Out-Law Guide | 30 Aug 2011 | 4:23 pm | 4 min. read
A company is considered to be insolvent under English law if it is unable to pay its debts.
There are two tests for corporate insolvency:
If the evidence proves that the answer to either of these questions is yes on the balance of probabilities, then the company is deemed insolvent under English law. Furthermore a company is deemed unable to pay its debts, and therefore insolvent, if:
What are the consequences of a company's insolvency?
Depending on the facts of a given case, the following consequences of corporate insolvency may apply:
What are the available insolvency procedures?
A company can be placed into a formal insolvency procedure by its directors, shareholders, creditors or the court. How it is done will depend on the facts of each case and the procedure involved. There are a limited number of UK corporate insolvency procedures, each of which is run under the control of an appointed insolvency practitioner (IP) who is professionally qualified and licensed.
Administration - this is a collective corporate rescue procedure run for the benefit of all creditors, under which the company's assets are protected by virtue of a statutory 'moratorium', or stoppage, of any forms of creditor action. Administrators have the power to trade on the insolvent business and may look to find a buyer for it. Administrations are commonly associated with 'pre-packaged' insolvency. For more information, please see our separate OUT-LAW Guide to Pre-packaged insolvency sales.
Administrative receivership – this is a process under which the holder of a floating charge against the company which pre-dates 15 September 2003 appoints a receiver-manager to sell the company's assets for maximum value in order to pay off its secured debt. The floating charge holder will usually be a bank. This procedure has been largely superseded by administration as a result of changes in the law.
Administrative receivers have no authority to pay unsecured creditors. Doing this will usually require a subsequent liquidation, although administrators can also make such payments with court approval.
Company Voluntary Arrangement (CVA) - this is a binding form of agreement between a company and its creditors which is legally regulated. Under a CVA, creditors will typically agree to a reduced or rescheduled debt arrangement which will allow the company to survive. CVAs are sometimes used in conjunction with the administration procedure.
Scheme of arrangement – this is a compromise or arrangement between a company and its creditors or members. It is similar to a CVA in many respects, although it must be approved by a court. The process is more complicated than a CVA, and will usually only be used for large companies and those with a significant number of classes of creditor or shareholder.
Whether unsecured creditors can be repaid where a company enters into a CVA or scheme of arrangement will be determined by the related documentation. These arrangements rarely interfere with secured creditors' rights.
Liquidation – this is the collective process by which a company is ended by converting all of its assets into their cash value and distributing them to shareholders if the company is solvent or creditors if the company is insolvent. The liquidator must also examine the directors' conduct, and take action if appropriate.
When a company is placed into administration or liquidation, creditors are repaid in the following descending order of priority depending on the amount of cash available:
The 'prescribed part' included above is an amount which must be set aside by the administrator or liquidator for the benefit of unsecured creditors. It is calculated as a proportion of the amount of assets which are subject to any floating charge created after 15 September 2003. The size of the fund will depend on the value of the assets, but can be up to a maximum of £600,000.