A Comprehensive Guide to Corporate Insolvency in the UK

Corporate insolvency is a challenging reality that many businesses may face.

Understanding the intricacies of this legal and financial state is crucial for directors, creditors, and anyone involved with a company experiencing financial distress.

This guide provides a comprehensive overview of corporate insolvency in the UK, outlining the key terms, processes, and procedures.

At its core, a company is deemed insolvent if it meets one of two key tests:

• Cash Flow Test: The company is unable to pay its debts as they fall due. This is about immediate liquidity. It is referred to as Practical insolvency.
• Balance Sheet Test: The company's liabilities exceed the value of its assets. This focuses on the overall financial health. It is referred to as Absolute insolvency.

Falling into a state of insolvency triggers potential formal procedures governed primarily by the Insolvency Act 1986. These procedures aim to either rescue the company or ensure a fair distribution of assets to creditors.

Here are the main types of corporate insolvency procedures in the UK:

Liquidation: Bringing a Company to an End

Liquidation, also known as winding up, is the process by which a company's assets are sold off to pay its debts. Once the process is complete, the company ceases to exist. There are two primary forms of liquidation for insolvent companies:

• Compulsory Liquidation: This is a court-ordered process, usually initiated by a creditor (or sometimes the company itself, or other parties like the Insolvency Service) when a company cannot pay its debts. The process begins with a creditor issuing a Statutory Demand for payment.
  If the debt remains unpaid and undisputed after 21 days, the creditor can present a Winding Up Petition to the court. If the court agrees that the company is insolvent and it is appropriate, they will issue a Winding Up Order, formally placing the company into compulsory liquidation.
  An Official Receiver, a government official, is initially appointed as the liquidator, though a private Insolvency Practitioner may be appointed later by creditors.
• Creditors' Voluntary Liquidation (CVL): This process is initiated by the directors and shareholders of an insolvent company. It often occurs when the directors recognise the company's insolvency and wish to take proactive steps to wind it up in an orderly manner. While initiated voluntarily by the company, it is a procedure for insolvent companies, and the creditors' interests are paramount.
  An Insolvency Practitioner is appointed as the liquidator to oversee the realisation of assets and distribution to creditors. This route is often preferred over compulsory liquidation as it offers more control and can be less adversarial.

It's important to distinguish these from Members' Voluntary Liquidation (MVL), which is a process for solvent companies that wish to cease trading and distribute accumulated profits or assets to their shareholders. This is not an insolvency procedure.

Administration: A Chance for Rescue

Administration is a protective procedure designed to provide a struggling company with breathing space from its creditors while an attempt is made to rescue the business or achieve a better outcome for creditors than immediate liquidation. An Insolvency Practitioner, acting as the administrator, is appointed to take control of the company, displacing the directors' powers.

The administrator has three primary objectives, in order of priority:

1. Rescuing the company as a going concern.
2. Achieving a better result for the company's creditors as a whole than would be likely if the company were wound up (liquidated).  
3. Realising property in order to make a distribution to one or more secured or preferential creditors.

During administration, there is a moratorium, which prevents creditors from taking legal action against the company without the court's permission. This allows the administrator time to assess the company's position and propose a way forward, which could involve restructuring, selling the business, or, if rescue is not possible, transitioning to liquidation.

Company Voluntary Arrangement (CVA): An Agreement to Repay

A Company Voluntary Arrangement (CVA) is a formal, legally binding agreement between an insolvent company and its unsecured creditors. It allows the company to continue trading while making agreed repayments to its creditors over a period of time, often based on a proportion of the debt owed.

The process involves the directors proposing a repayment plan to the creditors, which is then supervised by an Insolvency Practitioner who acts as the nominee and then the supervisor of the CVA. For the CVA to be approved, a statutory majority of creditors (75% by value of those voting) must agree to the proposal. If approved, the CVA is binding on all unsecured creditors, even those who voted against it. CVAs can be a valuable tool for viable businesses facing temporary financial difficulties, allowing them to avoid liquidation.

The Role of the Insolvency Practitioner

Central to most formal insolvency procedures is the Insolvency Practitioner (IP). An IP is a highly regulated and licensed professional (often accountants or lawyers) with the expertise to manage the complex process of corporate insolvency. Their duties are primarily to the creditors as a whole, ensuring the process is conducted fairly, legally, and with transparency. Depending on the procedure, the IP will act as the liquidator, administrator, or supervisor.

Key Documents and Actions

Understanding the role of certain documents and actions is also vital:

• Statutory Demand: As mentioned, this is a formal written demand for payment of a debt, often the precursor to a winding-up petition if the debt is not paid or disputed.
• Winding Up Petition: The legal document presented to the court to initiate compulsory liquidation proceedings.
• Winding Up Order: The court's official order that places a company into compulsory liquidation.

Conclusion

Corporate insolvency is a complex area with significant consequences for all stakeholders. Recognizing the signs of financial distress early and understanding the available procedures is crucial. Whether it's the terminal process of Liquidation (Compulsory or CVL), the potential for rescue through Administration, or a structured repayment plan via a CVA, each process has its own rules and implications.

The role of a licensed Insolvency Practitioner is fundamental in navigating these procedures, ensuring legal compliance and working towards the best possible outcome under challenging circumstances.

For any business facing financial difficulties, seeking professional advice from an Insolvency Practitioner is the critical first step.