Month: January 2021

Purpose

The IA 1986 gives both a liquidator and an administrator the ability to challenge certain transactions that have taken place within specified statutory periods prior to the insolvency of a company (or bankruptcy of an individual). These are known as ‘voidable’ or ‘antecedent’ transactions. The aim of a challenge is to restore the company to the same position it would have been in had the transaction not taken place and thereby, increase the funds available in the insolvent estate for the benefit of creditors.

Effect of an order

These provisions are often described as ‘clawback’ provisions which can result in an order reversing transactions or more usually, providing for financial restitution to be paid, in order to increase the assets of the insolvent company for the benefit of creditors. It is the beneficiary of the transaction with the insolvent company that is the target of the proceedings, rather than the directors of the company responsible for entering into the transaction. This rule is subject to ss.241(2) and 241(2A) which protect bona fide purchasers for value without notice who were not a party to the original transaction.

In addition, it should be noted that responsibility for entering into a voidable transaction is a relevant factor to which a court shall have regard when considering whether to make a disqualification order against a director for unfitness, and may also render the director liable for misfeasance.

Litigation expenses

Any legal challenge will involve litigation expenses (including the fees of the liquidator or administrator and potential liability for adverse costs if the action is unsuccessful). A major factor to be taken into account by a liquidator or administrator will be the cost of any legal challenge, given the inevitable risk that if the challenge fails, the assets will have been diminished (by the legal expenses and any adverse costs incurred) rather than increased.

The Insolvency Rules 2016 provide for the recovery by the liquidator of costs and expenses out of the company’s assets in a statutory order of priority and they allow recovery of costs and expenses relating to the conduct of any legal proceedings which he has power to bring or defend. A liquidator can therefore recover the costs of the litigation out of the assets in the insolvent estate even if he loses his challenge.

Purpose

Any breach of duty by the directors is generally actionable by the company only. On a winding up, typically it will be the liquidator, not the company, who will bring an action against the directors under s.212 for any breaches of duty committed by them.

Section 212 does not create any new liability or rights but simply provides a summary procedure to enable the company (acting by its liquidators) to pursue claims against directors who have breached their duties. Where a person’s liability is established, the court may order that person to compensate the company in respect of money or property misapplied as a result of the misfeasance.

Who may bring a claim? – s.212(3)

1. a liquidator (but note, not an administrator);
2. the Official Receiver; or
3. any creditor or contributory.

Against whom can a claim be brought? – s.212(1)

1. any person who is or has been an officer of the company (including present or former directors, managers or secretaries of the company);
2. any others who acted in the promotion, formation or management of the company; and
3. a liquidator or administrative receiver (a claim for misfeasance can also be brought against an administrator under Schedule B1 to the IA 1986).

What can amount to misfeasance?

Misfeasance covers the whole spectrum of directors’ duties and therefore includes:

1. misapplication of any money or assets of the company;
2. breach of a statutory provision or a duty, for example:
   1. unlawful loans to a director;
   2. a director entering into a contract with his own company and failing to notify the board (s.177 CA 2006);
   3. failing to seek prior general meeting approval where a director has entered into a substantial property transaction (s.190 CA 2006); and
   4. a director failing to act within his powers (s.171 CA 2006);
3. directors responsible for transactions at an undervalue as provided in s.238 (see section 9) or preferences as provided in s.239 may thereby commit a misfeasance; and
4. breach of the duty to exercise reasonable care, skill and diligence, i.e. negligence (s.174 CA 2006).

What about shareholder ratification?

As you are aware, ratification by the shareholders under s.239 CA 2006 can usually absolve the directors from personal liability for breach of duty. Ratification at a time when the company is solvent should therefore preclude misfeasance proceedings.

However, when a company is facing the prospect of insolvency, case law has established that the duties of directors shift towards the company’s creditors and away from the members as a whole. This is because in these circumstances, it is the creditors rather than the shareholders of the company who stand to lose if the directors breach their duties. Consequently, it is not possible for the shareholders to ratify what amounts to a breach of directors’ duty at a time when the company’s fortunes have declined to such an extent that there is a reasonable prospect that the company will go into an insolvent liquidation or administration. This is recognised in s.239(7) CA 2006 which provides that the ratification procedure does not prejudice any rule of law which provides that shareholder ratification is of no effect.

Relief

Relief under s.1157 CA 2006 (where the court is satisfied that the director acted honestly and reasonably and, having regard to all the circumstances of the case, ought fairly to be excused) is generally not available to wrongful trading claims as by definition, a director liable for wrongful trading has not acted reasonably.

Sanction

The court will examine the conduct of the director/other person and make an order for repayment, restoration or contribution to the company’s assets or such other order as it thinks fit.

A finding of misfeasance is also a relevant factor to which a court shall have regard when considering whether to make a disqualification order against a director for unfitness under s.6 CDDA 1986.

Disqualification of directors

Some of the grounds for a director to be disqualified particularly relate to insolvency, i.e.:

• fraud in a winding up (s.4 CDDA);
• unfit conduct of directors of insolvent companies (s.6 CDDA); and
• fraudulent and wrongful trading (s.10 CDDA).

A finding of misfeasance and/or responsibility for the company entering into any transaction at an undervalue (within s.238 – see section 9), a preference (within s.239 – see section 10) or a transaction defrauding creditors (within s.423 – see section 12) are also relevant factors to which a court shall have regard when considering whether to make a disqualification order against a director for unfitness under s.6 CDDA.

Where the court makes a contribution order against a director under ss.213, 214 or 246ZA or ZB, it also has a discretion to make a disqualification order against him/her under s.10 CDDA. The maximum period for disqualification under s.10 CDDA is 15 years.

Liability for fraudulent trading existed long before liability for wrongful trading was introduced. However, the high standard of proof required to establish liability for fraudulent trading has meant that proceedings have rarely been brought. Following criticism of the ineffectiveness of s.213, the concept of wrongful trading was introduced. This is now the major risk run by the directors of a company trading on the brink of insolvency. It is of interest to know that successful wrongful trading actions are still relatively rare and those actions which are brought usually settle without going to trial. Nevertheless, directors invariably take the risk of incurring wrongful trading liability very seriously and it is an important part of a lawyer’s job to advise on the risk and how to mitigate it.

Purpose

The IA 1986 was amended by the SBEEA 2015 so as to give the right to administrators to bring wrongful trading actions (originally, it was only available to liquidators). In the statutory references given below, the first reference is to the one which applies to liquidators and the second, to administrators. Substantively, the provisions are the same.

The purpose of ss.214 and 246ZB is to ensure that when directors become aware (or ought to become aware) that an insolvent liquidation (or insolvent administration, as the case may be) is inevitable, they are under a duty to do everything possible to minimise the potential losses to the company’s creditors. If they fail to do this, the court can, under ss.214 and 246ZB, order the directors to contribute to the insolvent estate by way of compensation for the losses that the general body of creditors have suffered as a result of the directors’ conduct, and thereby, increase the funds available for distribution to unsecured creditors in the insolvency. Wrongful trading liability therefore imposes personal liability on directors and marks a very important exception to the principle of limited liability under which those who run a company cannot be liable for its unpaid debts.

Note that there is no requirement to show intent or dishonesty and so it is easier for a liquidator or administrator to prove wrongful trading than it is fraudulent trading.

Who may bring a claim?

Liquidators and administrators may bring a claim (ss.214(1) and 246ZB(1)). Administrators and liquidators can now (under the SBEEA 2015) assign wrongful trading claims to a third party as a way of raising funds for the insolvent estate and thereby, avoid the risk of litigation.

Against whom can the claim be made? – ss.214(1) and 246ZB(1)

Any person who was at the relevant time a director (and this includes shadow directors as defined in s.251 CA 2006, de facto and non-executive directors).

Contrast this with fraudulent trading where a claim can be brought against any person who has the intention to commit a fraud.

Requirements for liability under ss.214(2) and 246ZB(2)

For a director to be liable for wrongful trading, the court must be satisfied that:

1. at some time before the commencement of the winding up or insolvent administration (for convenience, I will refer to that time as the ‘point of no return’)
2. the director knew or ought to have concluded that
3. there was no reasonable prospect that the company would avoid going into insolvent liquidation (or as the case may be, insolvent administration).

Note that a company goes into insolvent liquidation (or as the case may be, an insolvent administration) at a time when its assets are insufficient for the payment of its debts and other liabilities and the expenses of winding up (s. 214(6)) or, as the case may be, the expenses of the administration (s.246ZB(6)). Insolvency for wrongful trading purposes is therefore judged solely on the “balance sheet test” and not on the “cash flow test” (see s.123).

If the company has not reached the point of no return, then wrongful trading liability cannot arise and there is no need to consider the ‘every step’ defence which we consider below.

The ‘every step’ defence (ss.214(3) and 246ZB(3))

Assuming the company has reached the point of no return, a director may be able to escape liability if he can satisfy the court that, after he first knew or ought to have concluded that there was no reasonable prospect of the company avoiding an insolvent administration or liquidation (i.e. from the ‘point of no return’ onwards), he or she took every step with a view to minimising the potential loss to the company’s creditors.

Examples of evidence that may be supportive of establishing the every step defence include:

• voicing concerns at regular board meetings;
• seeking independent financial and legal advice;
• ensuring adequate, up-to-date financial information is available;
• suggesting reductions in overheads/liabilities;
• not incurring further credit; and
• consulting a lawyer and/or an insolvency practitioner for advice on continued trading and the different insolvency procedures.

The reasonably diligent person test (ss.214(4) and 246ZB(4))

The court applies the ‘reasonably diligent person’ test in ss.214(4) and 246ZB(4) in order to determine whether (i) a liquidator or administrator has established that a director ought to have concluded that there was no reasonable prospect of avoiding an insolvent liquidation or administration (the s.214(2)/s.246ZB(2) liability) and (ii) whether the director then took every step to minimise the potential loss to the company’s creditors (the s.214(3)/s.246ZB(3) defence).

Under that test, the facts which a director ought to have known or ascertained, the conclusions which he ought to have reached and the steps which he ought to have taken, are those which would have been known or ascertained, or reached or taken, by a reasonably diligent person having both:

1. the general knowledge, skill and experience that may reasonably be expected of a person carrying out the same functions as are carried out by the director in question (an objective test); and
2. the actual knowledge, skill and experience of that particular director (a subjective test).

The court then applies the higher of the two standards.

So, for example, although under the objective element to the test it might be reasonable to expect less of a director of a small company with less sophisticated financial systems than a much larger company, there is an objective minimum standard below which no director may fall. However, the court will also look at the subjective element to the test (i.e. the actual position of that director) and apply a higher standard if appropriate.

Directors should hold board meetings regularly and often to review the company’s financial position and consider whether in any particular case, it is appropriate to incur new credit and liabilities. They should write up minutes of each meeting so there is a written record on which the directors can later rely to justify why decisions were taken when they were. It is quite common for lawyers advising a company in financial difficulties to take an active role in helping directors to prepare minutes and to ensure that board meetings consider all the relevant issues.

Can a director avoid liability by resigning?

Sections 214(2)/246ZB(2) refer to a person who was a director at the relevant time. A director cannot therefore escape liability by simply resigning without previously taking every step with a view to minimising the potential loss to the
company’s creditors. In addition, a director who disagrees with how other directors are behaving should seek to persuade them to his point of view before resigning and only when he considers that he will not be able to do so may resignation be the most appropriate option.

Sanction

If a director is found to be liable for wrongful trading, the court can order that director to make such contribution to the assets of the company as the court thinks fit (ss.214(1)/246ZB(1)). The contribution will increase the assets of the company available for distribution to the general body of unsecured creditors.

The court has a wide discretion to determine the extent of the directors’ liability. Although ss.214 and 246ZB provide no guidance for calculating the amount of a director’s contribution, case law has clarified that the contribution will ordinarily be based on the additional depletion of the company’s assets caused by the directors’ conduct from the date that the directors ought to have concluded that the company could not have avoided an insolvent administration or liquidation (i.e. from the ‘point of no return’). An order by the court for a director to contribute to the company’s assets under ss.214 and 246ZB is compensatory and not penal in nature. An order to contribute may be made against the directors on a joint and several basis. However, the court has a discretion to apportion liability between directors based on their culpability by ordering the more culpable directors to pay more than the less culpable ones.

Under s.1157 CA 2006, the court may relieve a director from liability in proceedings for negligence, breach of duty or breach of trust, on such terms as it thinks fit, if satisfied that he/she acted honestly and reasonably, and having regard to all the circumstances of the case, the director ought fairly to be excused. However, that relief is not available in wrongful trading proceedings (Re Produce Marketing Consortium Ltd [1989] 1 WLR 745).

Where the court makes a contribution order against a director under ss.214/246ZB, the court also has a discretion to make a disqualification order against him/her under s.10 CDDA 1986.

Purpose

Sections 213 and 246Z impose a civil liability to contribute to the funds available to the general body of unsecured creditors suffering loss caused by the carrying on of the company’s business with intent to defraud. Additionally, there are criminal sanctions under s.993 CA 2006.

Who may bring a claim?

Originally, only liquidators could bring fraudulent trading claims. The SBEEA 2015 amended the IA 1986 to enable administrators to bring these claims as well. The relevant statutory provisions are s.213 for liquidations and s.246ZA for administrations. In the statutory provisions which are given below, the first section refers to the relevant provision for liquidations and the second for administrations. Substantively, the provisions are the same. Administrators and liquidators can now assign fraudulent trading claims to a third party as a way of raising funds for the insolvent estate and thereby, avoid the risk of litigation (similarly introduced by the SBEEA 2015, amending the IA 1986).

Against whom can a claim be brought?

A claim can be brought against any person (ss.213(2) and 246ZA(2)) who is knowingly party to the carrying on of any business of the company with intent to defraud creditors or for any fraudulent purpose (ss.213(1) and 246ZA(1)).

Requirements for liability under ss.213(1) and 246ZA(1)

Actual dishonesty must be proved. In practice, a very high standard of proof is required, which is likely to be extremely difficult for a liquidator or an administrator to establish. It is for this reason that claims for fraudulent trading are rare and claims for wrongful trading are more often brought against directors.

Defence

Dishonesty is assessed on a subjective not objective basis i.e. what the particular person knew or believed. Therefore, if the directors of a firm genuinely believed, however unrealistically, that ‘things would get better’ and the company would trade out of its difficulties, this would provide an effective defence, sometimes known as the ‘sunshine defence’.

Sanction

A person found to be liable under ss.213 and 246ZA can be ordered to make such contribution to the company’s assets as the court thinks proper. The court does not have the power to include a punitive element in the amount of any contribution to be made. The contribution should only reflect and compensate for the loss caused to the creditors.

Where the court makes an order against a person under ss.213 or 246ZA, and that person is also a director, the court is likely also to make a disqualification order under s.10 CDDA 1986.

In addition, criminal sanctions can be imposed by the court under s.993 CA 2006, to punish a person knowingly party to fraudulent trading, whether or not the company is being wound up. The penalties are imprisonment (of up to 10 years on indictment) and/or fines.

Introduction

The following posts will consider a number of statutory provisions in the IA 1986 which were enacted specifically to protect the creditors of insolvent or prospectively insolvent companies.

All of the provisions relate to a situation where a company enters into a formal insolvency procedure. Their aim is to enable the restoration of funds that ought to have been available to meet the claims of the company’s creditors as a whole. Most of the statutory provisions apply when a company is either in a liquidation or administration. The provisions do not apply to a company which is in administrative receivership or other type of receivership (except for proceedings relating to transactions defrauding creditors under s.423 which can be brought whether or not the company is in an insolvent procedure).

Both a liquidator and an administrator have the power to look back to a specific period before a formal insolvency procedure begins and to bring proceedings in which they request the court to make the necessary orders with a view to restoring the company’s position to what it would have been if the company had not entered into the transaction. The orders sought may include the unwinding of the transaction and hence the transactions are called voidable transactions. That said, often the office-holders are not seeking to unwind the transactions but rather to seek compensation that the company’s position is restored in monetary terms. It is important to note that the court has the power to make such order as it thinks fit.

Liquidators and administrators have the power to bring proceedings for compensation against the directors personally (for fraudulent trading and wrongful trading and in the case of liquidators only, for misfeasance).

Liability of directors for fraudulent and wrongful trading

The provisions on fraudulent and wrongful trading were enacted to prevent the reckless and negligent conduct on the part of those running companies. The concern is that directors may continue to incur further debts at a time when the company is in financial difficulty with no reasonable prospect of turning the company’s prospects around, with the result that losses to creditors are increased.

A liquidator will (and an administrator may) be required to distribute the assets of the company to its creditors by way of a dividend. This must be done in a specified order of priority in payment in accordance with complex rules. Inconveniently, these rules have no single source: they are found piecemeal in different parts of the IA 1986, the IR 2016, CIGA 2020 and general law. The following (simplified) order of priority in payment summarises the cumulative effect of these rules. This order assumes that that there is a QFC granted on or after the Relevant Date and assumes that where the company obtained a pre-insolvency moratorium, it has paid all moratorium debts and premoratorium debts without a statutory payment holiday which would otherwise have super priority status.

Administrators may also pay dividends to unsecured creditors if they have court permission to do so and the rules set out below will also apply to them. References below to ‘liquidator’ should also be read as including a reference to administrators. It should also be noted that the statutory order of distribution can be affected by priority or subordination agreements entered into by creditors under which one class of creditor agrees to rank behind another.

1. Liquidator’s costs of preserving and realising assets subject to a fixed charge
2- Fixed charge creditors (in respect of assets subject to a fixed charge)

The proceeds of selling assets which are subject to a fixed charge (or mortgage) must first be used to pay off the debt secured by such charge (or mortgage). The proceeds will be paid net of the liquidator’s costs and associated fees of realising the assets (that is, net of sums falling into the first category of priority above). If the proceeds are not sufficient to discharge the debt in full, then the creditor must await payment of the balance at an appropriate later point in the order of priority. This will depend on whether or not the same debt was also secured by a floating charge.

Note that secured creditors with a fixed charge are likely to enforce their security if a liquidator is appointed.

3. Other costs and expenses of the liquidation

This includes all other costs and expenses of the liquidation, including the costs of selling assets secured by a floating charge and the costs and expenses incurred in pursuing litigation. Such litigation will require prior approval from preferential creditors and floating charge holders, or alternatively from the Court, otherwise the liquidator cannot claim the costs of litigation. The reason for this rule is that it is these creditors who will effectively pay the costs of litigation should it fail.

4. Preferential debts (Schedule 6)

Although the EA 2002 removed the preferential status of certain Crown debts, some of these will soon be reinstated. The composition of the categories of preferential debts and their ranking has therefore become somewhat more complex than has been the case for some years.

For insolvencies occurring on or after 1 December 2020, there will be two tiers of preferential debts. The first tier must be paid in full before the secondary tier can be paid.

The first tier consists of the existing categories of preferential debts. The main ones are (i) employees for remuneration due in the four months before the ‘relevant date’ (generally the date of the winding up resolution or petition) but subject to a maximum of £800 per employee, plus accrued holiday pay and (ii) certain contributions owing to an occupational pension scheme. If the insolvent company is a bank or building society, certain retail deposits that are insured by the Financial Services Compensation Scheme will also be preferential debts.

The secondary tier consists of debts due within certain prescribed periods to HM Revenue and Customs in respect of PAYE, employee national insurance contributions and VAT. These represent taxes which companies collect on behalf of HMRC from third parties (employees and customers).

5. Prescribed part fund

The EA 2002 introduced the ‘prescribed part’ fund into the IA 1986 to increase the chance that unsecured creditors would get paid something in a liquidation. The prescribed part fund is sometimes referred to as the “ring fenced” fund.

The prescribed part fund is calculated by reference to a certain percentage (the ‘prescribed part’) of the company’s ‘net property’. This is set aside (ring-fenced) for distribution to the company’s unsecured creditors; s.176A. ‘Net property’ means the proceeds of selling property other than that which is subject to a fixed charge, after deduction of the liquidator’s expenses and any preferential debts. (The full definition in s. 176A (6) IA 1986 states: “… a company’s net property is the amount of its property which would, but for this section, be available for satisfaction of claims of holders of debentures secured by, or holders of, any floating charge created by the company”).

The amount of the company’s net property that will be ring-fenced is 50% of the first £10,000 and 20% thereafter up to a maximum fund of £600,000 for floating charges created before 6 April 2020 and £800,000 for floating charges created on or after that date. The ring-fencing provisions do not apply where the net property of the company is less than £10,000 as the cost of distributing the fund would be disproportionate to the benefit; see the Insolvency Act 1986 (Prescribed Part) Order 2003. You will not be required to calculate the amount of a ring-fenced fund on this course. This pot of money is reserved at this stage to be shared rateably among the unsecured creditors when they are paid. It should be noted that for this purpose, a floating charge holder who suffers a shortfall on floating charge realisations does not share in the prescribed part fund, although the shortfall does constitute an unsecured claim against the company.

Note: the ring-fencing provisions only apply to realisations from floating charges created on or after the Relevant Date. The holder of a pre-existing floating charge (created before the Relevant Date) therefore benefits from the abolition of the Crown Preference but does not suffer from the ring-fencing provisions.

6. Floating charge creditors

After payment of the general expenses of the liquidation, paying preferential debts and dealing with the prescribed part, the liquidator then pays any remaining realisations from assets subject to floating charges to the floating charge holders themselves (according to the priority of their security, if there is more than one floating charge holder).

7. Unsecured creditors

For example:

• ordinary trade creditors who have not been paid;
• secured creditors to the extent that the security is invalid or assets subject to the security have not realised sufficient funds to pay off the secured debt; and
• employees’ outstanding remuneration, to the extent that it does not rank preferentially.

All the unsecured creditors rank and abate equally. This is known as the ‘pari passu’ rule. For example, if a company has only two creditors (A and B) and creditor A has a claim against the company of 100 and creditor B has a claim against the company of 50 (making total claims of 150) but the assets available for distribution to the creditors are 75, creditor A will receive 50 and creditor B will receive 25.

Note that secured creditors who have not been paid in full from the realisation of assets subject to their security can only claim as unsecured creditors against realisations from unsecured assets, so they are not eligible to any payment from the prescribed part fund.

8. Interest on unsecured (including preferential) debts

Interest accruing on unsecured debts from the commencement of the winding up.

9. The shareholders

The shareholders who participate in the equity of the company will rank last. However, their rights, as between themselves, will depend on the rights attributable to their particular class or classes of shares. This will be written into the Articles of Association. For example, preferential shareholders may have preferential rights to a return of their capital on a winding up in priority to ordinary shareholders.

What is liquidation (otherwise known as winding up)?

Liquidation is the most basic and oldest of the corporate insolvency procedures. The liquidator’s function is to realise the company’s assets for cash, determine the identity of the company’s creditors and the amount owed to each of them and then pay a dividend to the creditors on a proportionate basis relative to the size of their determined claims (creditors of the same rank are said to rank ‘pari passu’). The ranking of creditors’ claims (that is, the order in which they must be repaid) is set out in the IA 1986, the IR 2016 and by general law.

Liquidation is not a rescue mechanism and a liquidator has only very limited powers to carry on the business of a company. He will usually close a company’s business and dismiss employees very soon after his appointment. He will usually sell assets on a piece-meal basis rather than selling the assets and business as a going concern. The statutory moratorium which applies in a liquidation is very limited. For these reasons, it is common for companies to enter into liquidation after having been through a different insolvency procedure (e.g. administration) first. In particular, the ability of an administrator to maximise value for creditors by selling a business as a going concern is an important advantage of administrations over liquidations. However, administrators do not generally have the power to pay a dividend to unsecured creditors (other than the prescribed part dividend out of the ring-fenced fund) and where there is a dividend to be paid to them, companies in administration may later enter into liquidation after the objective of the administration has been achieved and the administration comes to an end. In such a case, the main purpose of the liquidation will be to provide the mechanism for agreeing creditors’ claims and payment of a dividend to them.

Types of liquidation

There are two types of liquidation: compulsory and voluntary.

Voluntary liquidations are further divided into:

• members’ voluntary liquidations (which are solvent liquidations); and
• creditors’ voluntary liquidations (which are insolvent liquidations).

What follows liquidation?

The company’s life is generally brought to an end automatically by dissolution. In the case of a compulsory liquidation, this will be three months after notice by the liquidator to the Registrar of Companies that the winding up of the company has been completed. In the case of voluntary liquidation, dissolution will occur three months from the filing by the liquidator of the final accounts and return. On dissolution, the company ceases to exist.

Going into compulsory liquidation

Compulsory liquidation is a court based process for placing a company into
liquidation. To begin the process, an applicant presents a winding up petition to
the court under which the applicant requests the court to make a winding up
order against the company on a number of statutory grounds. The court issues
the petition and fixes a date for the hearing of the petition. The applicant then
serves the petition on the company.

The following can apply to the court for the issue of a winding up petition:

1. a creditor;
2. the company (acting by the shareholders; this would happen where there are insufficient assets in the company to fund a voluntary liquidator);
3. the directors (by board resolution); again, this would happen where there are insufficient assets to fund a voluntary liquidator;
4. an administrator;
5. an administrative receiver;
6. the supervisor of a CVA; and
7. the Secretary of State for Business, Energy & Industrial Strategy (on public policy grounds).

Given the ability of a QFCH to appoint an administrator out-of-court following the occurrence of an event of default under the relevant loan agreement, it is usually an unsecured creditor who will apply to the court for a winding up order. A secured creditor which holds only fixed charges (and so is not a QFCH) will usually enforce against the assets subject to its fixed charges by appointing a fixed charge receiver and will not usually resort to issuing a winding up petition.

Grounds of petition for liquidation

The usual grounds are:

1. insolvency, that is the company’s inability to pay its debts (s.122(1)(f) of IA 1986); or
2. the court being of the opinion that it is just and equitable that the company be wound up (s.122(1)(g) of IA 1986).

Technically, the just and equitable ground to wind up a company is not an insolvency situation.

Proof of inability to pay debts – s.123 of IA 1986

Methods

1. Failure by the company to comply with a creditor’s statutory demand. A statutory demand is a written demand in a prescribed form requiring the company to pay a specific debt. The statutory demand can only be used if the debt exceeds £750 and is not disputed on substantial grounds. The company has 21 days in which to pay the debt, failing which the creditor has the right to petition the court to wind up the company.
2. The creditor sues the company, obtains judgment and fails in an attempt to execute the judgment debt.
3. Proof to the satisfaction of the court that the company is unable to pay its debts as they fall due (the “cash-flow test”). The cash flow test is usually satisfied by going through the statutory demand process in 1 above but that is not essential.
4. Proof to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account contingent and prospective liabilities (the “balance sheet test”).

Note that some of the limbs of s.123 are very wide and borrowers will usually seek to restrict which limbs are deemed to be an insolvency event of default in their loan agreement with lenders.

Going into voluntary liquidation

Members’ voluntary liquidation (‘MVL’)

The MVL procedure is utilised only if the company is solvent. The procedure (set out in s.89(1)) is that the directors make a statutory declaration that the company will be able to pay its debts in full within a period specified in the declaration (not exceeding 12 months from the commencement of the winding up). The statutory declaration must attach a simplified form of balance sheet listing and giving values for the company’s assets and liabilities and showing that the assets exceed the liabilities.

The shareholders pass:

• a special resolution to place the company into an MVL; and
• an ordinary resolution appointing a liquidator.

Notice of intention to put a resolution for voluntary liquidation to the shareholders must be given in advance to any QFCH. Note that the MVL will be converted into a creditors’ voluntary liquidation (see below) if the company becomes unable to pay its debts within the period (invariably one year) specified in the statutory declaration.

Creditors’ voluntary liquidation (‘CVL’)

This is a form of insolvent liquidation commenced by resolution of the shareholders but under the effective control of the creditors who can choose the liquidator.

The procedure is for the shareholders to pass a special resolution to place the company into a CVL. The shareholders may also nominate a person to be liquidator, but in any event within 14 days of the special resolution being passed the directors of the company must ask the company’s creditors to either approve the nominated liquidator or put forward their own choice of liquidator. Where the creditors’ choice of liquidator differs from that of the company’s shareholders, the creditors’ nomination will take precedence. The directors must also draw up a statement of the company’s affairs (setting out the company’s assets and liabilities) and send it to the company’s creditors.

Effect of the pre-insolvency moratorium

A company cannot be placed into type of liquidation while a pre-insolvency moratorium subsists.

Liquidator’s powers and duties

The liquidator is the de facto agent of the company and has extensive statutory powers. The directors lose their powers upon the liquidator’s appointment. The liquidator’s powers include:

• To collect in and realise the company’s assets and to distribute them in the order of priority set out in IA 1986.
• To make any compromise or arrangement with creditors.
• To bring in or defend any action or legal proceeding in the name of and on behalf of the company.
• To maximise the assets available for distribution to the company’s creditors by:
  • challenging voidable antecedent transactions or to sue one or more of the directors for wrongful or fraudulent trading. It is of interest to note that liquidators (and administrators) also have the power to assign the right to wrongful and fraudulent claims as well as preference and transactions at an undervalue causes of action. This allows them to realise some money for the benefit of the estate without assuming the risk of litigating the claims; and
  • disclaiming onerous property (s.178) e.g. onerous, unsaleable or unprofitable contracts – this is available equally in both solvent and insolvent liquidations. The most important example of onerous property is a lease of land. When notice of disclaimer is given by the liquidator, all rights, interests and liabilities of the company in respect of the property cease. A person who suffers any loss resulting from a disclaimer is entitled to prove in the liquidation as an unsecured creditor, or in certain circumstances, to apply to the court for an order to have disclaimed assets vested in him.

Proceedings against the company

After presentation of a petition and before a winding up order is made, the company, or any creditor or contributory, can apply to the court to request it to make a provisional order to stay any action or proceedings then current against the company.

The effect of a winding up order will be automatically to stay any action or proceedings against the company, unless the court otherwise determines.

Until the implementation of the EA 2002, debentures generally provided lenders with a quick and (compared with administration) cheaper method of enforcement, through the appointment of an administrative receiver (‘AR’). Technically, the appointment of an AR is not an insolvency procedure but a procedure to enable a secured creditor to enforce its security by the realisation of the assets secured by the debenture.

The EA 2002 effectively abolished administrative receiverships in respect of QFCs created on or after the Relevant Date, except in respect of floating charges created as part of some special transactions. More importantly for present purposes, pre-Relevant Date QFCHs retain the right to appoint an AR; this is due to what are known as the grand-fathering provisions in the EA 2002.

For this reason, the following paragraphs apply only to pre-Relevant Date QFCs and QFCs created on or after the Relevant Date for the special transactions referred to in the preceding paragraph.

Because the AR owes his duty only to his appointor, QFCHs which took their security before the Relevant Date are in a better position than later QFCHs. Most tried to retain that security when refinancing the debt secured by a pre-Relevant Date QFC, rather than release the security and replace it with new security.

However, as the rescue culture engendered by the EA 2002 has taken hold and as lenders have become comfortable with the administration procedure, banks have become much less inclined to appoint an AR even if they have the right to do so and are much more likely in this situation to appoint (or encourage the directors to appoint) an administrator. Accordingly, administration has for some years now replaced administrative receivership as the main means of enforcing a fixed and floating charge, regardless of when the charge was created.

An administrative receiver cannot be appointed if a pre-insolvency moratorium subsists or if the company is in administration.

Appointment of administrative receivers

The holder of a floating charge created before the Relevant Date can appoint an AR without much formality, provided that in essence the floating charge meets the criteria of a QFC and its terms confer on the QFCH the right to do so. The appointment can be made very quickly (usually within a few hours on a business day) either (i) following the occurrence of an event of default under the terms of the relevant loan agreement and the charge holder accelerates the loan and makes demand for immediate repayment and the debtor does not satisfy the demand, or (ii) where the loan is repayable on demand (such as an overdraft), following the charge holder making demand for repayment and again, the debtor does not satisfy the demand.

Powers of administrative receivers

• All the express powers are set out in the debenture (the security documentation incorporating the floating and fixed charges); and
• Unless expressly excluded, the AR also has extensive powers set out in Schedule 1 to the IA 1986 (these are the same powers that are granted to an administrator).

The AR’s most important power is to take possession of, get in and sell the assets of the company and repay the debenture holder. There is no moratorium whilst the AR is doing so, thus any creditor can seek to exercise its rights and remedies e.g. to petition to wind up.

The administrative receiver’s role and duties

• The AR is required to be a licensed insolvency practitioner.
• Although nominally the agent of the company, the AR owes his primary duty to his appointor, and generally owes only a limited duty to the company and other creditors. The company as principal is not able to give instructions to the AR.
• The AR is both a receiver and a manager (you will recall that fixed charge receivers are receivers only and are not normally entitled to manage a company’s business). The AR’s role is to take possession of the assets secured by the charge under which he is appointed. Usually the assets are sold (preferably on a going concern basis), with the AR and his staff in the meantime running the business with the assistance of existing workforce (and perhaps the existing management).
• The order of priority for payments on the realisation of assets by the AR is essentially the same as on winding up.;

As the name suggests, a fixed charge receiver is appointed by the holder of a fixed charge in the circumstances set out in the loan or security documentation (e.g. on the occurrence of the usual types of events of default found in loan agreements). He will have certain limited powers set out in the Law of Property Act 1925 (‘LPA 1925’) and any additional powers (which are generally fairly extensive and include a power of sale) set out in the security documentation.

A fixed charge receiver becomes the receiver only of the property charged and is only entitled to deal with that property. He is not normally entitled to deal with any other property of the company or to manage the company’s business.

Fixed charge receivers are sometimes referred to as “LPA receivers”. Technically speaking, they are different. Fixed charge receivers are appointed pursuant to powers contained in a fixed charge or mortgage whereas a LPA receiver is appointed under the terms of the Law of Property Act 1925. Most receivers encountered in practice are fixed charge receivers because, as referred to above, this type of receiver has a more extensive set of powers.

A fixed charge receiver cannot be appointed while a pre-insolvency moratorium subsists or if the company is in administration.

Administration is an insolvency procedure introduced by IA 1986. It has been the most common and important insolvency procedure since 2003 but this is unlikely to remain the case now that the CIGA 2020 has introduced the new preinsolvency moratorium. That said, if a company enters into a formal insolvency procedure, it will probably enter into administration first and that will possibly be followed by a restructuring plan, a CVA, scheme or a liquidation.

A very important feature of administration is the creation of a moratorium which continues throughout the period of the administration. This provides the company in administration with a breathing space to achieve the purpose of the administration, as the moratorium prevents creditors without court or administrator consent from exercising their usual rights and remedies e.g. the right to enforce their security or in the case of a landlord, from attempting to terminate a lease by exercising a right of re-entry, or in the case of a creditor who has supplied goods on retention of title, from attempting to take possession of the goods to which it has title.

Administrators can be appointed either by court order or out of court (usually by directors or holders of “qualifying floating charges”). The methods of appointment are discussed below.

Qualifying Floating Charges

In practice the most important and common form of company security is a debenture which contains a floating charge and which, together with any fixed charge or other security, creates security over the whole or substantially the whole of the company’s assets. The debenture will usually include a provision giving the debenture holder (usually a bank) the right to appoint an administrator following the occurrence of an event of default under the loan agreement. This right is the central remedy available to a debenture holder to enforce its security.

The debenture holder has the right to appoint an administrator only if the floating charge created by its debenture is a Qualifying Floating Charge. This is defined in Schedule B1, paragraph 14 IA 1986 and includes a floating charge over the whole or substantially the whole of the company’s property (either alone or in conjunction with other security) and the charging document either states that paragraph 14 applies to the floating charge or purports to give the holder of the floating charge the right to appoint either an administrator or an administrative receiver (‘AR’). The holder of such a charge is called a Qualifying Floating Charge Holder (‘QFCH’).

A floating charge is a charge which, as created, was a floating charge and therefore includes any floating charge which has crystallised (i.e. converted into a fixed charge either as a matter of law or pursuant to the terms of the
debenture). It has the following characteristics:

1. it is a charge over a class of assets of the debtor/chargor;
2. the assets change from time to time in the ordinary course of the chargor’s business; and
3. the chargor remains free to deal with those assets in the ordinary course of its business until crystallisation of the charge (e.g. on winding up or other event specified in the debenture).

Statutory purpose of an administration – Schedule B1, paragraph 3(1)

The EA 2002 introduced a single statutory purpose for appointing an administrator divided into three cascading objectives:

1. The primary objective is the rescue of the company as a going concern.
2. If (1) is not reasonably practicable or would not achieve a better result for the creditors as a whole, then the objective is 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.
3. If neither (1) nor (2) is reasonably practicable and provided an administrator does not unnecessarily harm the interests of the creditors as a whole, then the objective is realising property in order to make a distribution to one or more secured or preferential creditors.

It is the administrator who decides which of the objectives it will be reasonably practicable to achieve and his view might change as the administration proceeds. In practice, the first objective is only rarely achieved. Most administrations will have the second or third objective.

Going into administration

Who can apply to the court to appoint an administrator?

The following parties can apply to the court for an administration order:

1. the company itself (i.e. acting with the authority of a resolution passed by the members in general meeting);
2. the directors of the company (by board resolution);
3. a creditor;
4. the supervisor of a CVA; and
5. a liquidator.

Who can use the out-of-court procedure to appoint an administrator?

1. the directors of the company;
2. a QFCH; and
3. the company acting through its members.

Nowadays, the most common method for appointing administrators is a directors’ out-of-court appointment. This is true even if there is a QFCH as QFCHs often do not like the publicity associated with appointing administrators. That said, a QFCH will usually be able to influence the timing of a directors’ appointment. Appointments by the company (acting through the members) are very rare. Appointments by court order are fairly uncommon; the usual case when this happens is where a creditor has begun winding up proceedings against the company and the directors wish to appoint administrators before the court has made a winding up order. In this situation, the out-of-court appointment procedure is not available to the directors and they must apply to court for an order to appoint administrators. If the court makes an administration order, the pending winding up proceedings are automatically dismissed.

Note that where there is an outstanding winding-up petition, a QFCH may still use the out-of-court procedure to appoint an administrator, in which case the petition is automatically suspended.

The out-of-court procedure differs depending on who appoints the administrator. If a QFCH appoints the administrator, it files a notice of appointment at court and the appointment commences on the date of the filing (subject to serving notice on any prior QFCH). If the directors or the company appoint the administrator, then they must file notice of intention to appoint an administrator at the court and serve it on any QFCH, identifying the proposed administrator and giving the QFCH five days’ notice of its intention to file a notice of appointment with the court. The QFCH then may appoint its own choice of administrator within the five day period (assuming its security is enforceable and it has the right to appoint administrators at this point of time) or it will do nothing and will allow the directors to continue with the appointment process. The directors will do this by filing a notice of appointment with the court within a further five day window. The administrators are appointed immediately on the filing of the notice of appointment. It follows from this that the QFCH is usually able to override the directors’ or company’s choice of administrator. In practice (and as mentioned above), the appointment of an administrator usually takes place at a time decided upon by the QFCH and the QFCH will liaise with the directors when it is ready and request the directors to appoint the administrators which it has chosen. Where the directors do this, the appointment can take place very quickly and it is usually possible for the directors to file the notice of intention to appoint administrators, to obtain the consent of the QFCH to the appointment and then to file the notice of appointment within a few hours.

As mentioned above, a company cannot enter into administration if it has obtained a pre-insolvency moratorium unless the directors appoint the administrators.

Administration moratorium

The appointment of an administrator creates an immediate moratorium on certain creditor action whereby (except with consent of the court or the administrator in each case):

1. no order or resolution to wind up the company can be made or passed;
2. no administrative receiver of the company can be appointed;
3. no steps can be taken to enforce any security over the company’s property or to repossess goods subject to security, hire purchase and retention of title;
4. no legal proceedings, execution or other process can be commenced or continued against the company or its property, and
5. a landlord cannot forfeit a lease of the company’s premises by means of peaceable re-entry.

There is also an interim moratorium if an application is made to court for the appointment of an administrator or a notice of intention to appoint the administrator is filed. Neither of these steps prevents a QFCH from appointing its own choice of administrator out-of-court (assuming its security is then enforceable and gives it the right to appoint an administrator).

The powers and duties of the administrator

Pending the appointment of an administrator, the directors remain in control of the company. They should merely preserve the company’s business and assets until the administrator is appointed and thereafter the administrator takes on the running of the business.

Note: following his appointment, an administrator must publicise his appointment and whilst the company is in administration, all business stationery must state that the company is in administration. The appointment of the administrators may adversely affect the company’s ability to enter into new contracts and/or obtain payment of outstanding invoices.

Duties

The administrator will run the company and its business with the aim of achieving the purpose of the administration. The directors are unable to exercise any management power without the consent of the administrator.

The administrator acts as agent of the company and incurs no personal liability on contracts he causes the company to enter into provided he acts within his powers.

The administrator is an officer of the court (even if appointed using the out-of-court procedure) and has a duty to the court and a duty to act in the interests of all the creditors.

Powers

Administrators have wide powers and these are set out in Schedule 1 to the IA 1986. An administrator’s powers include the power to carry on the business of the company, take possession and sell the property of the company, raise money on security and execute documents and deeds in the company’s name. As a general rule, administrators do not have the power to pay a dividend to unsecured creditors without obtaining court permission. They can pay a dividend to secured creditors out of the proceeds of the creditor’s security and can now (as result of the changes brought about by the Small Business Enterprise and Employment Act 2015) pay the prescribed part dividend to unsecured creditors out of the “prescribed part” (or ring-fenced) fund which we describe below. That aside, if there is a dividend to be paid to unsecured creditors, either the administrator will have to seek permission from the court to make the payment, or the administrator will propose a CVA or scheme on terms that he (acting as supervisor under the CVA) has the power to make dividend payments, or the administration will come to an end and liquidators (who will usually be the same individuals as the administrators) will be appointed to make the distribution.

The administrators’ appointment terminates automatically after 12 months. This period can be extended once by up to one year if the creditors agree. The court can also sanction any other extensions (which may be for more than one year).

The administrator (like a liquidator) has powers under the IA 1986 to apply to court and ask the court to make an order to set aside (avoid, or “claw back”) certain voidable transactions which occurred in defined periods before the start of the administration. They are known as “antecedent transactions”. One example is a transaction at an undervalue. These orders are sought with the aim of increasing the pool of the company’s assets available to creditors. Under the changes brought about by the Small Business, Enterprise and Employment Act 2015, administrators, like liquidators, now have the power to sue directors for wrongful or fraudulent trading.

Administrators can, in certain circumstances, bring the administration to an end without court involvement by filing the appropriate notice with the court. An example of when this procedure can be used is when an out-of-court appointed administrator believes that the purpose of the administration has been sufficiently achieved.

Pre-Pack Administrations

This term refers to the situation in which the administrator sells the business and assets of the company as a going concern very soon after his appointment. The terms of the sale agreement are negotiated and agreed before the administrators’ appointment and become immediately effective following the appointment. Pre-packaged sales have the advantage that the goodwill and continuity of the business are not damaged by the administration and certainty of result is achieved for the creditors.

Whilst these types of administration sales have been very common, some have argued that pre-packaged administration deals lead to a poor recovery for creditors as they are carried out without proper marketing of the assets and there is some doubt whether the administrators have satisfied their basic duty to sell the company’s assets at the best price reasonably obtainable. There is particular suspicion of pre-packaged sales where the buyer is a company owned by the directors or shareholders of the insolvent company. As such, pre-pack administrations have been controversial and in 2010 they were the subject of OFT calls for better regulation and transparency. The insolvency profession has responded to these calls and for some years, there has been more selfregulation imposed by relevant regulatory IP bodies and under these regulations (known as SIP 16) administrators must adhere to strict procedures reflecting best practise so that they can justify the price that is paid for the assets sold in a pre-packaged sale. Under the Small Business Enterprise and Employment Act 2015, there is a prospect that the relevant government department will receive enabling powers to make regulations prohibiting sales (including prepackaged sales) to connected companies unless certain conditions are fulfilled.