Insolvency and restructuring are covered by comprehensive but complex legislation in the UK. Below are some of the most commonly asked questions about how this area of law works in practice within the UK.
What is the legal definition of insolvency?
There are a number of ways that a company can be considered to be insolvent in the UK, namely:
- A court is satisfied that its liabilities are greater than its assets (also known as the balance sheet test)
- A court is satisfied that a company will be unable to pay its debts and liabilities when due (also known as the cash flow test)
- A creditor has been unable to enforce a judgement for debt against the company
- A statutory demand for payment which is greater than £750 cannot be met
The balance sheet test is more rigorous than the cash flow test because it takes into account not just the current position, but also contingencies and future liabilities. This means that it’s possible for a company to pass the cash flow test while failing the balance sheet test.
The law does not levy any specific sanctions for insolvency but the potential liability for the directors is often the motivating factor which drives a company to file.
What is the main legislation which deals with insolvency and restructuring in the UK?
The Insolvency Act 1986 (IA 1986) and Part 26A Companies Act 2006 (CA 2006) are the main pieces of legislation which set out the statutory processes in the UK. This latter Act (CA 2006) also governs the Scheme of Arrangement legislation which can be used for solvent, and sometimes insolvent, companies.
The same legislation applies throughout the UK, with relevant modifications where required.
Since Brexit and with effect from 31 December 2020, Regulation (EU) 2015/848 (the Recast Insolvency Regulation) no longer applies. Separate UK regulation contains a significantly amended version. The Recast Judgments Regulation (EU) 1215/2012 has also been similarly set aside. This was the legislation previously used which defined how schemed would be recognised within EU member states.
What are the different types of insolvency and restructuring options available?
The various options for insolvency and restructuring are:
An insolvency practitioner takes control of the daily operations, with the goal of either completing a successful sale to maximise returns to creditors or enabling the business to continue trading.
In contrast to administration, with liquidation an insolvency practitioner takes control with the sole goal of winding up the company and distributing its assets to creditors.
Where a secured creditor wants to realise assets over which it holds security, it may opt to appoint a receiver. This receiver will act solely for the benefit of the creditor, rather than for the company’s creditors as a whole. Receivership does not have to be court ordered as it is usually a contractual right.
Company Voluntary Arrangement (CVA)
A CVA is an agreement that a company reaches with its creditors which is supervised by an insolvency practitioner. Only 75% of creditors need to agree to the terms for the CVA to be put into force.
Scheme of Arrangement
A Scheme of Arrangement is an option for both solvent and insolvent companies which allows them to reach an agreement with creditors. An application needs to be made to the court which can either be filed by the company, its creditors, or an insolvency practitioner.
IA 1986 Moratorium
Under the Insolvency Act 1986 and set out within the Corporate Insolvency and Governance Act 2020 (CIGA), a new moratorium procedure is available to companies who meet the criteria. The directors must file with the court, which will then give the company 20 days during which time they will be supervised by an insolvency officer. This creates a “breathing space” for the business while they consider restructuring options.
The Companies Act 2006 was amended by CIGA to allow a new type of restructuring plan to be introduced. This is similar to the Scheme of Arrangement but provides more options, including setting aside a class of creditors if they won’t provide their approval. The action must be given approval by the court.
Are companies obliged to commence insolvency proceedings?
There is no explicit, separate and stated duty that requires a company to file for insolvency.
What are the conditions that create an obligation for insolvency?
The directors of the company have a responsibility towards the creditors in the event that the liabilities and debts are likely to be unmet. Where there appears to be no reasonable alternative to bankruptcy, an obligation is created whereby the directors must put the creditors’ needs as the priority.
What happens if this obligation is not met?
If the obligation to enter into insolvency is not met, the directors may find themselves exposed to considerable personal risk. This includes the risk of fraudulent trading, directors breach of duty, misfeasance, and wrongful trading. Directors cannot resign to escape their liability should they try to avoid filing for insolvency. In some circumstances, the consequences may even involve criminal liability and/or being disqualified as a director.
Are creditors all classified in the same way?
All creditors are split into one of three main groups: secured, unsecured and preferential. Each of these groups has its own sub-categories.
Creditors in the secured group may well be able to influence the restructuring because they will need to provide their authorisation for the disposal of any assets that are secured with them.
When distributions are ready to be made, the creditors would be ranked as follows:
- Secured creditors (where security is held over a fixed asset)
- Expenses associated with the insolvency process (such as insolvency practitioner fees, and other professional fees)
- Preferential creditors – this group includes HMRC and the company’s employees
- Creditors with floating security (changeable class assets)
- Creditors in the unsecured group
- Interest on some debts accrued during insolvency
The creditors in the unsecured category rank equally with each other. However, in practice it’s uncommon for anyone in this category to receive any of the distribution. It is even less common for shareholders to receive any payment.
Do the legal entity’s representative bodies have any responsibility to become involved in insolvency or restructuring?
There is no official responsibility which is imbued upon representative bodies during the process of restructuring. However, they may be required to assist with communication where employee engagement and/or retention is a priority for restructuring.
What responsibilities do shareholders have during the insolvency and restructuring process?
The shareholders’ role in the insolvency or restructuring process is minimal and will depend on the proposed solutions. For example, the shareholders must be asked to vote on a CVA, but the vote of the creditors will take precedence. If the share capital needs to be reorganised, such as with a Scheme of Arrangement, the shareholders will need to agree to the changes.
Can solvent liquidation be considered as an alternative to insolvency proceedings?
No. To be eligible for solvent liquidation the company must be able to make a truthful declaration that they will be able to settle all their liabilities in full, plus any accrued interest, within the next 12 months. A company which is able to pass this test for solvent liquidation would therefore not meet the required criteria for insolvency. It is not possible to pass the test for both states simultaneously.
However, there may be some cases which began as a solvent liquidation that then become an insolvency case due to the liabilities not being settled within 12 months.
Is there a recognised legal framework which covers preventative restructuring?
Yes, there are a number of options as outlined higher up such as the Restructuring Plan, CVAs, and Schemes of Arrangement.
What is the average success rate for different types of insolvency and restructuring?
Success rates are difficult to quantify and verify, and there’s a lack of accurate, up-to-date information. However, there is some limited data available.
The outlook for CVAs is mixed, based on older, empirical data that’s available. The most probably outcomes are administration, or particularly liquidation. For this reason, landlords have typically opposed the use of CVAs as they fall within the group of creditors which are the least likely to receive any payment. Preferential terms e.g.,/upside sharing agreements have often been requested in return for landlord agreement.
Despite these difficulties, CVAs are still often relied upon in cases where the company has a clear and viable rescue plan, and where breathing space would provide a genuine advantage. The casual dining, restaurant and retail industries have been particularly successful in their use of CVAs.
Historically administration has been used as a mechanism to sell the company assets, either via the process of winding down or by a prepack administration. However, in a bid to avoid the damage to businesses which were previously viable, there is growing enthusiasm for “light touch”. This means the focus is now on enabling the business to continue with assistance from a rescue package.
Anecdotal research suggests that previously around 30% of administration packages were successful. This means either a completed sale or enabling the business to continue trading as a going concern.
Schemes of Arrangement
When Schemes of Arrangement reach implementation, they are usually successful, but the challenge exists in achieving this point. Stakeholders must approve the plan, and very often reject the Arrangement proposal, preventing a successful strategy from being put in place.
New Moratorium and Restructuring Plan
As a more proactive approach, the New Moratorium and Restructuring Plan bears strong similarities to the US Chapter 11. The goal is to ensure rescue strategies are implemented sooner in the process, and in doing so, secure a better outcome. The CIGA procedures don’t quite extend as far as debtor-in-possession financing, so the structure is a compromise. As a more recent measure, there are fewer cases, but early indications seem to suggest a positive success rate.