Insolvency: Becoming Insolvent or Bankrupt
When a company faces financial difficulty, there may be no other option than insolvency. Insolvency is commonly referred to as bankruptcy and occurs when the business can no longer meet the demands of their debtors. Bankruptcy is often used in relation to an individual while insolvency normally applies to a company.
Reasons for Insolvency
Insolvency can result from many different scenarios ranging from external factors such as the economy to internal factors relating to poor management.
Some of the common reasons of business insolvency include:
- Poor marketing or sales strategies
- Making unwise business decisions or risky investments
- Adverse economic times resulting in reduced consumer spending
Individual bankruptcy on the other hand can be caused by:
- Abuse of credit
- Poor management of investments or assets
- A sustained period of ill health
Insolvency is not a decision that any individual or business should take lightly. It can have far reaching and lasting implications. Where possible, it is always better to find a solution.
However, if there is no other option, the first step is to estimate as accurately as possible the amount of debt that you owe.
Once you have done this, look at the assets that you have. In terms of a business, you may have equipment and resources that you can use. However sometimes it may be the case that debts have spiralled out of control and they are considerably higher than all of your assets and creditors combined. When this is the case, it is important that you seek help from a financial institution who can reorganise your business or personal finances.
This sometimes happens during uncertain economic times. Lenders sometimes help businesses through hard times based on the assumption that when the economy improves the business will pick up and become solvent once more. This process is referred to as administration. If debts far outweigh any assets and outstanding money owed to the company, the best course of action may be to file for bankruptcy.
What Happens Next?
If a company does file for insolvency, there are specific laws in the UK that must be followed. This legislation defines four main measures that must be used to deal with insolvency cases. Any of these measures can result in administration, receivership, liquidation or a voluntary agreement.
There are a series of UK laws in place that aim to save companies from insolvency. Provisions are made for what is known as administration. This solution is designed to keep the business operational during tough economic times. The majority of businesses prefer to file for administration to ensure that assets are protected from creditors. A business covered by a UK administration policy will need to submit detailed restructuring and debt management plans for consideration.
It is for this reason that this measure is often only available to those who show signs of recovery.
It doesn’t necessarily follow that a business that files for insolvency cannot repay their debt. The company may have other assets and items under their control that they can use to repay the debt. Where this is the case, the Court will decide to grant receivership. This measure will provide the lender or creditor to obtain assets that the company owns as payment for outstanding debt.
In many cases, this means that the creditor will acquire all of the companies assets. Where a business has multiple creditors, problems may arise with receivership because the assets available may not be sufficient to pay for the debt that is outstanding. Where this applies, the business or the owner may be required to pay money for the outstanding debt. Liability in this instance will vary depending on the way in which the business is structured.
When a company is placed into liquidation, this is perhaps the worst case scenario. This means that the Court has decided the company needs to close down and all operations must cease. Usually this is to prevent the business from accruing further debt or failing to provide services that it has promised. Once a company falls into liquidation it cannot be recovered.
That being said, liquidation is only applied when the court is satisfied that the company can no longer recover what it has lost. When this happens, the company and its employees are affected.
Company Voluntary Arrangement
A Company Voluntary Agreement may be reached which involves the company and an insolvency solicitor meeting with creditors to negotiate suitable arrangements to make a payment, agreeing suitable dates and amounts to be repaid. Securing a Company Voluntary Agreement can however take a considerable amount of time depending on conditions which have been specified by creditors.
There are several ways in which insolvency can be dealt with and a number of alternatives:
Debt Relief Order
This is perhaps one of the easiest ways in which to avoid insolvency, but there are strict limitations attached to this arrangement. A Debt Relief Order will only be issued to an individual who has very few assets or money, the debt is less than £15,000 and the business or individual does not own their own home. This order will last for a period of 12 months. If the individual or business cannot prove that their financial situation has improved, they will be exempt from their debts.
An Informal Arrangement
This is an unwritten agreement between the debtor and creditor that outlines terms under which the debt will be repaid. This is often a verbal agreement. When an informal agreement is made, it is not legally binding so there is a certain element or risk associated with it. Creditors can sometimes deny that they approved the conditions (even if they did agree) and it will be an issue that has to be resolved through the courts.
Debt can be a problem for anyone at any time. Businesses can fall into debt as a result of many different scenarios, many of which are completely beyond their control. If you are facing problems with debt on a business or personal level, it is important to seek advice early, before problems escalate and you are facing and lasting consequences of bankruptcy.
What is the order of priority for Creditors in relation to Corporate Insolvency?
Businesses can experience financial difficulty for many different reasons. When this happens, it is up to the Director to identify problems and take proactive steps to resolve the financial issues. There are several different options when it comes to addressing financial problems.
Businesses should have in place suitable procedures that will be implemented in an insolvency situation. When suitable strategies are in place a business can quickly work with its creditors either on a formal or informal basis to agree an extension for funding, place itself into administration or call in a receiver to manage the process of liquidation. There are multiple enforcement and collective insolvency procedures that you can use to resolve matters in the best possible way. An enforcement procedure enables creditors to exercise their rights against the company. Collective procedures are implemented in an attempt to help the business survive.
Administration is just one of the many insolvency procedures. The ultimate goal of this process is to rescue the business and prevent it from closing down entirely. Under this arrangement, creditors cannot enforce their rights without prior approval from the court. Administrators must be put in place to deal with the process. The Administrator will be accountable for the day to day management of the company with a view to rescuing the business.
The appointment of an administrator will halt any action that creditors may be taking by using something called a moratorium. When this is in place, an order to wind up the company cannot be sought, an administrative receiver cannot be appointed and landlords will not have to give up property.
When a business is in receivership it is not uncommon for there to be multiple receivers. When an administrative receiver is appointed, this will demonstrate a specific type of enforcement process which involves the creditor being paid in terms of the assets held by the company. There are disadvantages to calling in an administrative receiver and a moratorium cannot be implemented in this instance. Creditors can still make an application for an order to wind up the business if they wish to do so.
Liquidation is a process which involves identifying the company’s assets and then dividing these between the people who are owed money. Liquidation can be either compulsory or voluntary. It is always recommended that if you are in a situation where liquidation is likely, voluntary liquidation is preferable. Once a company has been liquidated it will no longer exist, but in order for a business to be liquidated there must be adequate grounds for the company to be closed.
Typical reasons for liquidation include:
- If the business can no longer pay its debts
- If the court believes that it would be fair and reasonable to wind up the company
The way in which insolvency is managed is outlined in the Insolvency Act 1986. Liquidators are responsible for selling assets and then dividing the proceeds of any sales between the creditors to repay the outstanding debt. Liquidators are skilled in maximising the amount of assets that can be sold to achieve the best possible outcome for the business and creditors.
Order of Priority
When a business goes into liquidation, its assets and capital will fragment so it is up to the liquidator to decide where these are allocated. Businesses may have employees who will expect their wages, even if a company is in liquidation and there may be also some creditors such as a lender who will have to be repaid for any loans that the business owner has taken out. In addition shareholders may have bought some shares and they require their dividends. Each of these elements are part of the business and as such they need to be appropriately allocated in order of priority.
The order of priority usually goes through the following order:
- The liquidator will need paying first and these are costs associated with identifying fixed charged assets.
- Once the liquidators have been paid, the fixed charge creditors need to be paid next. A fixed charge creditor is someone who the business owes money to but the creditor has some sort of security over the company assets. The creditor can exercise their right to sell the assets and use the proceeds of the sale to pay off the debt.
- Preferential creditors follow. A preferential creditor is someone who is owed money by the liquidated company. Typical preferential creditors include employees. When preferential creditors are paid, there is a limit on how much can be allocated to each employee.
- Ring Fenced Funds are next in the chain. A floating charge is a charge that is held over an asset which then becomes fixed. An unsecured creditor can pursue floating charge creditors. Furthermore, an unsecured creditor would be a crown debt or the provision of remuneration to an employee. The business will still remain liable for any interest which is accrued on debts which arises after unsecured creditors.
- Shareholders are the last people to get paid.
About the author:
This article was written for Allaboutuklaw by a member of the Expert Answers legal advice team and posted by Lloyd Barrett. Expert Answers provides online legal advice on all aspects of UK Law to users in the United Kingdom.