Chapter 11: Insolvency
Chapter learning objectives
Upon completion of this chapter you will be able to:
- explain the meaning of and the procedure involved in voluntary liquidation
- explain the meaning of and the procedure involved in compulsory liquidation
- explain and apply the rules in the 1997 UNCITRAL Model Law on Cross-Border Insolvency
- explain administration as an alternative to winding up
- compare administration and Chapter 11 Protection of US Bankruptcy Code 1972.
1 Voluntary liquidation: s84 Insolvency Act 1986 (IA 1986)
If a company finds itself in financial difficulty, the two main options available to it are:
- Administration. This aims to rescue the company so that it may continue trading as a going concern.
- Liquidation. This winds up the company, thus bringing its life to an end.
A voluntary liquidation occurs where the members pass a resolutionto go into liquidation. The type of resolution needed depends on thecircumstances:
- Where the period fixed for the duration of the company expires or an event occurs upon which the articles provide that a company should be wound up, an ordinary resolution must be passed.
- A special resolution must be passed if the company is being wound up for any other reason.
There are two types of voluntary liquidation:
- A members' voluntary liquidation is used where the company is solvent.
- A creditors' voluntary liquidation is used where the company is insolvent.
Distinctions between members' voluntary liquidation and creditors'voluntary liquidation are contained in s90 IA 1986 â€“ 'a winding up inthe case of which a directors' statutory declaration under s.89 has beenmade is a members' voluntary winding up; and a winding up in the caseof which such a declaration has not been made is a creditors' voluntarywinding up'. If in the course of voluntary winding-up it becomesapparent that the company will be unable to pay its debts, theliquidation automatically becomes creditors' voluntary liquidation.
Directors must have reasonable grounds for issuing declaration of solvency.
Members' voluntary winding up
Creditors' voluntary winding up
Converting a members' voluntary liquidation into a creditors' voluntary liquidation
If the liquidator discovers that the company's debts will not bepaid in full within the time specified in the declaration of solvency,members' voluntary liquidation is automatically converted into acreditors' voluntary liquidation.
Meetings of the company's creditors must be convened â€“ S96 IA 1986.
At the meeting the liquidator must:
- lay before the creditors a statement of affairs
- invite the creditors to appoint a different insolvency practitioner as liquidator
- invite the creditors to appoint a liquidation committee.
Test your understanding 1
Compare and contrast the characteristics of a members' voluntary winding up and a creditors' voluntary winding up.
2 Compulsory liquidation
Grounds for winding up by the court (s122 IA 1986)
A compulsory winding up commences when a petition for a winding up order is presented to the court.
The possible grounds for the petition are set out in s122 IA 1986:
- The company has passed a special resolution to be wound up by the court (s122(1)(a) IA 1986).
- A public company has not been issued with trading certificate within a year of incorporation (s122(1)(b) IA 1986).
- It is an old public company, within the meaning of the Consequential Provisions Act (s122(1)(c) IA 1986).
- The company has not commenced business within a year of being incorporated or has suspended its business for over a year (s122(1)(d) IA 1986).
- The company is unable to pay its debts (s122(1)(f) IA 1986). A company is deemed to be unable to pay its debts where a creditor who is owed at least Â£750 has served a written demand for payment and the company has failed to pay the sum due within three weeks (s123 IA 1986).
- It is just and equitable to wind up the company. However, the court will not make an order on this ground if some other more reasonable remedy is available (s122(1)(g) IA 1986).
The following persons may petition the court for a compulsory liquidation (s124 IA 1986):
- The company itself.
- The Official Receiver.
- The Department for Business, Enterprise and Regulatory Reform.
- A contributory (this is any person who is liable to contribute to the assets of the company when it is being wound up. The contributory must prove that the company is solvent).
- A creditor who is owed at least Â£750.
Effect of winding-up (s130 IA 1986)
The winding-up petition has the following effects:
- All actions for the recovery of debt against the company are stopped.
- Any floating charges crystallise.
- Any legal proceedings against the company are halted, and none may start unless leave is granted from the court.
- The company ceases to carry on business except where it is necessary to complete the winding up, e.g. to complete work-in-progress.
- The powers of the directors cease, although they still continue in office.
- The employees are automatically made redundant, but the liquidator can re-employ them to help him complete the winding up.
Test your understanding 2
Fill in the gaps in the following sentences:
The possible grounds for a compulsory liquidation petition are set out inâ€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦..:
- The company has passed a â€¦â€¦â€¦â€¦â€¦. resolution to be wound up by the court.
- A â€¦â€¦â€¦â€¦â€¦.company has not been issued with trading certificate within â€¦â€¦â€¦â€¦â€¦ of incorporation.
- A creditor who is owed at least â€¦â€¦â€¦â€¦has served a written demand for payment and the company has failed to pay the sum due within â€¦â€¦â€¦â€¦...
- It is â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦â€¦to wind up the company.
Application of assets
The liquidator must repay debts in the following order:
- Fixed charge-holders.
- Liquidator â€“ expenses and remuneration.
- Preferential creditors:
- wages or salaries due in the four months preceding the commencement of winding up (maximum Â£800 per employee)
- all accrued holiday pay.
All preferential creditors rank equally amongst themselves.
- Floating charge-holders.
- Unsecured creditors â€“ rank equally amongst themselves. The Enterprise Act 2002 introduced into the Insolvency Act 1986 a ring-fencing mechanism where part of assets which are subject to a floating charge are available to unsecured creditors. The amount ring-fenced is 50% of the first Â£10,000, plus 20% of the rest up to a maximum ring-fenced fund of Â£600,000.
- Post-liquidation interest.
- Members â€“ declared but unpaid dividends.
- Members â€“ return of capital (in accordance with class rights).
- Any surplus to be distributed to members.
Test your understanding 3
Sharepak Ltd is being wound up. Rank the following persons in the order in which they will be paid by the liquidator:
3 UNCITRAL Model Law on Cross-Border Insolvency
Illustration â€“ UNCITRAL Model law on Cross-Border Insolvency
Alphagroup is a large company with establishments in variouscountries. It becomes insolvent. Alphagroup has assets in six countriesand creditors in nine countries. How are the creditors, particularlythose in countries where Alphagroup does not have any assets, going toobtain payment for monies owed to them?
UNCITRAL have issued a Model Law on Cross-Border Insolvency to dealwith situations where an insolvent company 'crosses' nationalboundaries, by having creditors and/or assets in more than one state.Its stated purposes are listed in the preamble and are to promote:
- Co-operation between the courts/other authorities in one state with those in foreign states involved in cases of cross-border insolvency (CBI).
- Greater legal certainty for trade and investment.
- Fair and efficient administration of CBI that protects the interests of all creditors and other interested parties.
- Protection and maximisation of the value of the debtor's (the insolvent entity's) assets.
- Facilitation of the rescue of financially troubled businesses, thereby protecting investment and preserving employment (we will look at business rescue in the next section of this chapter).
The model law applies in four cases:
- Where assistance is sought in home state by a foreign court or representative in connection with insolvency proceedings being carried out in the foreign state (Article 1(a)).
- Where assistance is sought in a foreign state in connection with insolvency proceedings under home law (Article 1(b)).
- Where a foreign insolvency proceeding and a home proceeding concerning the same insolvent entity are taking place at the same time (Article 1(c)).
- Where creditors or other interested persons in a foreign state have an interest in requesting the commencement of, or participation in, a home insolvency proceeding (Article 1(d)).
Note: The model law is drafted to be adopted into a state'sown law, so the terms home and foreign have been used here todistinguish between the state adopting the model law, and the otherstates that it is dealing with. So for instance, in the case of the UK,home law would be proceedings in relation to IA 1986, as set out above.
The following definitions are given in the model law.
A foreign proceeding is a collective judicial oradministrative proceeding in a foreign state, including an interimproceeding, pursuant to a law relating to insolvency in which proceedingthe assets and the affairs of the debtor are subject to control orsupervision by a foreign court for the purposes of reorganisation orliquidation (Article 2(a)).
A foreign main proceeding is such a proceeding in the state where the debtor has its main centre of interests (Article 2(b)).
A foreign non-main proceeding is such a proceeding in a state wherethe debtor has any place of operations where the debtor carries out anon-transitory economic activity with human means and goods or services(Article 2(c)).
A foreign representative includes a person or body including oneappointed on an interim basis authorised in a foreign proceeding toadminister the reorganisation or the liquidation of the debtor's assetsor affairs or to act as a representative of the foreign proceeding(Article 2(d)).
A foreign court is a judicial or other authority competent to control or supervise a foreign proceeding (Article 2(e)).
Establishment â€“ means any place of operation where the debtorscarries out non-transitory economic activities with human means or goodsand services (Article 2(f)).
Access of foreign representatives and creditors to courts in home state
The Model Law gives the following rights to foreign representatives and creditors:
- Direct access to apply to a court in the home state (Article 9).
- Entitlement to apply to commence a proceeding in the home state if conditions are met under home law (e.g. if the UK were the home state, a foreign creditor owed more than 750 pounds sterling who has served a written demand and not been paid within three weeks could present a winding up order to a UK court) (Article 11).
- Foreign creditors given equal rights to home creditors, that is, they will be allocated payment according to the order of payment in home law (Article 13).
- Foreign creditors have the right to be notified of proceedings in the same way as home creditors are required to be (Article 14).
The fact of making such applications relates only to theapplication and does not open any of the parties involved to anyjurisdiction other than as relates to the application.
Recognition of a foreign proceeding and relief given
A foreign representative:
- may apply to a home court for recognition of a foreign proceeding in which he has been appointed representative (Article 15(1))
- must provide with the application evidence that the foreign proceeding exists/is legal and a statement of any other known foreign proceedings being carried out against the debtor (Article 15 (2) and (3)).
Under Article 17(1) a foreign proceeding will be recognised if:
- it meets the definition given in the Model Law
- the associated foreign representative meets the definition in the Model Law
- the application meets the criteria set out above
- the application has been submitted to the appropriate court.
Under Article 17 the court:
- must decide on the application at the earliest possible time (it can be terminated later if found to be granted wrongly)
- may grant interim relief during the application process (unless this would interfere with a foreign main proceeding)
- if recognised, must classify the proceedings as main or non-main according to the definitions.
Potential interim relief includes (Article 19):
- a stay of execution against the debtor's assets
- entrusting the administration of the assets to the foreign representative or a different representative
- any relief potentially available after recognition (see below).
Once a foreign proceeding has been recognised (Article 20):
- the foreign representative should inform the court of changes or other foreign proceedings that he is aware of from then on
- interim relief ceases
- the court may grant appropriate relief in order to protect the assets of the debtor or the interests of the creditors.
Such potential relief includes (Article 21):
- Parties are prevented from starting or continuing individual actions/proceedings against the debtor's assets, rights, obligations and liabilities (automatic if the proceeding is a main proceeding â€“ Article 20).
- Parties are prevented from executing against the debtor's assets (automatic if the proceeding is a main proceeding â€“ Article 20).
- The debtor is prevented from transferring, encumbering or disposing of (i.e. dealing with in any way) its assets (automatic if the proceeding is a main proceeding â€“ Article 20).
- Providing for the examination of witnesses, evidence or other information in relation to the proceedings.
- Entrusting the administration or the realisation of the assets to the foreign representative or other party (providing that home creditors are given adequate protection).
- Extending any relief given as interim relief.
- Granting any additional relief available under home law.
Concurrent proceedings: Chapter V
The following rules are set out for when more than one insolvencyproceeding is being carried out against the same debtor at the sametime:
- After a foreign main proceeding has been recognised, a proceeding under home law may only be commenced if the debtor has assets in the home state (Article 28).
- When insolvency proceedings are in process in the home state when an application is made for a foreign proceeding, relief granted in the foreign proceeding must be in line with home law and, if the home proceeding is determined to be the main proceeding, home law will apply to the main proceeding rather than the compulsory effects of a main proceeding being recognised above (Article 20).
- When insolvency proceedings in the home state are commenced after an application for recognition of a foreign proceeding, the relief granted in respect of the foreign proceeding should be reviewed and modified if necessary, any relief granted under Article 20 should be consistent with home law.
Administration involves the appointment of an insolvencypractitioner, known as an administrator, to manage the affairs, businessand property of a company. It was first introduced by Schedule 16 IA1986, but has subsequently been amended by the Enterprise Act 2002.
Administration is often used as an alternative to putting a company into liquidation, e.g. to:
- rescue a company in financial difficulty with the aim of allowing it to continue as a going concern (Schedule B1, para 3(1)(a))
- achieve a better result for the creditors than would be likely if the company were to be wound up (Schedule B1, para 3(1)(b))
- realise property to pay one or more secured or preferential creditors (Schedule B1, para 3(1)(c)).
The administrator can only use the third option where:
- he thinks it is not reasonably practicable to rescue the company as a going concern, and
- where he thinks that he cannot achieve a better result for the creditors as a whole than would be likely if the company were to be wound up, and
- he does not unnecessarily harm the interests of the creditors of the company as a whole.
Who can appoint an administrator?
An administrator can be appointed by any of the following persons:
- The court in response to a petition by e.g. a creditor, the directors or the company itself (Schedule B1, para 11 in conjunction with para 12).
- The holder of a qualifying floating charge over the company's assets (Schedule B1, para 14(1)).
- The company provided that winding up has not already begun â€“ Sch.B1, par.22(1).
- The directors of the company (Schedule B1, para 22(2)).
With the exception of appointment by court order, an administratorcan be appointed without the involvement of the court. In fact, thecourt will only agree to appoint an administrator if it is satisfiedthat:
- the company is or is likely to become unable to pay its debts, and
- the administration order is likely to achieve its objectives.
Consequences of administration: Schedule B1, para 40
The appointment of an administrator has the following effects:
- The rights of creditors to enforce any security over the company's assets are suspended (Schedule B1, para 43(2)).
- There can be no enforcement of charges, retention of title clauses or hire-purchase agreements against the company.
- Any petition for winding up is dismissed (Schedule B1, para 40(1)(a)).
- No resolution may be passed to wind up the company (Schedule B1, para 42(2)).
- The directors still continue in office, but their powers are suspended.
Carrying out the administration
The administrator has a number of tasks:
- He is the company's agent, but must act in the best interests of all the company's creditors (Schedule B1, para 69). He can do anything necessary for the management of the company.
- He has wide powers to manage the business and property of the company, including the power to bring and defend legal proceedings, sell assets and borrow money (Schedule B1, para 59(1) and (2)). With regard to selling assets this includes property which is subject to both fixed and floating charges, which may be disposed of without the consent of the charge holder, although they retain first call against any money realised by the sale of the asset.
- He has the power to remove and replace directors and employees. If an employee's contract is not adopted by the administrator within 14 days, that employee is made redundant (Schedule B1, para 61(a) and (b)).
- He must draw up a statement of his proposals for achieving the purpose of administration (Schedule B1, para 49(1)). This proposal must be submitted to a meeting of creditors for approval within eight weeks of the commencement of administration (Schedule B1, para 49(5)). Please note that the period specified in this paragraph may be varied in accordance with paragraph 107.
- If the meeting does not approve the proposals, the court may dismiss the administrator or make such provisions as it sees fit (Schedule B1, para 22(2)).
- If the meeting approves the proposals, the administrator must report this decision to the court (Schedule B1, para 53(2)(a)); the registrar of companies (Schedule B1, para 53(2)(b)) and such other persons as may be prescribed (Schedule B1, para 53(2)(c)) and then can carry them out.
The administrator also has a number of legal duties. As soon as is reasonably practicable after appointment:
- He must send notice of appointment to the company and publish notice of appointment.
- He must obtain a list of company creditors and send notice of appointment to each.
- Within 7 days if appointment, he must send notice of appointment to the registrar.
- He must ensure that every business document of the company bears his identity as administrator.
Ending the administration
The administration will end when it is completed or when the administrator is discharged by the court:
- The administration must normally be completed within 12 months of the date on which it commenced (Schedule B1, para 76). However, this term can be extended with the consent of the court or the secured creditors (Schedule B1, para 76(2)(a) and (b)).
- The administrator may apply to the court for discharge at any time (Schedule B1, para 79(1)). He must make an application when the purpose of the order has been achieved (Schedule B1, para 79(3)(b)). He may also file a notice to the registrar and all of the creditors (Schedule B1, para 80(2)).
Chapter 11 of the US Bankruptcy Code 1972 is the US corporatereconstruction model which we can compare with the UK model outlinedabove.
The purpose of Chapter 11 procedure is to:
- provide a moratorium for the company
- so that it can put forward a proposal to creditors
- to preserve the business by restructuring debt and/or equity.
During the moratorium period the company:
- is temporarily relieved of paying pre-petition debts
- needs only to pay post-petition wages, expenses, taxes and administrative expenses
- has an automatic stay of all actions against the company and its property
- formulates a 'plan of reorganisation' which must then be approved by the creditors to go ahead.
The procedure is:
- initiated by application to the court
- may be voluntary (application by the company) or involuntary (application by the creditors)
- usually voluntary
- available to solvent companies.
Once a Chapter 11 proceeding has been granted:
- Existing management continue to manage and control the company, unless there is shown to be fraud, dishonesty or gross mismanagement, in which case the court will appoint a trustee to control the company.
- The company has a 120-day exclusivity period in which to file a plan of reorganisation (this period can be extended by court order if the court sees fit subject to complex rules).
- A trustee will be appointed by the US Department of Justice to deal with administrative issues and oversee the appointment of a creditors' committee.
- A creditors' committee must be consulted on all major decisions relating to the company.
- The company may obtain super-priority financing, for which the new lender has particular priority and rights.
- The company is given certain flexibility relating to existing contracts and may negotiate suspended debt with creditors to attempt to come to a settlement when the moratorium is over.
If the company does not file a plan of reorganisation, such a plan may be filed by:
- the trustee
- the creditors' committee
- a single creditor
- an equity security holders' committee
- a single equity security holder.
Test your understanding 4
Compare and contrast the US and the UK corporate recovery models.
Test your understanding answers
Test your understanding 1
A voluntary winding up takes place when the company resolves byspecial resolution to be wound up for any cause whatsoever: S84Insolvency Act 1986.
In both cases of voluntary winding up the passing of theresolution, which must be advertised within 14 days in the LondonGazette, has the following consequences:
IThe winding up commences from the time of the passing of the resolution.
II The company ceases to carry on business, except in so far as is necessary for its beneficial winding up.
IIIAll transfers of shares, except those made with the concurrence of the liquidator, are void.
In the case of a members' voluntary winding up, the directors mustmake a declaration of solvency stating that after full inquiry into thecompany's affairs they are of the opinion that the company will be ableto pay its debts within 12 months of the commencement of the winding up.In a creditors' voluntary winding up, such a declaration is notpossible owing to the circumstances leading to the winding up. In amembers' voluntary winding up, the liquidator is appointed by themembers and is accountable to them. In a creditors' voluntary windingup, both members and creditors have the right to nominate a liquidatorand, in the event of dispute, subject to the right of appeal to thecourts, the creditors' nominee prevails. Here the liquidator isprimarily accountable to the creditors.
In a creditors' voluntary winding up, the resolution is followed bya creditors' meeting where it is possible for a liquidation committeeto be appointed. Such meetings form no part of a members' voluntarywinding up.
Test your understanding 2
The possible grounds for a compulsory liquidation petition are set out in s122 IA 1986:
- The company has passed a special resolution to be wound up by the court.
- A public company has not been issued with trading certificate within a year of incorporation.
- The members of a plc have fallen below the statutory minimum of two.
- A creditor who is owed at least Â£750 has served a written demand for payment and the company has failed to pay the sum due within three weeks.
- It is just and equitable to wind up the company.
Test your understanding 3
The liquidator will repay in the following order:
(1)Midwest Bank â€“ the charge on the companyâ€™s headquarters is a fixed charge therefore it has priority over any other debts.
(2)Mrs Patel â€“ employees who are owed holiday pay are classed as preferential creditors
(3)Barlloyd Bank â€“ the chargeover all the companyâ€™s current assets is a floating charge and ranksafter fixed charge & preferential creditors.
(4)HMRC â€“ the Enterprise Act 2002 removed HMRC from the category of preferential creditors. They now rank as unsecured creditors.
(6)Ordinary shareholders â€“ the ordinary shareholders will share in any surplus assets.
Test your understanding 4
The aim of both of the models is to allow the company 'breathing space' to work out a plan of survival.
Created at 5/24/2012 2:50 PM by System Account
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Last modified at 5/25/2012 12:54 PM by System Account
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