Insolvency is a term that has been bandied around a lot in the media recently as high-profile insolvency cases, such as The Body Shop or Ted Baker, make headline news. Unfortunately, the descriptions used by the media are not always accurate. Take the administration procedure. This term is often used alongside the word ‘collapse’ when describing the Administration of a business. However, an Administration is actually a business rescue procedure that aims to save jobs and at least part of the business and its value.
Given the loose terminology regarding corporate insolvency we have encountered recently, below is a guide on the key processes used by Insolvency Practitioners (IPs) and what they mean in law.
When is a company insolvent?
There are two legal tests that can define if a company is insolvent.
The first is the cash flow test, which can reveal whether the company is unable to pay its debts in full as they fall due.
The second is the balance sheet test, which will outline whether the company’s liabilities exceed its assets.
Full details of these two tests can be found in our guidance document, here.
It is essential that a company’s directors are aware when their business has entered into insolvency because their fiduciary duties change. They are no longer required to run it for the benefit of its shareholders. Instead, they must put the interests of the creditors first. This means doing everything possible to mitigate the losses suffered by the creditors.
If a director continues to trade in the knowledge that their business is insolvent, they run the risk of being prosecuted under Wrongful Trading.
The key processes used by Insolvency Practitioners
Insolvency procedures under the 1986 Insolvency Act
Administration
An Administration is designed to put a protective ring fence around a Company’s assets to prevent any enforcement action by its creditors while the possibility of a business rescue is explored and then implemented. Responsibility for controlling and managing the company passes to Administrators, who must be licensed insolvency practitioners.
The outcome does not necessarily have to be the survival of the Company as a going concern, although this is the best result. Instead, it could be that the process achieves a better return for creditors than they would have received if the Company went into Liquidation. Finally, the objective could be just to facilitate the repayment of secured or preferential creditors.
Company Voluntary Arrangement (CVA)
A CVA is essentially a deal between a Company and its Creditors, under which the creditors agree either to accept a reduced amount or wait longer for their money. The process, which usually runs for between three and five years, must be supervised by licensed IPs but the directors will continue to run the Company as ‘debtors in possession’. Once the CVA has been successfully completed, the IPs stand aside and the Directors become solely responsible once more for the Company.
Liquidation
This is the end of the road for a Company. Liquidators, who must be licensed IPs, are appointed to take control of all its assets, turn them into cash and distribute whatever is left over after costs to the creditors in accordance with the priorities set by the Insolvency Act (known as the ‘insolvency waterfall’). Once the Liquidation process has been completed, the Company will be dissolved and will cease to exist.
There are two types of insolvent Liquidation, differentiated by how the Liquidators are appointed. Creditors can apply to the court to have a Company wound up through a Compulsory Liquidation, or the Directors and Shareholders can take the initiative through a process called a Creditors’ Voluntary Liquidation (CVL). There are some procedural differences between the two processes.
Company Act of 2006
Scheme of Arrangement
A scheme of arrangement is a court-sanctioned agreement between a Company and other parties. Schemes are a flexible and long-established Companies Act procedure. They are a useful strategic device in a wide range of circumstances including restructurings, takeovers and mergers.
Schemes are usually proposed by a Company, although Administrators may propose a scheme. A scheme is a compromise or arrangement between a Company and its members or creditors. They need to be implemented in accordance with the Companies Act 2006 and will involve two court applications: one to convene meetings to approve the scheme and one to sanction the scheme. If approved, the scheme will be binding on all creditors and shareholders, including those within each class voting against the scheme.
A Scheme of Arrangement is not an insolvency process.
Business rescue procedures under the 2020 Corporate Insolvency & Governance Act
Moratorium
The Moratorium was introduced at the peak of the pandemic when many businesses were struggling, with the intention to give a business breathing space from its creditors without necessarily having to go into a formal Insolvency Act procedure. Directors are given 20 business days to assess their rescue and recovery options under the guidance of Monitors, who must be licensed IPs. During this time, the company continues to operate under the control of its Directors and is protected from creditor enforcement action. Depending on the outcome of their deliberations, the Directors can then work through a business rescue plan or use one of the Insolvency Act procedures. The Moratorium itself is not an insolvency process.
Restructuring Plan
A Restructuring Plan is a formal compromise between a Company and its creditors and/or shareholders. They help Companies facing financial difficulty to reach a compromise with creditors and/or shareholders in order to continue to trade and be able to continue as a going concern. In order to proceed, a Restructuring Plan must be approved by creditors and by the Court, but can, under certain circumstances, go ahead despite the objection of some creditors.
Restructuring Plans share some of the key features of the existing Scheme of Arrangement procedure and the Company Voluntary Arrangement process, while being distinct from both. They are not a formal insolvency process.
Solvent winding up
A Members’ Voluntary Liquidation (MVL) is the safest way to bring a solvent Company’s life to an end once it has served its purpose or if the shareholders decide not to continue with it. The Liquidators appointed must be licensed IPs. Their task is to get in the assets, pay all remaining liabilities and then distribute whatever is left to the shareholders in accordance with their entitlements. Once the process has been completed, the Company will be dissolved and will cease to exist.
Although the procedure is governed by the 1986 Insolvency Act, it is not an insolvency process.
The takeaway for businesses
A wide range of options are available to deal with difficulties at a Company or close it down at the end of its natural life.
Understanding the different insolvency procedures and how they can aid Directors through a business rescue or a controlled winding up of their Company is essential. For so long, the insolvency sector has been viewed as the bogeyman of the business community, but in reality, IPs are here to help businesses that are in financial distress reach the best outcome possible for all parties within the strictures of the UK’s insolvency and other laws.
We always advise directors to seek advice at the earliest opportunity of a business’s financial difficulties because there are often many more options, including business rescue, on the table than they may realise.
How we can help
We have extensive experience assisting business owners and directors, and we will always work with you to find the best solution for you and your business.
One of our Partners would be more than happy to have a non-obligatory confidential chat with you. We can be contacted at rescue@opusllp.com or call us on 0203 995 6380 and we will arrange for a call with one of our Partners.