government has made big changes to both personal and corporate insolvency. The thrust of the 2002 act was to place more emphasis on helping companies survive and repair, help ensure creditors get what they are owed and making it harder for culpable directors to leave broken businesses in their wake.
A direct upshot of this new approach has been the large growth in the use of administrators as a main insolvency procedure, which has translated to more businesses surviving insolvency.
Below, this article will detail the various steps to declaring insolvency and possible actions thereafter.
Tests for Insolvency
There are specific, prescribed tests in English Law that test for corporate insolvency. If a company fails these tests, then the law considers it insolvent.
- The Balance Sheet Test: This test assesses the value of the company’s assets. If the value of the company’s assets is less than its liabilities – debts, overheads and so forth, then it becomes insolvent under the law. This test must also take into account future and possible liabilities.
- The Cash Flow Test: The aim of this test is to see if the company can pay any debts it has and, furthermore, if it can meet repayments when they come due.
If the results of either of these tests are in the affirmative, then English law deems the company as insolvent.
There a few other factors that can also see a company legally labelled as insolvent:
- A court judgement or court order has gone unfulfilled by the business, or;
- A creditor of the business to whom the company owes £750 or more serves a formal demand for the sum at the company’s registered office. If this demand has gone unpaid in full for three weeks, then this is also ground for insolvency proceedings.
There are a number of insolvency procedures available to companies. The route an insolvent company takes depends on the individual facets of each case, what the business feels is the best route, what an insolvency practitioner advises and many other factors besides.
A company can go into formal insolvency by: the business directors, shareholders, its creditors or the courts. An insolvency practitioner will guide the business through the process. These are qualified and licensed individuals appointed from private firms, so they have no attachment to the business or other interested parties.
Enacted for the benefit of creditors, administration places all of a company’s assets under a protective ‘moratorium’. This stops dead all forms of creditor action and places the business under the power of appointed administrators.
These administrators have the power to look for a buyer for the insolvent business and to trade on the business. Administration may also entail a ‘pre-packaged insolvency’, which entails negotiating the sale of all or part of the company’s assets or business before appointing an administrator. The administrator than effects the sale shortly after the appointment.
Largely replaced by administration since the Enterprise Act 2002, some companies still find themselves under administrative receivership.
This process enables the holder of a floating charge against the company in question (which pre-dates the 15th of September 2003) to appoint a receiver/manager to sell or ‘liquidate’ the assets of the company in order to pay off secured debts.
There is no authority under which administrative receivers can pay unsecured creditors, as this usually requires more asset liquidation. An administrative receiver must apply for court permission to make payments such as these.
Company Voluntary Agreement
As the name might suggest, this is an agreement that a company and its creditors agree to. A CVA is legally binding and regulated .
In this arrangement, creditors will usually agree to an agreed (usually reduced or rearranged) debt repayment schedule that will, hopefully, enable the company to survive. Some insolvency procedures combine a CVA with Administration.
Scheme of Arrangement
Usually more complex that a CVA, a scheme of arrangement usually takes place with considerably large companies with a large amount of different creditors and/or shareholders.
A scheme of arrangement is an arrangement arrived at between a company and their creditors, shareholders or members. A scheme of arrangement must receive approval from a court before it becomes official.
The terms of repayment for creditors is usually agreed between them and the business, and set down in official documentation.
This is the most extreme end of corporate insolvency. Under liquidation, all of a company’s assets – goods, property, manufacturing equipment and so forth, are sold and converted to money.
This money then goes to either shareholders or creditors. If the business is insolvent, then the money from liquidation goes to creditors. If the business is solvent, then it goes to the shareholders.
In this arrangement, a liquidator may also investigate director behaviour and assess whether they were at fault and, if necessary, take further steps.
Liquidation, like administration, has prescribed priorities in who receives money from liquidation, depending on the amount raised:
- Secured creditors
- Expenses resulting from the liquidation itself
- Fees for the insolvency practitioner(s)
- Preferential claims of creditors’ – including those by employees of the company
- The prescribed part – money set aside for unsecured creditors
- Secured creditors – this could mean the realisation of floating charges
- Claims of unsecured creditors
- Shareholders – they rarely receive anything from a company in the grips of insolvency