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Corporate Law - Insolvency

Law (The University of Warwick)

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Insolvency I & II

Test for insolvency

Types of winding up – voluntary vs. compulsory

VOLUNTARY WINDING UP WINDING UP BY COURT ORDER

IA 1986, Ss.84-116 IA 1986, ss.117-162

Voluntary winding up by members Due to inability to pay debts  insolvency test

 When company is still solvent  IA1986, S.122(1)(f)  usually used as
 For it to be a members’ voluntary a remedy of last resort for unsecured
winding up, necessary for directors to creditors
make a declaration of solvency   “inability to repay debts”  defined in
otherwise, automatically become IA1986, S.123 –
creditors voluntary winding up IA1986, o S.123(1)(a)  cash-flow test
S.90  where a written demand
 “declaration of solvency”  IA1986, (in prescribed form) has
S.89 declaration to the effect that been served on a
o (1) the directors have made a company by a creditor
fully inquiry into the company’s owed more than £750 –
affair; and and the company has
o (2) formed opinion company been unable to pay in 3
will be able to pay debts in full weeks; or
within 12 months from the o S.122(1)(e) where proved
commencement of winding up company is unable to pay its
 if the company turned out to be unable debt as they fall due; or
to pay off its debts  rebuttable o S.123(2)  balance-sheet test
presumption that directors did not  proved the company’s
have reasonable grounds for their assets is less than its
opinion  false declaration without liabilities
reasonable grounds IA1986, S.89
 tough penalties, eg: imprisonment

Voluntary winding up by creditors On other grounds OR in the public interest

 When company is insolvent  IA 1986, S.122(1)(g)  winding up on
“fair and equitable” grounds

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o Remedy for minority

shareholders in a small company

Collective nature of liquidation

 Remember where a company is wound up (whether voluntarily or by the court) – the possibility
to bring litigation against the company / to execute a judgment / to enforce security right 
collective nature!
o Ie: the only way creditors can be satisfied is through the liquidation process
 The mandatory collective procedure is important because:
o Orderly distribution of assets
o Minimization of cost by avoiding multiple parallel procedures
o Saves court time + helps enforce relevant rules
o Removes incentives to dismantle assets which is bad for creditors
 This is due to the COMMON POOL PROBLEM

Process of winding up + role of liquidator

Creditors voluntary winding up Winding up by court order

Procedure  By special resolution of the Application for winding up by petition by

members S.84 S.124:
 Advertisement in the  The company;
Gazette within 14 days S.85  The company’s directors;
 Company’s creditors;
 Any contributories
o Broad technical meaning of
“every person liable to
contribute to the assets of a
company in event of being
wound up” S.79(1)
o But not all contributories
will actually have to
contribute any – eg: where
the shareholders in a
company limited by shares
who had paid up
 Secretary of state
o on grounds of S.122(1)(b),
(c) and (g)

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 Any liquidator

Commencement  When the resolution is  On the making of the order S.129

passed S.86
Jurisdiction
 The High court – but if the
company’s net assets are less than
£120,000 the county court has
concurrent jurisdiction S.177

Effects  The company has to cease  No disposition of the company’s

carrying on its business S.87 property / shares
o Except as required  No execution against its assets;
for its beneficial  No action against the company can
winding up, commence / proceed
o BUT legal
personality persists
until dissolution of
company
 Any transfer of shares post
winding up is void S.88
 Voluntary winding up does
not preclude a creditor from
seeking winding up by the
court if prejudiced S.116

Creditors  Creditors meeting up to 14  The Official Receiver becomes the

meetings to days after GM that decides liquidator – unless another
appoint the winding up S.98 liquidator is appointed S.136
liquidator  Directors to lay statement of  Creditors may nominate a
affairs to creditors S.99 liquidator S.139
 Creditors may nominate a
person to be liquidator S.100
 Creditors may appoint a
liquidation committee of no
more than 5 persons S.101
 On the appointment of a
liquidator, all powers of the
directors cease S.103

Liquidator VS Official Receiver

Liquidator Official Receiver

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 Key role  get in the company’s assets,  officer of the Insolvency Service
realize them and distribute the net value to  also an officer of the court to which he
the creditors S.143 is attached and is therefore answerable
 fix the time period for creditor’s claims to to it
be proved S.160  key duties when winding-up order is
 custody of all of company’s property made S.132
S.144 o investigate the causes of
 duty to summon final meeting of creditors company’s failure;
S.146 o report to the court
 Duty to summon if asked by a meeting or  these investigatory powers  attempts
by 10% in value of members or creditors to obtain explanations from former
 power to summon meetings of directors as to their conduct
members/creditors S.168 o directors may be subject to
 discretion to apply to court for directions liability
S.168  has the power to apply to the court for
public examination of officers S.133
o but more commonly exercise
power for private investigation

Distinguish between fixed and floating charges

Fixed charge Floating charge

Attaches to a specific asset or assets that are Attaches to a shifting fund of assets which
capable to be ascertained / identified in the changes from time to time
contract

The company cannot dispose of these assets The company is free to dispose of the
without the permission of the chargee charged assets in the ordinary course of
business

“fixed charge” includes a “charge by way of legal Commercially the contract creating a
mortgage” LPA 1925 floating charge is usually referred to as a
debenture

Current law in distinguishing fixed from floating charges

 the label agreed to by the parties is not conclusive  the court will turn to look at the substance
of the arrangements
 leading case: Re Spectrum Plus Ltd
o Facts:

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 A charge over Spectrum’s book debt was secured in favour of NatWest for
Spectrum’s overdraft of £250,000
 Inland Revenue also had a claim
 But the debenture sought to create a “specific charge of all book debts and other
debts…now and from time to time due or owing to Spectrum”
 Spectrum Plus was prohibited from charging or assigning debts and was
required to pay the proceeds of collection into a NatWest account
 But there were no other restrictions on Spectrums operation of the account  ie:
Spectrum was not prohibited from taking the money from the account
o Held:
 It was a floating charge instead of a fixed on
 Post- Spectrum Plus Ltd
o A charge on book debts will be FIXED if
 the terms of the debenture prevent all dealings with the book debts other than
their collection; and
 to require the proceeds when collected to be paid to the chargee in
reduction of the charger’s outstanding debt
o An clear indication of a fixed charge is if the account which the proceeds are paid into
must be blocked so as to preserve the proceeds for the benefit of the chargee’s security.

How are assets distributed to creditors – priority rules

General priority rules:

 Debts secured by a fixed charge
 Liquidation expenses
 Preferential claims of employees
 Prescribed part: for unsecured creditors
 Debts secured by a floating charge
 General unsecured claims (pari passu principle)
 Contractually deferred debts
 Interest on all debts that accrues after winding up
 Debts owed to directors who are guilty of wrongful trading
 Remaining assets are distributed to the shareholders

Liquidated expenses

 Rules  to ensure liquidations can run smoothly and appropriate liquidators can be found
o Have absolute priority over all unsecured claims
o Have priority over claims of floating charge holders if assets insufficient
IA1986,S.176ZA

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Preferential debts  employees

 Amount owed by the company to person who are or have been its employees by way of
remuneration for 4 months before the winding up

Prescribed part  goes to unsecured creditors

 Normal rules on prescribed part

o First £10k  50%
o Additional asset  £20%
o But total value of prescribed part CANNOT EXCEED £600k
 If the assets are less than £10k  then the rule on prescribed part does not apply at all
 If the value of the prescribed part is low (eg: £5k-10k)  costly to determine who are entitled to
it
o So the liquidator may disapply the provision and distribute the funds to the floating
charge holder instead
 Who would qualify for the prescribed parts of the assets
o Generally  for creditors with “unsecured debts” S.176A(2)(a)
o A floating charge holder cannot participate in the distribution of prescribed part for the
shortfall in its security Re Permacell Finesse Ltd
o A fixed charge holder cannot participate in the distribution of prescribed part for its
shortfall – because the debts were not “unsecured debts” under S.176A(2)(a) – Re
Airbase (UK) Ltd
o A floating charge holder who releases his security can participate in the distribution of
the prescribed part Re Pal SC Realisations

Insolvency set off  exception to paripassu rule

 General idea  there must be a mutuality of claims

o These set-offs need not arise from the same transaction / a series of transactions
o Furtemore, one can be contractual and the other in tort SoS v Frid
 Insolvency set-off is mandatory  cannot be excluded by agreement National Westminster
Bank v Halesowen Presswork Ltd

How to enlarge the company’s assets to be distributed – ways to “upset” transactions

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Transaction IA, S.423

defrauding creditors
Ground:
 Gift or transaction at an undervalue made with intent to put
assets beyond the reach of creditors or prejudicing their interests

Remedy:
 The court can make such order as it thinks fit to restore the
position and protect the victim – eg:
o Require the property to be vested in any person
o Release / discharge any security given by the company
o Require any person to make a payment to any other
person

Transactions at an IA, S.238

undervalue
Scope  company in liquidation or administration

Relevant time  2 years S.240

Notion:
 Gift, transaction with no consideration; or
 The company enteres into a transaction for a consideaton the
value of which is SIGNIFICANTLY LESS than the value of
the consideration provided by the company

Preferences Relevant time S.240:

 6 months; or
 2 years if with a connected person

notion of preference:
 better position than in a winding-up
 influenced by a desire to produce such effect

Extortionate credit S.244

transactions
Scope: the provision of credit to the company

Relevant time: 3 years before the commencement of administration or

liquidation

Powers of the court

 set aside;
 vary the term;

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 order payment to be made to the liquidator

“extortionate”
 the terms require grossly exorbitant payments to be made
 it otherwise grossly contravened ordinary principle of fair
dealing

Late floating charges S.245

A floating charge given by an insolvent company at a relevant time is

invalid - except as to the extent that:
 new value (money/goods/services) was offered to the company
or
 a debt was discharged/reduced

relevant time:
 12 months before the onset of insolvency if the company was at
the time / became as a result insolvent
 2 years if the holder of the charge is a connected person
 the time between the submission of an administrative application
and the making of an administration order

What does “connected persons” mean?

 IA 1986, S.249  Connected persons include:
o Directors,
o Shadow directors,
o Associates of directors or
o Shadow directors, and
o Associates of the company
 IA 1986, S.435  meaning of “associate”
o Spouses, relatives (sibling, uncles, nephew, ancestors, descendants), and relatives of
spouses
o Partners, employers, employees, and trustees,
o A company is an associate of its controller
o A company is an associate of other companies in the same group

Directors’ liability in relation to insolvent companies

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Misfeasance action IA, S.212  General summary remedy

Grounds:
 An officer who has misapplied or retained or become
accountable for, any money or other property of the company;
or
 Been guilty of any misfeasance; or
 Breach of any fiduciary or duty in relation to the company

Who can bring an action?

 Liquidator,
 Any creditor
 Any shareholder with the leave of the court

Powers of the court?

 Order the director to make a payment; or
 Order the director to account for money/property

NB: shareholders can no longer bring a derivative claim

Fraudulent trading Carries Civil and criminal liability

For civil liability  IA, S.213

 In the course of winding up – any business of the company has
been carried on with intent to defraud creditors
 Application  by liquidator
 Requires “actual dishonesty, involving, according to current
notions of fair trading among commercial men, real moral
blam” Re Patrick & Lyon Ltd
 Remedy:
o The court may declare any person knowingly parties to
the carrying on of the business in such a manner to be
liable  make contributions to the company’s assets
Eg: Morphitis v Bernasconi
 Facts:
o A director of a troubled company resigned and used a
shceme to avoid its liquidation for a year – to establish
another company with the same name without incurring
liability under “Phoenix” rules
o Directors knowingly failed to pay their final instalment
to their lessor  sufficient to establish fraudulent
trading?
 Held CA:

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o Director not liable

 Reasoning:
o There was no intent to defraud creditors – but merely to
avoid liability under S.216
o There must be a causal link between the fraudulent act
and the loss
o Held obiter  that it cannot be the intention of the P to
allow more than compensatory claims under S.213

For criminal liability  CA 2006, S.993

 Regardless of whether the company is being wound up – any
business of company is carried on with intent to defraud
creditors
 Remedy
o Any person who is knowingly a party to the carrying on
of the business in such a manner commits an offence
o Imprisonment up to 10 years and/or fine

Wrongful trading IA1986, S.214

 Application  by the liquidator
 Ground:
o At some time before the commencement of the winding
up of the company, that person knew/ought to have
concluded that there was no reasonable prospect that the
company would avoid going into insolvent liquidation
 Remedy
o The director (or shadow director) liable to make such
contribution to the company’s assets as the court thinks
proper
 Defence
o Reasonable steps to protect creditors

Eg case: Re Produce Marketing Consortium Ltd

 Confirms the compensatory, rather than penal, nature of the
court’s jurisdiction under S.214

Eg case: Re Sherbourne Associates

 Onus is on the liquidator to specify the relevant date;
 Death of D does not prevent action

Disqualification of Company Directors Disqualification Act 1986

directors  General ground

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o unfitness to be a director (2-15 years)  S.6

 Specific grounds for disqualification
o Conviction of indictable offence in connection with the
management or promotion of a company (up to 15
years)  S.2
o Breaches companies legislation (up to 5 years)  S.3
o Any fraud connected to winding up (up to 15 years) 
S.3
o Wrongful trading (up to 15 years)  S.10

How do courts interpret unfitness?

 Specific qualifications of a director
o Eg: where there are accounting irregularities, a director
with accounting expertise is likely to be disqualified
while a director without such expertise is not Re
Cladrose
 Mitigating factors:
o a director’s personal monetary losses and lack of any
gain  mitigating factors
 Re Sevenoakes Stationers; and
 Re Swift
o Young age
 Re Chartmore
 Apologising and expressing regret  relevant
o Re Churchull Hotel Plymouth

Disqualification procedure
 Court order on the application of:
o the liquidator;
o administrator;
o the SoS; or
o ex officio when finding a director liable in wrongful
trading
 undertaking by the former director to no act a director for a
period of 2-15 years accepted by the Secretary of State (CDDA,
S.1A,7)
 consequences of breach:
o criminal offence – up to 2 years imprisonment) 
CDDA, S.13
o personal liability  CDDA, S.15

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Corporate rescue – administration / pre-packaged administration / CVAs

Administration Key provision  IA 1986, Sch. B1

Statutory duty owed by administrators- para 3 (1):

 The administrator must perform his functions with the objective

of:
o rescuing the company as a going concern
o achieving a better result for the company’s creditors as
a whole than would be likely if the company were
wound up,
o realising property in order to make a distribution to one
or more secured or preferential creditors.

Who appoints the administrator?

 An administrator may be appointed:
o By the company or its directors – para 22
o By a qualifying floating charge holder (charge covering
substantially all assets of the company) - para 14
o By order of the court, after a petition of the company,
its directors, its creditors, or a public officer - para 11
 Note: the Qualifying Floating Charge holder can in practice
pre-empt the appointment of an administrator by other parties.
Is the new administration the son of receivership?

Effects and powers of the administrator

 The effects of administration: moratorium on insolvency
proceedings (para 42) and other legal processes - para 43
 The administrator has a broad range of powers: he may ‘do
anything necessary or expedient for the management of the
affairs, business, and property of the company’ - para 59(1)
 Without prejudice to the generality of this, some of his powers
are specified, such as
o removing and appointing directors (para 61) and
o applying to the court for directions (para 63).
 The administrator can make distributions to secured and
preferential creditors and also to unsecured creditors with the
permission of the court (para 65).

Administration – the reorganization proposal

 The administrator makes a proposal about the reorganisation of
the company (para 49) to the meeting of the creditors which can
approve it or modify it (with the administrator’s consent).

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 No need for a meeting (para 52) if:

o The company can pay all its debts in full
o There are no funds available for unsecured creditors
apart from the prescribed part
 The administrator’s proposal cannot prejudice the right of
secured creditors to enforce their security and the priority of
preferential creditors without their consent (para 73).
 Administration ends automatically a year after the appointment
of the administrator, but can be extended by the court (para 76).

Pre-packaged administration
 The main advantage of pre-packs is that they are cost-efficient
and quick.
 Most IPs (insolvency practitioners) are in favour of them.
 Research undertaken by R3 found that in 92% of pre-pack cases,
100% of jobs are saved – that’s compared to 65% for a business
sale.
 However, as they are orchestrated by companies and their major
(usually secured) creditors i.e. banks, they may prejudice the
general body of creditors.
 Courts, although not challenging the legality of pre-packs, have
expressed such concerns.
o Re Kayley Vending Ltd [2009]
 ISSUE!! ARE THEY FIAR?!

Company voluntary Key provision  IA 1986, S.1

arrangement  Proposal made by the directors of a company to its creditors
 Or, if the company is in administration or liquidation, by the
administrator or the liquidator
 For a composition in satisfaction of the company’s debts or a
scheme of arrangement of its affairs
 Providing for a nominee to act as trustee or supervisor of the
implementation of the arrangement
 The nominee needs to submit a report to the court within 28 days
stating whether the CVA has a reasonable prospect of being
approved and implemented

Approval of the arrangement by members and creditors  IA 1986,

SS.4-4A
 The nominee summons meetings of the members and creditors to
approve (or modify) the CVA.
 They cannot approve a CVA which affects the rights of a secured
creditor to enforce his security or the priority or a preferential
creditor unless with the consent of these creditors.
 If the meeting of shareholders does not approve it, the CVA is
still approved by they can apply to the court within 28 days and
the court then reviews the CVA.

Legal effect of a CVA  IA 1986, S.1A and 5A

 Takes effect as if made by the company at the creditors’ meeting

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 Binds all creditors entitled to vote at the meeting

 The court, if the company is in liquidation or administration,
may stay the winding up proceedings or cease the appointment
of the administrator
 Moratorium: can be obtained for the time until the approval of a
CVA based on Sch. A1.

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