Insolvency has taken on a whole new meaning in the Covid-19 world we are living in. But, what are the rules as we knew them… Training Link’s Jennifer Nyland takes a look for us.
A company is insolvent when it can’t pay its debts. This could mean either it can’t pay bills when they fall due or it has more liabilities than assets on its balance sheet. A company may also be forced into an insolvent procedure either by the Court because it is just and equitable, it hasn’t traded for over a year since incorporation, or the process may be forced by a creditor.
We learn throughout our studies about company formation and the statutory requirements of preparing accounts, but what about when the life of that company comes to an end and it runs out of money?
Ending a business is a traumatic but often a necessary procedure if the business is under performing, has creditor pressure, or has had customers fold on them.
It is important to note that anyone dealing with formal Insolvency Proceedings and taking ‘appointments’ must be licenced by a governing body, they are known as Licenced Insolvency Practitioners (IP). The Official Receiver (OR) is an exception to this rule as they are civil servants working on behalf of the Insolvency Service, and they are an officer of the Court.
Insolvency proceedings are dealt with under their own law, by way of an Act and Rules with accompanying schedules. It is known as the Insolvency Act 1986 (IA1986). Insolvency is very technical and complex area, but in this article I intend to give a very simple outline and the specific terminology used in the different processes of:
1: Individual/personal insolvency procedures.
2: Corporate insolvency proceedings.
3: The order of distribution to the creditors.
1: Personal insolvency/sole trader
This type of insolvency will only relate to an individual (a sole trader or as part of a partnership, or be working under PAYE).
Bankruptcy: This is the oldest form of insolvency, dating back to 1572 when the first piece of legislation appeared in England (it was called the Statute of Bankrupts 1542). Bankrupts were then seen as crafty individuals that would obtain others good and flee to places unknown. This Act gave the Lord Chancellor the power to imprison these people, take their assets and sell them for true satisfaction and payment of the creditors.
The Insolvent Debtors (England) Act 1813 gave rise to the possibility that debtors could request release from jail after 14 days by taking an oath that their assets didn’t exceed £20, and the Bankrupts (England) Act 1825 allowed people to start processing their own bankruptcies. While the general principle remains the same, the stigma surrounding bankruptcy has changed, you can no longer be sent to prison and you’re no longer seen as a crafty crook.
Bankruptcies are now looked at by a person from the Insolvency Service, known as an ‘adjudicator’, who will then decide if you should be made bankrupt. A creditor may also petition for your Bankruptcy at the Court. Initially, it is dealt with by the OR, who will be appointed as the Trustee.
All assets belonging to the individual and/ or has an interest in, will vest in the Trustee, meaning they are available for the Trustee to sell. This includes their cars, homes, watches and jewellery, etc. Tools of the trade and basic living essentials are not included, but if you have a Rembrandt hanging on the wall, be prepared to lose it!
Individual Voluntary Arrangement (IVA): This is a procedure that is dealt with only by an IP. It is essentially a deal that is done to pay the creditors so many pence in the £ over a period of around four to five years.
The debtor will approach an IP and request they become their Nominee to deal with the arrangement. A proposal is drafted and sent to all known creditors. If approved, the Nominee then becomes the Supervisor of the arrangement.
In short, the debtor will pay a monthly amount that is collected and then paid to the creditors (generally they are around 40p in the £). However, the interest in any home, buildings or land will have to be dealt with in year 4, which could mean the re-mortgage or the sale of the equity.
2: Corporate insolvency
The most ‘exciting’ insolvency processes happen in the corporate world, they encapsulate huge buyouts, trading administrations and major deal making.
However; most newspapers and other media giants fail to recognise the proper terminology
and function of the IP. These following processes can only take place over Limited Companies and LLP’s.
Compulsory Liquidation (Winding Up): Initially dealt with by the OR, this type of insolvency will have been processed by the Court by issue of a Statutory Demand. Then, upon failure to pay, compound or satisfy, a Winding Up Petition will be served upon the debtor by a creditor.
This is then be passed to the OR who will act as the Liquidator, providing certain conditions are met. If the case is too big an IP can be appointed who will then act as Liquidator.
All the company assets will be under the control of the liquidator and it is his/her duty to realise these for the benefit of the creditors and investigate the director’s conduct for the entire period they have been a director. They will also look at shadow directorships and the reasons for the failure.
Creditors’ Voluntary Liquidation (Winding Up): This type of liquidation is as it reads, it is voluntary. The Director of the company with agreement of the members (shareholders) resolve to place the company into liquidation as the company is unable to pay its debts. This process is undertaken by the IP and does not require a Court hearing. Creditors are informed a meeting that will take place in the future to place the company into liquidation.
Once this has happened the IP is then the Liquidator of the company, and as above, has a duty to realise the assets for the benefit of the creditors and investigate the Directors conduct for the entire period they have been a director, they will also look at shadow directorships and the reasons for the failure.
Company Voluntary Arrangement (CVA): This procedure is the same as the IVA but for a company. The company can continue trading during the CVA and afterwards. A CVA can be proposed by the company’s directors, but not by its shareholders or creditors.
Administration: This is the most versatile process, but certain conditions must be met in order to place the company into Administration. The process is done always via an application to Court and can be done by the Company, its Directors, Company creditor(s) or the holder of a floating charge. The OR does not have any function in this type of process.
Administration has to achieve one or more
of the following objectives:
a. Rescuing the Company as a going concern, or
b. Achieving a better result for the company’s creditors as a whole than would be likely if the company were wound up (without first being in administration), or
c. Realising property in order to make a distribution to one or more secured or preferential creditors.
Once appointed, the Administrator will take over the running of the company and work for the benefit of the company creditors and realise a better result. Directors will lose their powers and the Administrator (IP) can replace and appoint new directors. The Administrator will work to establish subsidiaries, raise or borrow money and grant security over property or bring and defend any legal action.
Administration is very powerful, but is only commonly seen with large businesses that have a trading value or a value to be sold.
3: The order of distribution to creditors
When the assets have been realised (this can take years on large cases) they will be distributed to the creditors in the following order of preference.
• Secured creditors with a fixed charge.
• Trustee/liquidator fees.
• Preferential creditors – employees and HMRC.
• Secured creditors with a floating charge.
• Unsecured creditors – trade creditors and suppliers.
• Unsecured creditors connected to the business (director wages, family members).
• Shareholders/bankruptee (if there is any surplus remaining).
Insolvency is a minefield of options and what ifs; professional advice should be sought immediately if a client is experiencing financial difficulty. It is important to note that as the accountant you will most likely be the second person to know the company is in financial difficulty (I say second, because one would think the director or individual would know first).
There are, however, certain warning signs that may alert you:
1: Payment demand letters arriving at the registered office.
2: A Statutory Demand (SD1) being served at the registered office.
3: Rushed requests for management accounts for the purposes of loans.
4: Delayed responses to furnish you with information.
5: Extending financial year ends.
• Jennifer Nyland, Training Link