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When a business is looking to cease trading, it has a number of options to consider. One of the reasons why many businesses fail, particularly following the financial crash of 2008, is for reasons of insolvency. As is explained in our guide to insolvency, there are a number of procedures available to organisations experiencing financial difficulties under the Insolvency legislation.
This article explains two procedures that operate under the Insolvency legislation in the UK: Receivership and Liquidation.
When dealing with ‘Corporate Insolvency’ i.e. where a business is facing financial difficulties, there are a number of procedures that are available to organisations. Each of these procedures has a different objective, whether this is to save the business, or to bring its activities to an end.
As with any aspect of Corporate Insolvency in the UK, most of the procedures and the rules detailing how they it will affect a business are set out in the Insolvency Act 1986, with some amendments made by the Enterprise Act 2002. The Insolvency Rules 1986 also contain some of the important insolvency rules which businesses must be aware of.
This article will discuss the relevant insolvency procedures available to Limited Companies. It should be noted that the procedures discussed here are also available to Limited Liability Partnerships (LLPs). For more information on different business structures, read our ‘Business Structures’ guide.
Receivership is a procedure that is available to and often used by secured creditors of a business, or by a court on behalf of a secured creditor, with a view to ensuring the payment of an outstanding debt.
Receivership is a procedure that is normally considered when a business doesn’t meet the terms of a borrowing agreement that it has made with another organisation – this is normally a loan that is taken out by the organisation from a bank.
In law, the receiver is the person that is placed within an organisation to look after or safeguard creditors' property when a business is facing financial difficulties. It is important to point out that in law, a receiver can be appointed by a court, a government department e.g. HMRC or by the holder of a security in business property, called the ‘charge holder’. Historically, the courts have tended not to get involved in appointing receivers, and charge holders or government departments tend to be the party that will look to appoint a receiver. Owing to the financial difficulties experienced in the UK in recent years, HMRCs involvement in appointing receivers has been particularly high.
It is important when discussing Receivership as a procedure, to note that there are two different kinds of receivers;
This refers to an individual that has been appointed to a business by an organisation that has a security interests in the debtors property. This is the ‘charge holder’. While safeguarding the interest of the organisation that appointed him/ her, the job of the receiver is to manage the debt that he/ she was appointed to look after so to realise the value of the debt that the company owes.
This is not dissimilar to a receiver. An Administrative receiver is appointed by an organisation that holds a security interest in a business’s property – normally a bank – that was granted before 15 September 2003. The use of Administrative Receivers is likely to continue for the foreseeable future.
The use of Administrative Receivership has been heavily curtailed, following the passing of the Enterprise Act 2002. The UK Government in passing this legislation, wanted businesses to make greater use of other less rigid insolvency regimes e.g. Administration. As mentioned above, this process can only be used for security interests granted before September 2003 or for certain special kinds of financial arrangements that are set out within the Enterprise Act.
When a receiver is appointed to a business, their goal is to protect and ensure payment of the security interest that the organisation that appointed them has in the organisation. The powers of the receiver are quite broad and outlined within the Insolvency Act. Essentially, there are entitled to do anything that is required in order to ensure payment of the outstanding debt that the company owes to the organisation that appointed him/ her.
The appointment of a receiver has severe consequences for the directors of a company. As with administration, in receivership, directors of the company lose control over the organisation. The receiver is the one who will then manage the affairs of the company, not the directors.
A receiver is appointed by the holder of a security interest. This is important to bear in mind from the point of view of shareholders and other creditors of the company. The courts tend not to get involved in the process of appointing a receiver, but are the only body able in law, to remove a receiver. The directors will be obliged to provide a report on the company’s affairs prior to his appointment. Within three months of their being appointed, receivers are required to provide a report to both the company creditors and Companies House on their dealings with the company, what has been paid out to creditors and what remains available as company assets.
An important point relates to the ‘hierarchy’ of creditors. As mentioned earlier, the primary duty of any receiver is to ensure payment of the security interest which the organisation that appointed him/ her has in the business. However, where a receiver is appointed by a floating charge holder, they are required to pay preferential creditors before the realisation of the security of the floating charge holder. These are discussed in detail below.
Liquidation is a term that is often used to describe businesses that are to cease trading. However, the term ‘liquidation’ is not comprehensive in the sense that there are two different kinds of liquidation or ‘winding up’ that an organisation can become subject to; compulsory liquidation and voluntary liquidation. Regardless of the kind of liquidation that takes place, both are designed to bring the operations and existence of the company to an end.
As mentioned earlier, one of the main reasons why the liquidation of a company might be sought is where the business becomes insolvent – it cannot pay its debts. However, there are other reasons why a business may be ‘wound up’. In the case of small businesses, it is not unusual that the founder of the business may look to retire, and with no succession planning made, the logical option is to dissolve the company. Alternatively, the objectives that the business was created to achieve may have been satisfied, and so a decision is taken to end the businesses existence.
As mentioned above, there are two different kinds of liquidation.
Voluntary Liquidation can be a decision by either the members of a company i.e. the shareholders or of the creditors of the company.
This option is only available to shareholders in a company, if the business is solvent – it can pay its debts.
In order for the members to voluntarily initiate that the company be liquidated, they must pass a ‘special resolution’ i.e. a vote by 75% of shareholders present, which will provide evidence that there is majority agreement that the business should be ‘wound up’. Providing this happens, the directors of the business, within five weeks of the resolution having been passed, must complete a statement or ‘declaration’ that sets out the assets and liabilities of the company. This document is called a ‘Statement of Affairs’ in Scotland. The declaration has to make very clear that the directors are of the opinion, having made a full investigation into the state of the company’s affairs, that it will be able to pay all of its debts within a 12 month period of the members’ voluntary winding up beginning.
The declaration of the directors must be delivered to the Registrar of Companies at Companies House within 15 days of the member’s (shareholders) special resolution being passed.
If however, at a meeting of the members of the company on the prospect of a voluntary winding up, it becomes clear that the business will not be able to pay all of its debts within a 12 month time frame, the liquidator must communicate this to the creditors. The voluntary winding up, will then be for the creditors to agree to.
If there is a need to liquidate a business, but the business will not be able to pay off all of its debts i.e. it is not solvent, then the decision to liquidate the company is that of the creditors. As mentioned above, a members Voluntary Winding Up can only take place where a business is still ‘solvent’. The creditors will be notified of this by the liquidator, if a meeting of the members fails to yield a decision to pursue voluntary liquidation, because the business is insolvent.
The liquidator must call a meeting of the business’s creditors within 14 days of the members’ meeting, where they are unable to pass a resolution that demonstrates the business’ solvency.
Compulsory liquidation will occur where a court orders that a business is ‘wound up’. A court will normally be presented with a request, called a ‘petition’ from an interested party that the business be liquidated. In England & Wales, the relevant court is normally a Chancery court. In Scotland, either the Court of Session or the relevant Sherriff court will be the appropriate forum to petition.
A petition to liquidate a company can be brought before the courts for a number of reasons. The most common of these, recognised in the legislation, is that the business is unable to pay its debts. The legislation is very clear on when a company will be deemed unable to pay its debts. Under the Insolvency Act, a company cannot pay its debts;
It should be noted that there are other reasons why a court may order that a company is liquidated, but the above are the most commonly used. As such, companies should be very aware of when they are vulnerable to a petition for liquidation.
Generally, it will be a creditor of the company that will seek to have it liquidated. However, it should be noted that a court may grant a petition for liquidation which is brought by;
This information is publicly available on the Companies House website (www.companieshouse.gov.uk).
A lot will happen to a business that is going through the liquidation process, and this is discussed in detail below. However, the prospect of liquidation can and does cause a degree of panic in creditors of the company. An important point to note is that the beginning of the liquidation process has an impact on the ability of creditors to bring claims against the company.
Where there has been a Compulsory liquidation begun i.e. where a court has granted a petition brought by a creditor or other interested party, no other kind of legal action can be brought against the company. This is part of the reason why Liquidation is such a drastic step. The courts may allow for a separate action to be brought, but only if it is convinced that there is a good reason. However, it would be possible for a party e.g. a creditor, in between a petition being brought to the court and a liquidation order being granted, to have a small pause, or ‘stay’ in matters. However, there must be good reason before the court will allow this.
With a Voluntary Liquidation, it is possible to ask that the process of liquidation be paused – again, assuming that the timeframe has been complied with. However, as above, this will not necessarily be granted automatically.
Liquidators are often unpopular among other business professionals. To an extent this is understandable, as their appointment has an impact on how a company is managed and what happens to business assets. The appointment of a liquidator to a company has particular consequences for directors. Directors will no longer be in control of a company, or act for a company in liquidation. They will be required to provide the liquidator with any information that he/ she needs to establish what the business’s assets and liabilities are, and may be required to explain why the business failed.
The role of a liquidator is to in-gather all of the assets of a company and to use their value to pay creditors who are due monies from the company. A reality of business practice, unfortunately, is that there is rarely enough money in business assets to pay all of the creditors. As a result there is a procedure for establishing who is to be paid first, but this will be discussed later.
In fulfilling their role, liquidators are granted wide varying powers. Under the Insolvency Act 1986, but subject to some procedural restraints, these powers include;
As mentioned earlier, the role of the liquidator is to in-gather company assets with a view to discharging outstanding debts to creditors. However, the total value of company assets rarely, if ever, satisfies every outstanding debt. As a result, liquidators will take note of the debt which the company owes each creditor, and will then pay close attention to creditors’ entitlement in law, to repayment.
Owing to the fact that liquidators need to have regard for creditors’ legal entitlement to repayment for debt, this does mean that there is a ‘hierarchy’ as to who will be paid first.
As far as liquidators are concerned, their primary concern is to satisfy the outstanding debt owed to creditors with a security interest over ‘charged’ property. There is however a problem of what is to happen when more than one creditor has security in the same asset. The Companies Act 2006 stipulates that the security that is registered first will have priority.
There are important distinctions between different types of securities. In terms of liquidation, and which creditors will be paid first, a fixed charge holder i.e. a holder of a security in a particular asset of a business will ‘rank’ ahead of a holder of a floating charge i.e. a charge that has yet to ‘attach’ to business assets. There is an exception to this rule, and that is where a floating charge was created that explicitly prevents the creation of any later fixed charges and the holder(s) of a fixed charge had notice of its creation – there is normally a clause within the documentation for the ‘floating charge’ that makes such a condition very clear.
The next concern for the liquidator, after having satisfied the fixed charge holders will be to account for the cost of liquidating the company. These costs are normally accounted for from the assets of the company that would be used to pay general creditors – those that do not hold security over company assets.
When a liquidator has satisfied the costs of pursuing the liquidation, they will then turn to deal with the so called ‘preferential debts’. The debts that this refers to, have been changed after some reforms in this area of the law. The current preferential debts that will need to be discharged are;
A liquidator will then turn to deal with those creditors that hold floating charges over company assets. This is an area of the law that has undergone a great deal of reform. The law requires that a liquidator set aside a portion of the company’s assets, called the ‘Prescribed Part’ to pay for ‘unsecured’ debt. Floating charge holders will be paid from company assets, in so far as they can be, from monies that do not make up the ‘Prescribed Part’.
Unsecured or ordinary creditors are the last to see a debt repaid. They will be paid out of the ‘Prescribed Part’ which the liquidator will calculate from the company assets. The calculation is as follows;
When the liquidator has realised all of the debts, the company will be dissolved. ‘Dissolution’ means that the company will no longer exist. Depending on the procedure that is used, dissolution is achieved in different ways;
Nothing in this guide is intended to constitute legal advice and you are strongly advised to seek independent advice on matters that affect you.
