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 administration as an alternative to liquidation.

1 Voluntary liquidation: s84 Insolvency Act (IA 1986)

Introduction

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 resolution to go into liquidation. The type of resolution needed depends on the circumstances:

• 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.

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 be paid in full within the time specified in the declaration of solvency, he must convert the members' voluntary liquidation into a creditors' voluntary liquidation. This is done by convening a meeting of the company's creditors.

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: 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.
• A public company has not been issued with a trading certificate within a year of incorporation.
• The company has not commenced business within a year of being incorporated or has suspended its business for over a year.
• The company is unable to pay its debts. A company is deemed to be unable to pay its debts where a creditor who is owed at least £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. However, the court will not make an order under this ground if some other more reasonable remedy is available.

Petitioners

The following persons may petition the court for a compulsory liquidation:

• the company itself
• the Official Receiver, who is a civil servant in The Insolvency Service and is an officer of the Court
• the Department for Business, Innovation and Skills
• 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 £750.

Effect of winding up

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 the directors remain in office.
• The employees are automatically made redundant, but the liquidator can re-employ them to help him complete the winding up.

Subsequent procedures

Test your understanding 2

Fill in the gaps in the following sentences:

The possible grounds for a compulsory liquidation petition are set out in .................... :

AThe company has passed a .................... resolution to be wound up by the court.

BA .................... company has not been issued with a trading certificate within .................... of incorporation.

CA creditor who is owed at least .................... has served a written demand for payment and the company has failed to pay the sum due within ....................

DIt is .................... to wind up the company.

Application of assets

The liquidator must repay debts in the following order:

• fixed charge-holders.
• expenses of liquidation.
• preferential creditors
  • wages or salaries due in the four months preceding the commencement of winding up (maximum £800 per employee)
  • all accrued holiday pay.

  All preferential creditors rank equally amongst themselves.

• floating charge-holders.
• unsecured creditors – 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 £10,000, plus 20% of the rest up to a maximum ring-fenced fund of £600,000.
• post-liquidation interest.
• members – declared but unpaid dividends.
• members – 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:

Preference shareholders.

Mrs Patel – an employee who is owed holiday pay of £1,000.

Barlloyd Bank – which has a charge over all the company’s current assets.

Midwest Bank – which has a charge on the company's headquarters.

HMRC – which is owed corporation tax of £15,000.

Ordinary shareholders .

3 Administration

Purpose

Administration involves the appointment of an insolvency practitioner, known as an administrator, to manage the affairs, business and property of a company. It was first introduced by Schedule 16 IA 1986, 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
• achieve a better result for the creditors than would be likely if the company were to be wound up
• realise property to pay one or more secured or preferential creditors.

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
• the holder of a qualifying floating charge over the company's assets
• the company or its directors provided that winding up has not already begun.

The court will only agree to appoint an administrator if it is satisfied that:

• 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

The appointment of an administrator has the following effects:

• the rights of creditors to enforce any security over the company's assets are suspended
• there can be no enforcement of charges, retention of title clauses or hire-purchase agreements against the company
• any outstanding petition for winding up is dismissed
• no resolution may be passed to wind up the company
• 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. 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. With regards 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.
• He can pay out monies to secured or preferential creditors without the need to seek approval of the court. He can also pay out monies to unsecured creditors but this must be with the approval of the court.

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 will arrange for certain relevant people to provide a statement of affairs of the company.
• He must ensure that every business document of the company bears his identity as administrator and a statement that the company affairs and property are being managed by him.
• Based on the statement of affairs, he must draw up a statement of his proposals, which must be approved at a meeting of creditors within eight weeks of the commencement of administration.
• If the meeting does not approve the proposals, the court may dismiss the administrator or make such provisions as it sees fit.
• If the meeting approves the proposals, the administrator can carry them out.

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. However, this term can be extended with the consent of the court or the secured creditors.
• The administrator may apply to the court for discharge at any time. He must make an application when the purpose of the order has been achieved. He must also notify the registrar and all of the creditors.

4 Chapter summary

Test your understanding answers

Test your understanding 1

A voluntary winding up takes place when the company resolves by special resolution to be wound up for any cause whatsoever: S84 Insolvency Act 1986.

In both cases of voluntary winding up the passing of the resolution, which must be advertised within 14 days in the London Gazette, 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 make a declaration of solvency stating that after full inquiry into the company's affairs they are of the opinion that the company will be able to pay its debts within 12 months of the commencement of the winding up. In a creditors' voluntary winding up, such a declaration is not possible owing to the circumstances leading to the winding up. In a members' voluntary winding up, the liquidator is appointed by the members and is accountable to them. In a creditors' voluntary winding up, both members and creditors have the right to nominate a liquidator and, in the event of dispute, subject to the right of appeal to the courts, the creditors' nominee prevails. Here the liquidator is primarily accountable to the creditors.

In a creditors' voluntary winding up, the resolution is followed by a creditors' meeting where it is possible for a liquidation committee to be appointed. Such meetings form no part of a members' voluntary winding up.

Test your understanding 2

The possible grounds for a compulsory liquidation petition are set out in s122 IA 1986:

AThe company has passed a special resolution to be wound up by the court.

BA public company has not been issued with a trading certificate within a year of incorporation.

CA creditor who is owed at least £750 has served a written demand for payment and the company has failed to pay the sum due within three weeks

DIt is just and equitable to wind up the company.

Test your understanding 3

The liquidator will repay in the following order:

Midwest Bank – the charge on the company's headquarters is a fixed charge.

Mrs Patel – employees who are owed holiday pay are classed as preferential creditors.

Barlloyd Bank – the charge over all the company's current assets is a floating charge.

HMRC – the Enterprise Act 2002 removed HMRC from the category of preferential creditors. They now rank as unsecured creditors.

Preference shareholders.

Ordinary shareholders – the ordinary shareholders will share in any surplus assets.

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