Insolvent company: procedures and directors' duties

Introduction

The purpose of this article is to brief the owner-manager on the duties and liabilities of a Director whose company is in financial difficulty.

The Starting Point: Good Independent Objective Advice

The starting point is to understand that you are not alone! Every day of every week of the year businessmen and businesswomen are grappling with the same problems that you are facing: how to respond to cash flow pressures. These may be caused by negative short term factors (e.g. a problem contract) or negative long term factors (e.g. increased competition) or by positive factors (e.g. the need for extra cash to provide working capital for new contracts).

So because these problems are commonplace there are people out there who can help you. Taking objective independent advice from a business adviser (such as an accountant or solicitor) or an insolvency practitioner (see below) will often be the first step that should be taken.

What is Insolvency?

There are two sorts of insolvency.

First, balance sheet insolvency: this is where the company's liabilities exceed its assets. Secondly, cash flow insolvency: this is where a company cannot pay its debts as they fall due.

Cash flow insolvency can lead to balance sheet insolvency; if a company has to cease trading because it cannot pay its bills as they fall due the value at which it is carrying its assets may need to be written down to their forced sale value instead of being shown at their going concern value.

Different Insolvency Procedures

The very word insolvency can be threatening but please read on. Several of these procedures can be used to save a business so it is important that you have an idea what is available.

Administration

This procedure is equivalent to the "Chapter 11" Rescue procedure available in the US. It provides the company with protection from its creditors; so for example any winding-up petitions are put on hold, finance houses cannot repossess motor cars and machinery. Also landlords and HM Revenue and Customs cannot take possession (known as distrait) of plant and equipment and stock.

This can give the company a breathing space to raise new funds, to perhaps reach agreement with its creditors on deferred (or reduced payment) of existing debt or to give time to sell the business.

Administration involves an insolvency practitioner (someone licensed by the DTI) taking responsibility for the business. So Directors lose their powers to run the business in favour of the administrator: a step which an owner manager will not want to take lightly.

The overriding duty of the administrator is to save the business as a going concern, if possible. An administrator can be appointed by the company or by a bank holding a debenture. Since the Enterprise Act 2002 came into force administration must be used (rather than administrative receivership, see below) by banks holding debentures entered into after 15 September 2003 except for certain exceptional cases (e.g. capital market or PFI transactions).

Administrative Receivership

An administrative receiver is an insolvency practitioner appointed by a bank (or other secured lender) who has taken a debenture with a floating charge; that is a general floating security over assets such as stock, machinery and (perhaps) book debts. He has power to run the business and sell the business and its assets.

The overriding duty of the administrative receiver is to pay off the bank (or other secured lender) who has appointed him.

Since the Enterprise Act 2002 came into force the administrative receivership has been a less used procedure. This is because (save for exceptional cases) banks who have taken debentures since 15 September 2003 must appoint an administrator whose job (see above) is to try to save the business.

Corporate Voluntary Arrangement

This procedure needs to be supervised (but not controlled by) an insolvency practitioner. It can be used to compromise (or settle) creditor claims so that, for example, creditors receive a delayed payment or a reduced payment of so many pence in the pound.

The procedure involves the preparation of a proposal and the convening of a creditors' meeting to vote on the proposal. A 75% vote (by value of debt held) of the creditors is needed for the proposal to be passed. It is then binding on all creditors.
This can be a powerful procedure for a company running a business that has suffered an unexpected problem but is otherwise viable (e.g. a major bad debt).

Compulsory Winding-up

This is the procedure taken by a creditor who is owed at least £750. It is generally preceded by the making of a 21 day statutory demand: failure to pay a bona fide debt after a 21 day written demand gives grounds to start the winding-up procedure by issuing a winding-up petition.

This procedure involves the appointment of a liquidator who is normally the Official Receiver: a civil servant. The role of the liquidator is to collect in the assets and pay off the debts of the company. He has ancillary powers to run the business but will not have the resources (or skills) of the administrator.

Members' Voluntary Liquidation

This is a procedure initiated by a (75%) vote of the shareholders of the company for the appointment of a liquidator. There are two varieties:-

Creditors' Voluntary Liquidation ("CVL")

This applies where the Directors are unable to make a declaration of solvency. The liquidator is usually an insolvency practitioner chosen by the Directors but it can be the Official Receiver (a civil servant) if no insolvency practitioner is available or willing to act.

A creditors' meeting is held and a creditors' committee appointed.

Members' Voluntary Liquidation

This is the same as for the CVL except that it is preceded by a Directors' declaration of solvency and there is no need for a creditors' committee.

The role of the liquidator in either case is to collect in the assets and pay off the liabilities. The liquidator also has power to give up (or disclaim) onerous property such as an unprofitable contract or lease liabilities.

Conclusion

For a businessman who has put his heart and soul into a venture, the poor financial performance of that business will be a very stressful experience. The insolvency of such a business is sometimes likened to bereavement.

The co-Directors' family and the friends of such a businessman should recognise these intensely personal issues in offering their help and support.

What to do next

Speak to us and we can put you in touch with reputable advisors. The introduction is of course, free of charge.

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