A business may cease trading for a number of different reasons, the most common being insolvency. Insolvency is a term often used in the media to describe a business in financial difficulty, but the rules for insolvency and what it involves are not usually elaborated on.
This guide introduces the topic of insolvency and two of the main processes available to businesses facing financial difficulties: administration and the company voluntary arrangement.
Insolvency is a term used to describe either an individual or an organisation that is experiencing financial difficulties. More specifically, it means that an individual or organisation’s liabilities exceed their assets.
The term ‘insolvency’ tends to be split into two different sets of rules: one set governing personal insolvency and another governing corporate insolvency. This guide covers corporate insolvency.
If a company faces financial difficulties, the two main types of procedure that can be used to save it are administration or a company voluntary arrangement. Which procedure is most suitable depends on the company’s circumstances.
Administration is a procedure designed to save a company from being ‘killed off’ or ‘liquidated’. The purpose of administration is to save a business as a ‘going concern’ (a ‘going concern’ is a business that operates without the threat of liquidation for a future period, usually at least one year). This procedure is designed to save a viable company that happens to be experiencing some financial difficulties.
A company can begin the process of administration when an administrator is appointed. An administrator is a qualified insolvency practitioner (IP) who is appointed to the company to investigate its affairs. An administrator may be appointed to a company by:
An administrator looks into the company’s affairs with the following objectives:
These objectives are listed in order of importance. The primary objective of an administrator is to save the company. The only reason an administrator would not have this as his or her main objective is if it would have a harmful effect on the business’s creditors. An administrator performs his or her duties in the interests of the creditors, not the business.
When an administrator is appointed to a company, the company is ‘in administration’. This has an impact on the company’s creditors, who, without receiving permission from either the administrator or a court, will not be able to:
The inability of creditors to take any of the above action is called a ‘moratorium’. This ‘freezing’ of a company’s assets is designed to help the administrator rescue the company as a going concern.
Stage 1 – Announcement of Appointment of Administrator
The first stage of the administration process is that an administrator, once appointed, must give notice of this to the company and its creditors. The appointment must also be published in a newspaper where the company has the majority of its business. The administrator also has to send notice to the Registrar of Companies within seven days of his or her appointment.
When an administrator is appointed, he or she is expected to manage the affairs of the company, with the objective of rescuing it as a going concern. To help achieve this, administrators have the power to do anything necessary to effectively manage the assets and liabilities of the business. The powers granted to administrators often lead to other organisations viewing them negatively. These powers are described in detail in the Insolvency Act, but some of the most controversial are:
These powers often mean that another business connected to the company that is in administration risks losing assets, despite having some security interest in property. This will not matter to an administrator, who must have the interests of business creditors in mind when managing the affairs of the company.
Stage 2 – Statement of Affairs
When an administrator is appointed, he or she needs to issue a ‘statement of affairs’. This document sets out the financial position of the company, its assets and liabilities. There is a strict time limit for when this document has to be prepared. From the day an administrator receives notice that a statement is required (this normally comes from the Registrar of Companies) they have 11 days to provide it. This document is normally something that directors of the company provide, but an administrator can ask that directors, working in partnership with the administrator, contribute to the document before it is submitted.
Stage 3 – Proposals
An administrator needs to prepare plans to help save a company as a going concern. He or she then sends them to all interested parties. This includes the creditors of the company (whose interests the administrator is looking to protect) as well as the Registrar of Companies and any shareholders of the company. Generally, plans must be submitted to these parties within eight weeks of the beginning of administration. The sooner the parties are informed of the administrator’s ideas to save the company, the sooner these plans can be analysed and put into action.
Stage 4 – Creditors’ Meetings
When an administrator begins working, they must organise an ‘initial creditors’ meeting’ within ten weeks of a company entering administration. The purpose of this meeting is to discuss the administrator’s plans to save the business as a going concern. Creditors are entitled to make suggestions to change the administrator’s plans, or they may agree to them without any amendments. Much will depend on the circumstances.
An administrator is entitled by law to make payment to secured creditors (those that hold a security interest in company property without the need to get permission from a court). However, the administrator needs to get court permission to make payment to unsecured creditors.
Stage 5 – Outcomes
The entire process of administration is built around the idea of trying to save a business. All of the powers granted to administrators are used with the hope of achieving this goal. Governments do not wish to see what would otherwise be very successful companies exit the marketplace, if it can be avoided. However, in some cases, a company is not able to be saved. If this is the case, then the administrator must pursue other options.
If an administrator believes it is not possible to save a company as a going concern, then he or she is required by law to find a better result for the company’s creditors than would be achieved if the company is wound up. An administrator will then attempt to use the company’s assets to pay the company’s secured creditors, and then will probably have the company dissolved. Administrators are required by law to notify the court if they think they cannot achieve the objectives of administration.
The administration process can be very rigid, and administrators usually try to conclude the process as soon as possible. Administrations, by law, end twelve months after the day on which they began. Alternatively, if there is good reason to do so, an administration can be extended for up to six months if the creditors agree, or if a court grants its consent. Again, the only reason an administration is likely to be extended is where it is believed that its objectives are likely to be met, and a business is likely to be saved by the extension.
As with administration, a company voluntary arrangement (CVA) is an option a business can use instead of liquidation.
A CVA is a course of action agreed between a business experiencing financial difficulty and its creditors, in an attempt to pay back some or all of the debt it owes.
The process of starting a CVA depends on the situation a business is in. In particular, the financial position of the business will determine who is able to pursue a CVA. Here are some examples:
Scenario 1 – The business is not doing very well and needs to look at insolvency options
This scenario is where a business has not engaged in any formal insolvency procedure, but the management are concerned about financial difficulty in the very near future. In this situation, the directors of the business can propose that the business enters into a CVA with its creditors.
Scenario 2 – The business is being wound up and needs to consider what it is able to pay back
This scenario is where a business is being dissolved or liquidated. The liquidator can, having looked at the state of the business, propose that the business enters into a CVA with creditors.
Scenario 3 – The business is in administration but needs to consider its debts
This scenario is where a business is in administration. After looking at the affairs of the business, the administrator is entitled to propose that the business enters into a CVA.
Regardless of who suggests the CVA, a proposal outlining the financial position of the company with its assets and liabilities, and details of what could be achieved by a CVA, must be sent to creditors. The proposal also has to identify an insolvency practitioner (IP) who will action the points mentioned in the proposal.
A CVA is not the same as an administration. One important difference between a CVA and administration is that entering into a CVA does not result in a moratorium (which prevents creditors from enforcing their security interest over business property). As a result, businesses often include in CVA proposals a request to creditors not to enforce their security interests, or pursue money owed within a period of time. This is normally proposed where a business may not be able to pay money now, but should be able to do so in the future.
Assuming that the nominated IP is not the liquidator, administrator or director of the business, the IP must be given all of the paperwork (the proposal, company assets and liabilities, details of creditors etc.). He or she then reports to the court on whether it is necessary to call a meeting of creditors and company shareholders, to consider the terms of the proposal.
If the IP believes that a meeting is necessary, and there is no competing argument from the courts, a meeting must be called. Details of the meeting must be sent to every shareholder and creditor that the IP is aware of, along with the proposals and the IP’s report on the proposal.
The mechanics of shareholder and creditor meetings are different. In a shareholder meeting, a simple majority is needed to approve the proposal. With creditors, at least three quarters of unsecured creditors must approve the proposal, but a simple majority of unsecured creditors who are not connected with the company need to approve the proposal. The IP must report to the court on the outcome of these meetings.
If shareholders and creditors agree to a CVA at their respective meetings, and the court does not query any decisions from the meetings, the decision to enter into a CVA is binding on everyone who voted, or would have voted at the meeting.
CVAs are a popular method of resolving financial difficulties. Much of the decision making is left in the hands of those who understand the business: its shareholders and creditors. This allows flexibility and reflects the fact that people are more likely to agree to the terms of a CVA if they are involved in the negotiation of its terms, than if they are forced to agree with them.
Nothing in this guide is intended to constitute legal advice and you are strongly advised to seek independent advice on matters that affect you.