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Introduction to FRP Insolvency - Video
Insolvency is the inability to pay one’s debts as they fall due. Bankruptcy and individual voluntary arrangements (IVAs) are insolvency processes used by individuals; liquidation, administration, administrative receivership and company voluntary arrangements (CVAs) are insolvency processes used for businesses.
When a company is unable to pay off its debts, it is referred to as insolvent or trading as insolvent and specialist Insolvency Practitioners are required. The UK Insolvency Act 1986 defines insolvency both in terms of cash flow and balance sheet. A company can be cash-flow and/or balance sheet insolvent. The key parts of the Act for defining being unable to pay a company’s debts:
Section 123 (1) (e) if it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.
Section 123 (2) A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.
Once a business is insolvent there are various core options available to management and creditors – those who are owed money by the business. Creditors include bank lenders, suppliers, other trade creditors and the Inland Revenue. Directors risk civil and criminal offences if they knowingly allow a company to trade whilst insolvent.
One broad approach to deal with an insolvent business involves putting an insolvent company into liquidation, a process referred to as "winding up". To be legally effective liquidations involve the appointment of licensed Insolvency Practitioners.
Both directors and shareholders can instigate the liquidation process without court involvement by passing a shareholder resolution and the appointment of a licensed Insolvency Practitioner as a liquidator. In order to take effect, creditors must convene a Creditors Voluntary Liquidation (CVL) - and have the opportunity of appointing a liquidator of their choice. A creditor also has the option to petition the court directly for a winding-up order which, if granted, will place the company into what is called compulsory liquidation or winding up by the court. A liquidator then realises the assets of the company and distributes funds realised to creditors according to their priorities, after the deduction of costs. There are strict rules governing priority of creditors.
Introduced under the Insolvency Act 1986, Administration is an insolvency procedure aimed at allowing an insolvent business to continue to trade within certain prescribed parameters, to allow time for the underlying business in part or in whole to be saved. An administration can be initiated by both the company’s management and the secured lenders. Often a pre-packed sale of the assets is arranged to be triggered once an Administration is granted. This is known as a Pre-Pack. The person who runs the business is an Administrator, who in the UK must be a licensed Insolvency Practitioner. The Administrator will manage the company’s affairs, but he has a duty to protect the interests of the creditors. The period of administration will likely involve an operational and financial restructuring to try and save the business.
Introduced under the Insolvency Act 1986, Administration is an insolvency procedure aimed at allowing an insolvent business to continue to trade within certain prescribed parameters, to allow time for the underlying business in part or in whole to be saved. While an Administrator is being appointed, the company can obtain a moratorium – a freeze on any actions – by creditors by having an Insolvency Practitioner file for Administration Order at Court. The period between filing for Administration and an Administrator being appointed allows a company time to consider some strategic options, including both financial and operational restructuring. This often includes attempts to sell parts of the business, free of any onerous liabilities in a pre-pack sale triggered by the company going into Administration. The business will be run by an Administrator - a licensed Insolvency Practitioner brought into to run the business in place of previous management – to rescue the business. Should nothing be salvaged via restructuring or sales, the company is put into liquidation to distribute the remaining funds to creditors.
Company Voluntary Arrangement (CVA)
Introduced, like the Administration, under the Insolvency Act 1986, the CVA process is aimed at saving or turning around a business either in whole or in part and involves the agreement of creditors to take a reduction in the actual debt owed to them. A CVA must be overseen by a licensed Insolvency Practitioner known, in this process, as a Supervisor. The directors however, remain in control of the company during a CVA.
In a Company Voluntary Arrangement, creditors agree a plan to write off a proportion of a business’ debt – often known in financial markets as “taking a haircut”. The CVA usually involves creditors’ receiving reduced monthly payments over a fixed term while the company continues to trade. During this period the creditors agree that they will not individually take action to recover their debts to the business, affording the business effective protection from creditors. If however the CVA fails, the company is usually put into liquidation by the Licensed Insolvency Practitioner.
The Administrative Receivership process is frequently referred to as a self-help recovery process for secured lenders. The receivership process is controlled by a lender to a business, not its directors and has reduced in popularity since the revised Company Administration process was introduced, via the Enterprise Act, to help rescue or turnaround businesses. The Administrative Receiver had a duty only to secured and preferred creditors and unsecured creditors rarely saw a return. Secured creditors can only rely on the Administrative Receivership process if their debentures pre-date September 2003 – the onset of the Enterprise Act, coinciding with the change in status of the Inland Revenue from preferential to unsecured creditors. Lenders may also rely on The Law of Property Act to take control of a premises and force the sale of a property via any charge they have over business property. The LPA Receiver has no power over any other asset owned by the company and cannot therefore trade the business on.