Corporate Insolvency

Insolvency occurs when an individual or business does not have sufficient assets to cover its debts, or where they are unable to pay their debts as they become due. The procedure to be followed differs depending on whether the insolvent concerns an individual or company. For individuals who are unable to pay their debts, one the most common routes to take is to file for bankruptcy. But how do company directors know if their company is insolvent, and how can a sinking company be brought back afloat? 

Definition of Corporate Insolvency 

The core legislation that governs this area is the Insolvency Act 1986, but the law underwent significant change when the Corporate Insolvency and Governance Act 2020 came into force. 

In the UK, insolvency refers to the state of a company deemed unable to pay its debts, which occurs where a company either: 

• Fails to comply with a statutory demand for payment of a debt over £750 

• Fails to satisfy enforcement of a judgement debt 

• Is unable to pay its debts as they fall due (the cash flow test) 

• Has liabilities exceeding its assets, taking into account contingent and prospective liabilities (the balance sheet test) 

Whilst insolvency is a perilous position, it does not necessarily mean a company is beyond rescue. As such, insolvency procedures are grouped into two kinds:  

1. Procedures that allow for the rescue of a company in financial difficulty 

2. Procedures that only concern the rescue of the business and the cessation of trade and realisation or distribution of assets 

Overview of the ‘rescue’ insolvency procedures 

The recent introduction of the Corporate Insolvency and Governance Act 2020 introduced new permanent measures as well as insolvency procedures as a means of tackling COVID-19 related financial distress (and beyond). The permanent measures included a free-standing moratorium and restructuring plan, as detailed below. 

Administration 

Administration is an insolvency procedure designed to allow a company ‘breathing space’ by protecting the company from creditors trying to enforce their debts whilst financial restructuring plans are put in place. An administrator is appointed who has the power to any decisions in relation to managing the business. 

Although the administrator may ultimately sell the business and its assets, a company can continue to trade under administrative control. Where the company is successfully rescued (in whole or part), the company can then be passed back into directorial ownership. 

Pre-packaged administration occurs where the sale of the business is agreed in advance of an administrator being appointed and is finalised as soon as the appointment is made. 

Administrative receivership 

If a company is loaned money, the lender can ask for security over certain assets. This makes the lender a secured creditor with a fixed of floating charge. Receivership is a remedy for secured creditors, which allows them to appoint an administrative receiver to sell the company’s assets and use the assets to cover the debt. The receiver only owes a duty to the debtor that appointed them rather than unsecured debtors in general. This route is now incredibly rare and has been virtually abolished.  

Company Voluntary Arrangements (CVA) 

A CVA regards a legally binding agreement made between a company and its creditors to repay debts over a fixed period of time. These payment renegotiation plans become binding on all creditors if approved by the appropriate majority of creditors. They can also be negotiated, and implemented, outside of court under the supervision of an insolvency practitioner. A company need not be insolvent to use this procedure.  

Again, unlike administration, CVAs allow the opportunity for companies to remain under directorial control. However, there is no automatic moratorium to protect against creditors taking action against the company.  

Scheme of arrangement 

A scheme of arrangement, as introduced by the Companies Act 2006, is an arrangement between a company and its creditors, which is made binding by approval by a majority of creditors. Unlike a CVA, however, a scheme of arrangement must be sanctioned by the court, and once sanctioned becomes binding irrespective of whether individual has notice of the scheme of arrangement. These can again be used in conjunction with administration; however, a company need not be insolvent to use this procedure. 

Moratorium 

As introduced by the Corporate Insolvency and Governance Act 2020, a free-standing moratorium allows company directors some breathing space while they try to resolve any financial difficulties. Creditors are generally prevented from taking any action against the company. The focus of this is on recovery of the company rather than the realisation of assets. They are initially granted for 20 days but this can be extended. The directors remain in control of the business with a monitor (a licensed insolvency practitioner) supervising them. 

Restructuring plan 

Also introduced by the Corporate Insolvency and Governance Act 2020, restructuring plans are similar to schemes of arrangement but specifically target companies encountering financial difficulties. Nevertheless, again, a company need not be insolvent to use this procedure. 

Like schemes of arrangement, a restructuring plan entails a compromise or arrangement between the company and its creditors, allowing for restructuring of debt repayments. The relevant voting threshold is 75% of creditors so this remains unchanged from previous restructuring tools. However, there is a new cross-class cram-down feature which allows a plan to proceed in certain circumstances even if the class of creditors voted against it.  

Liquidation 

Liquidation (also known as winding up) is a final resort involving the court’s appointment of a liquidator who takes control of the company’s assets, selling them and distributing the proceeds to creditors. There exist two types of liquidation: 

• Compulsory liquidation, which is court-ordered 

• Voluntary liquidation, where a company goes into liquidation by resolution of its shareholders or directors