UK: Question Time - Corporate Distress

Last Updated: 9 March 2009
Article by Catherine Feechan

2009 is beginning with more and more retailers closing their doors and the press is full of stories about companies teetering on the brink of collapse, they are going under, calling in the receivers, going into liquidation. But what do these terms mean and is there any differences between them?

Back in 2002 the Government decided to promote a "rescue culture", that encouraged responsible risk taking in business. This was a significant change in approach and the aim of the new insolvency laws was to try and obtain the best recovery rates possible for creditors by rescuing and restructuring businesses rather than just closing them down and selling off their assets. The new legal framework aims to balance the interests of creditors, to promote corporate rescues, recoveries and restructurings and to make sure directors of insolvent businesses are properly dealt with.

So firstly, what does it mean when a company is insolvent?

There are two tests commonly used. The first is the cashflow test – by this test a company is insolvent if it cannot pay its debts as they fall due. In certain circumstances this can be supplemented by a balance sheet test. A company that can pay its debts as they fall due could still be insolvent if, by looking at its balance sheet, its liabilities exceed its assets.

Having established that a company is indeed insolvent – what is the next step?

1. Administration

If the company has some ongoing business activity which may be saleable, the most common approach is for the company to be put into administration. This procedure is designed to allow reorganisations or more efficient sale of assets during a period of a statutory moratorium. This acts as a block on any actions being taken by creditors during the period of the administration and allows the administrator time to agree and implement a plan. Legally the administrator has a threefold purpose, first if possible, he must promote the rescue of the company or any suitable parts as a going concern, if survival is not possible then he must attempt to obtain a better realisation of assets for creditors as a whole than he would have achieved in liquidation, and if even that is not possible then he must confine his activities to realising assets with a view to distributing the sums gained to preferential and secured creditors.

Administrators can be appointed cheaply and quickly using an out of Court procedure by any secured creditor or by the company itself or its directors. A trade creditor would require to go to court to get an administrator appointed and in complex administrations with overseas assets involved a court appointment can be preferable.

Administrators have very wide powers to deal with the assets of the Company as they see fit without consulting with creditors or management. At the end of the administration procedure which can last for up to 1 year, the Company will either have come out of administration and returned to trading, it can be liquidated to allow realisations to be distributed, or it can be dissolved if there is no cash to distribute.

2. Liquidation

If a company is aware there is absolutely no hope of survival or reconstruction of its business, liquidation is the only option (also called winding up). If a company no longer has any active business worth realising then a liquidator will be appointed to realise its assets and distribute them to creditors. This is the end of the road for the company and there are two options available here:-

(a) creditor's voluntary liquidation – this occurs when the shareholders of the company resolve the company is no longer able to pay its debts and that a liquidator should be appointed. They select an initial liquidator although the creditors may change the liquidator if they are dissatisfied with the choice.

(b) compulsory liquidation – this usually occurs where a creditor applies to the Court to have the company wound up.

At the end of the liquidation process the company is dissolved. During the liquidation process all securities in place can be enforced but no new court actions can be raised against the company without specific permission.

3. Administrative Receivership

Strictly speaking this is not an insolvency procedure. Holders of floating charges dated prior to 15 September 2003 are able to appoint an Administrative Receiver to realise assets and pay off their debt. The administrative receiver acts only for the holder of the charge and is not interested in saving the company or assisting unsecured creditors. These are becoming less common.

4. Company Voluntary Arrangements/Schemes of Arrangement

These are used to supplement other kinds of insolvency procedures, for example, they can be combined with administration. A CVA allows the administrator to agree proposals with the creditors and implement these. A Scheme of Arrangement is more complex and has to be approved by the Court. Any such scheme if correctly implemented is binding on all members or creditors, no matter whether or not they consent, which can be essential.

Directors of insolvent companies are allowed to become directors of new companies unless they are subject to disqualification orders or they become personally bankrupt but there are restrictions on using the name or trading name of a company which goes into liquidation. In that case directors for the previous 12 months prior to liquidation may not be involved in any business with the same or similar name for the period of 5 years. Breach of this is a criminal offence which can lead to imprisonment or a fine and the relevant director can incur personal liability for the company's debts.

For companies concerned about insolvency getting advice sooner rather than later is vital in order to minimise impact on the directors personally and maximise protection for the business.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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