Corporate Insolvency Notes for exam PDF

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Notes on corporate insolvency - the law and processes...

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Corporate Insolvency Introduction  

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Insolvency refers to the company’s inability to pay its debts (s122 and s123 IA 1986) Two tests: 1. Cash flow test: a creditor may take insolvency proceedings against a debtor company who simply fails to pay its debt. Not having enough money to pay debts when they fall due (company’s assets could technically be greater than its liabilities but could have cash flow issues) 2. Balance sheet insolvency test: absolute insolvent. The creditor establishes that value of the company’s assets is less than the value of its liabilities and that the company is unable to pay its debts It might not be the ned of the company, nor does it automatically lead to liability for the company’s directors There are many costs of insolvency: immediate/wider costs

Terminology     

Insolvency: where liabilities exceed assets, or debts cannot be paid when they are raised Winding up/liquidation: the death of a company, that can wind up solvent or insolvent companies Administration: when the company is in administration, can go down the corporate rescue route or into liquidation Bankruptcy: refers to individuals not companies Dissolution: the final stage where the company is removed from the register

Underlying principles of insolvency 

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Collectivity: collecting assets from the company and distributing them to creditors according to their respective priority. Creditors are bound by process and are prevented from taken individual action. BUT if the majority of creditors vote on something they are all bound Equality and equity: same creditors/charges will be treated similarly - Parri Passu Distribution: creditors should share rateably in any distribution of assets BUT subject to rights of secured creditors and preferential creditors - Treating creditors fairly Accountability: administrator is accountable to all parties - Preventing removal of assets from insolvent estate: anti deprivation role - Recognition of parties pre insolvency rights (e.g. contractual rights) BUT this is subject to removal of assets and statutory inference (floating charge holders) Multiple values approach: valuing both economic and non-economic consideration Creditor wealth maximisation: maximising return to creditors Communitarianism: weighing the interest of different parties, saving of viable enterprises as well as distributing assets

Corporate Rescue 

The business might be a better option than winding up the company – the development of corporate rescue culture is reflected in the Insolvency Act - Re Paramount Airways [1995]: “The rescue culture, which seeks to preserve viable businesses, was and is, fundamental to much of the Act in 1986” – Lord Browne Wilkinson

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Benefits of corporate rescue: - Saving the company: creditors agree to take less or delay repayment (debt restructuring) - Saving the business: keep the viable parts - Improve realisation: asset/business sale that is outside liquidation will often be more profitable

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s1 (1): Arrangement between company and creditors either: “Composition in satisfaction of the company’s debt” = creditors accept less than amount due OR: “scheme of arrangement” = creditors agree to delay payment of debts of change terms

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“the compounding creditors agree with debtor and expressly or impliedly with each other, to accept from the debtor payment less than the amounts due to them in full satisfaction of the whole of their claims”: IRC v Adams [2001] - Mummery LJ

Company Voluntary Arrangements (CVAs)   

Moratorium = period of time where the creditors can’t take action against the company (useful because you don’t want to be sued whilst you’re trying to fix things) Without moratorium = Part 1, 1A IA 1986 – common With moratorium = Sch A1 IA 1986 – only available to small companies, so is not popular as it is more complex

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To obtain a moratorium, you have to file: 1. The proposal for the voluntary agreement 2. A statement of the company’s affairs 3. A statement that the company is eligible for a moratorium 4. A statement from the nominee giving his consent to act 5. A statement from the nominee that, in his opinion: “the proposed voluntary arrangement has a reasonable prospect of being approved and implemented, and the company is likely to have sufficient funds available to it during the proposed moratorium period to enable it to carry on its business”

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Process: 1. CVA overseen by “Supervisor of CVA”  Must be Insolvency Practioner or otherwise authorised by Secretary of State to be a Supervisor: s7 IA 1986

2. Once approved, binds all creditors who are party to the CVA  Binds all creditors – not just those who voted in favour of it  CVA proposal must receive 75% approval of creditors, by value  Can’t have 50% or more who votes against it, in numbers 3. Aim of CVA is usually to rescue the company:  “True” corporate rescue – but not particularly popular  Can be complex/expensive – smaller companies less likely to use CVA’s  Directors remain in control (different from liquidation/winding up) Administration 

This is the main rescue procedure; most administrations go under s8 IA & Sch B1 IA 1986 – the aim is not rescue the company or secure better realisation than on liquidation

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Moratorium applies during administration, as it gives the company breathing space and protects them from hostile creditors

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Administration is a collective insolvency procedure: - The administrator acts interests of all creditors and must be qualified Insolvency Practitioner  Administrator can be appointed by: o The court under Administration Order o Holder of qualifying floating charge o Company or its directors: (will be this in 80% of cases when the director puts the company into administration)

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Administration objectives Schedule B 1

- Administrator must perform functions with one of three objectives:

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a) Rescuing company as a going concern b) Achieving better result for company’s creditors as a whole than likely if the company were wound up c) Realising property in order to make distribution to one or more secured or preferential creditors. Must follow a) unless the administrator thinks it’s not reasonable to achieve, or that b) would achieve better result for company’s creditors as a whole. In practice b) is far more common You would only pursue c) if it’s not reasonably practical to achieve a) or b)

Administrator takes over management of the company: Sch B1, para 59 and Sch 1 IA

- Gives them the power to do anything necessary/expedient for management of affairs/business/property of company 

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Administrator makes proposals for achieving purpose of administration (the objective/s) - Creditors meet to approve or reject the proposals and you need a majority in value of creditors present and voting Administrator carries out function to achieve objectives:

- Must perform functions as quickly and efficiently as it reasonably practical

- Must perform function in interest of creditors as a whole, unless administrator seeking objective c): then they must not “unnecessarily harm” the interest of creditors 

Pre pack administrations: - Sometimes before a company goes into administration there are meetings with lawyers, directors and insolvency practioners so that as soon as you go into administration everything is ready to go. - Pre-arranged sale of the company’s business/assets immediately following appointment of administrator (even before the first meeting with creditors), the sale proceeds will then be distributed to creditors) - Happens is 30-50% of administrations - Validity of pre packs accepted by the courts: Re Hellas: courts don’t really like it but it’s up to the creditors to take action if they don’t like it

- Merits: Speed, lack of publicity, increase chance of business survival, another company might by assets from within the failing company, more money for creditors, may increase realisations, costs minimised, quickly removes uncertainty as they won’t be in administration for long Concerns: Kayley Vending: “speed and secrecy…may too easily lead the directors and the insolvency practioner to arrive at a solution which is convenient for both of them and their interests” – could harm the interests of general creditors, doesn't allow for statutory scheme where creditors vote on plans, phoenixing – sale is often to the director of connected person, lack of independent scrutiny, secured creditor benefits most, full value may not be realised – secrecy/speed restricts advertising (danger of undervalue if sale to connected party)  Statement of Insolvency Practice No 16: administrator must tell creditors within 7 days of pre pack administration. Still problematic to be provided info after the vote 

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Collective process: - Part 26 Companies Act 2006 - Provides mechanism to come to arrangement with creditors  Need separate meetings of different classes of creditor and member and court approval  Comparatively complex and expensive Workouts and debt restructuring:

- Contractual arrangement for reorganisation, is not part of statutory scheme, requires support of major creditors (banks) 

Receivership and Administrator Receivership: - Can work for a single secured creditor who can work towards selling an asset to pay their debt - Will likely lead to liquidation as they are taking the best assets - Receiver appointed by secured creditor with floating charges over all or most of the company’s assets

- Can only appoint admin receiver in respect of floating charged created before 15th September 2003

- CREDITOR WITH FLOATING CHARGE WILL NOW USE ADMINISTRATION Winding Up/Liquidation 

The realisation and distribution of the assets of a company to its creditors in the order provided in the Act. Liquidation may be voluntary or compulsory. It brings about the end of a company’s life by automatic dissolution.

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Steps: 1. Commence liquidation proceedings 2. Appoint liquidator (or official receiver), who will administer winding up  Once a liquidator has been appointed an administrator cannot be 3. Liquidator collects company’s assets and can review past transactions 4. Liquidator distributes assets in the statutory order to the creditors 5. Company is dissolved

Members voluntary liquidation: SOLVENT         

Members voluntary winding up only for solvent company If the company is solvent, but the members wish to wind up the company, it may put itself into voluntary liquidation The directors must make a Statutory Declaration of Solvency s89 (1) IA stating that the company will be able to pay its debts in full for 12 months A Special Resolution approving the Members Voluntary Liquidation within 5 weeks An ordinary resolution appointing a liquidator Must be lodged at Companies House in 15 days (s84(1) and 89 (3) Within 28 days the liquidator must notify all creditors of his appointment S91(2) director’s powers cease but are not removed from office S94 (1) once wound up must hold a general meeting which he shows his accounts of insolvency to the members

Creditors voluntary winding up: INSOLVENT    

S90 IA Creditors entitled to appoint liquidator and may appoint liquidation committee The company must convene a meeting and pass an Extraordinary Resolution (s84(1)(c) and an Ordinary Resolution (s100 (1)) A creditors meeting it then convened at which the creditors may veto the company’s choice of liquidator

Compulsory winding up: By the court  

Company wound up following petition presented to the court who may then appoint a provisional liquidator immediately if thought necessary in the public interest. Petition will most likely be presented by a hostile creditor

Process 1. Petition presented to the court  Must be petitioner within s124 - Most petitions are brought by creditors - Other main petitioners are: company, directors, contributory/ies = s79, office holders (Insolvency Practioner, supervisor of CVA, administrator) - Public interest petition by Secretary of State: s124A 

Rely on one of the grounds in s122 - Company unable to pay its debts: (f)  Statutory demand: s123(1)(a) – non-payment following written demand in prescribed form for due debt of over £750  Filed execution of judgement: s123(1)(b) – attempt to get payment on judgement debt through court process has failed  Cash flow test: s123(e) – company unable to pay its debts as they fall due o s23 (1) (a) o Currently payable and future debts are relevant – more likely to find cash flow test if there are coming up debts o Re Cheyne Finance Ltd: court could take into accounts debts falling due in the future o Cash flow test is not absolute insolvency, so evidence that company has surplus of assets over liabilities doesn’t in itself prevent petition: Cornhill Insurance o DISPUTED DEBTS: where petition based on non-payment of debt, debt must be genuine and not disputed – Taylors v M&H • If debt is disputed on genuine grounds, petition usually dismissed: Mann v Goldstein (cannot be disputed on frivolous or without substance) BECAUSE the petitioner will not have locus standi: Mann v Goldstein (the winding up jurisdiction is not for the purpose of deciding a disputed debt) • It is not the role of the courts to resolve factual disputes: Selectmove • Failure to pay undisputed debt is prima facie evidence of inability to pay debts: Taylors Industrial Flooring v M&H Plant Hire o CROSS CLAIM: petition usually dismissed if company has cross claim that equal too or exceeds the claimed debt. Re Bayoil SA: Norse LJ: Must be genuine and serious cross claim for amount exceeding the petitioners debt o If there is a disputed debt or cross claim, whether the petition is dismissed is up to the discretion of the court: Parmalat  Balance sheet test: s123(2) – value of company’s assets less than amount of company’s liabilities o Even if company managing to pay debts as they fall due o It is usually relatively easy to determine o BNY Corporate Trustee v Eurosail: SC = Necessary for the court to consider all the evidence when determining whether a company is balance sheet insolvent, various factors such as the timing of future liabilities can make it harder to establish that a company fails the balance sheet test

2. Service of petition on company  Petition served at company’s registered office  Informs company 3. Advertisement (notice)  Petitioner must give notice in London Gazette at least 7 days after service and at least 7 days before hearing 4. Hearing  Winding up Order made, or petition adjourned or dismissed 

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Making a winding up order: at the discretion of court – s125(1) - But if the petitioner has locus standi, has grounds for petition and has legitimate interest in winding up, court would need some special reason why order should not be made: Re Demaglass Holdings Reasons for rejecting petition:

- Disputed debt/cross claim - Failure to give notice - Improper purpose:  

Petitioner seeking private advantage or has ulterior motive: Greenwood: creditor doing it for their own benefit only, rather than than for creditors at large But malicious motive alone is not sufficient: Mann v Goldstein (personal hostility, venom, ulterior motive) – more practical approach as its not uncommon for creditors to have strong feelings about a debtor

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Effects of a winding up order: - Liquidator:  Liquidator appointed (Official Receiver becomes liquidator unless and until replacement appointed: s136(2).  Liquidator takes control of company’s property and business, with the function (s143) to bring in company’s assets and distribute them. Also investigate company’s affairs and reports to DBIS - Directors:  Power of director’s cease: Re Farrows Bank – not express in the act but their role ceases when the liquidator comes in  Company could no longer employee the director: Measures Brothers Ltd v Measures - Employed  Employments terminated – winding up order operates as notice of dismissal - Stay on legal proceedings  Pending legal proceedings halted and no new proceedings can be started without leave of the court: s130 (2)  Allows liquidator to administer winding up without harassment from legal action

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When does winding up commence? s129 - Compulsory winding up: the time of the presentation of the petition for winding up, so winding up effectively back dated once order is made

In compulsory winding up, s127 (transactions after commencement of winding up) operates between the presentation of the petition and the making of the winding up order Voluntary winding up: the time of the passing of the resolution for voluntary winding up – s86 

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Assisting the liquidator    

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Liquidators functions and investigations are assisted by extensive powers – directors and other are obliged by statute to assist the liquidator General obligations: cooperate with liquidator – s235 Specific obligations: deliver up company’s property, books, papers and records on demand – s234 Proactive obligations: R v McCredie – require officers of the company to be pro-active, and not merely reactive. They must help the liquidator actively in discovering company property unknown to the liquidator and the requirements are not dependant on a prior request May be called to attend public or private examination: s236 – application by liquidator or Official Receiver, with the purpose to assist liquidator in carrying out role and obtain information not obtainable in interview Public examination: s133 – Application by Official Receiver. Purpose is to form basis of report for disqualification, offences, obtain material information, give publicity to facts and features of company’s failure

Distribution of assets Principles 

Anti-deprivation principle: - The rule seeks to prevent removal of assets at, or just before point of insolvency, to prevent creditors depriving other creditors of assets - Ex Jay: cannot have property going to someone else, and be taken away from his creditors after bankruptcy – Cotton LJ - Transactions at an undervalue - Must not interfere with proper commercial bargains: Belmont Park Investments  Parties can avoid the rule provided genuine commercial purpose and no intent to evade insolvency law: - Lomas v JFB Firth Rixon: Held: commercial objective was to explicitly deprive creditors benefitting from the agreement – was void contrary to public policy

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Swelling assets: - Through transaction avoidance, preference payments, action against directors. Can only bring in assets that belong to company and are available for distribution (some assets not available for creditor – Return on Investment Clauses

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Parri Passu Distribution:

- Principle where the assets of a company in liquidation are shared equally amongst

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unsecured creditors in proportion of their debt. It only deals with the dregs of money that are left over after secured creditors and liquidators fees paid. Will not be relevant when its insolvency liquidation. Keay & P Walton: principal has been eroded significantly and remains only as a theoretical doctrine Other creditors may avoid pari passu through other means (set off, retention of title)] Creditor cannot contract out of pari passu distribution to own benefit:  NatWest v Halesowen But they can agree to subordinate debt and agree to rank behind others provided it does not affect other creditors: Re Maxwell Communications (No 3)

Securities to charges 

Often nearly all assets subject to charge – fixed or floating. - M...