Stages of Insolvency
The following article explains in depth the various stages of insolvency and the various processes that are available under insolvency.
WHAT ARE THE STAGES OF INSOLVENCY?
Insolvency is defined in law and there are two tests as to whether you / your company is insolvent:
- BALANCE SHEET INSOLVENCY: This is where, on a balance sheet basis, you have more liabilities than assets.
- CASH-FLOW INSOLVENCY: This is where you cannot pay creditors when they fall due.
The reality is that many individuals or companies are often balance sheet insolvent. For example, if you look at domestic mortgages, it is very unlikely that an individual can repay their mortgage in full at any point in time before the lifespan of the mortgage has expired.
Debt consolidation: This is a process of merging multiple debts into one loan, which may help simplify repayments and reduce stress.
In reality, this means a company or individual may have multiple small debts with a high-interest rate but measures are taken to consolidate all their outstanding debts together. This can be done by taking on a loan to cover the total value of the existing debts. It’s likely that one loan will result in lower overall interest rates. Individuals and companies can undertake this process themselves. It is not necessary for any insolvency professional to be involved, although they may be able to assist in obtaining finance.
There are many options available to avoid an insolvency procedure, and an Insolvency Practitioner will be able to guide you as to which processes may be available, and which are unlikely to be available to you.
Once the Insolvency Practitioner has concluded that alternatives are not available, and it has been concluded that the client is insolvent, the correct insolvency procedure for the client will be decided upon, which will be entirely dependent on the circumstances of the individual or company. Often multiple processes are available, but looking at all circumstances will allow the IP to advise the best process for your situation.
Once the most appropriate procedure has been agreed upon, the Insolvency Practitioner is engaged and will start to oversee the entire process from the initial engagement through the insolvency procedure to the wrapping up of the affairs of the individual/company, which is the final stage.
WHAT ARE THE DIFFERENT TYPES OF INSOLVENCY?
These can be split into two main types:
PERSONAL INSOLVENCY (INDIVIDUAL VOLUNTARY ARRANGEMENTS & BANKRUPTCY)
In personal insolvency (which is where an individual rather than a company enters insolvency) there are two main procedures:
- An Individual Voluntary Arrangement is a contract between a debtor and creditors which agrees on how the debtor’s debts will be resolved. The debtor will prepare, with the assistance of an Insolvency Practitioner, a proposal to their creditors as an offer of settlement. Whilst the contents of the proposal are not prescriptive, normally it will include contributions from surplus income, the release of equity from property interests, and the realisation of any assets not required by the debtor to live their day-to-day life.
- The second personal insolvency process is Bankruptcy. Bankruptcy is a formal insolvency process which is ratified by the Court in England and Wales. Upon the making of a Bankruptcy Order the bankrupt’s assets and liabilities become part of an estate which is initially presided over by an Official Receiver in the role of the Trustee of the bankruptcy estate.
An Official Receiver is a Government employee who works for the Insolvency Service and is licensed to take insolvency appointments. Following a court making a Bankruptcy Order by default an Official Receiver responsible for the geographical area in which the bankrupt lived or carried on their business will initially be appointed trustee of the relevant individual’s bankruptcy estate.
CORPORATE INSOLVENCY (LIQUIDATIONS, COMPANY VOLUNTARY ARRANGEMENTS and ADMINISTRATIONS)
For corporate insolvency, there are several types of processes available. The following summarises the most commonly used processes.
The first one is Administration. A company going into Administration means that a licensed Insolvency Practitioner is appointed to act as an Administrator. By doing so, from the date of appointment, the overall control and management of the company will be given to the Insolvency Practitioner.
Another corporate process is Company Voluntary Liquidation. This is where the directors of a company have identified that it has reached the end of its natural life, or that the company is insolvent.
The final process is Compulsory Liquidation which is where the company, its directors, shareholders, and the company’s creditors are entitled to apply for an Order of the Court that the company is placed into liquidation, also referred to as being “wound up”.
WHAT HAPPENS WHEN A COMPANY CANNOT PAY ITS DEBTS?
When a company cannot & therefore does not pay its debts, the first action creditors will take is to ring their debtor and ask for payment. If the creditors are long-standing customers, the calls may initially just be a pleasant conversation to see if the debt has just been an oversight. Most companies may ignore the call or provide an excuse stating that funds are expected to arrive soon and the invoice will be paid promptly.
If payment is still not received then the next step is issuing formal written demands for repayment. If payment is still withheld, then the likely next step creditors will take is one of the following:
- They may exercise any rights they have under the existing contract which could result in the termination of your contract. This can be terminal to the business if they are not able to purchase from other suppliers as it means it may quickly stop business operations if it cannot obtain a particular item that is needed for the business operation to produce its products.
- Creditors can apply to the court for a County Court Judgement (CCJ). In certain circumstances, the County Court Judgement can be defended. The hearing will be held if an order is made and your company is liable and the creditor can take further action resulting from the judgement. A petition can be made to wind up a company. If the CCJ is successful, high court enforcement officers will be engaged. High court enforcement officers serve a similar role to what most members of the public know as bailiffs. Their main role is to recoup goods to cover the value of the debt and they will take every step possible to do so.
- They can issue a statutory demand.
When served with statutory demand a debtor has 18 days to respond to court to dispute the demand. Assuming the debtor doesn’t make an application to contest the demand, by day 21, the creditor is in a position to take recovery action, which is usually presenting a winding-up petition. An unsatisfied statutory demand which is being uncontested is evidence of your insolvency. Therefore it is imperative, if you are served with a statutory demand, you take urgent advice. In addition, if the demand needs disputing and you fail to do so, you will likely end up in court defending a winding-up petition.
WHAT ARE THE INSOLVENCY RESCUE STRATEGIES
There are two main strategies an Insolvency professional will take:
- Negotiation & communication
It’s likely an Insolvency Practitioner will need to take a very detailed review of a company’s affairs to give best advice. The review will depend on the size of the entity. There is usually early negotiation with creditors to request breathing space whilst rescue options are formulated. The IP will formulate a timeline to work towards to facilitate prompt advice and action. - Refinance and restructuring
As outlined in this article above, refinance and restructuring will be considered to see if efficiencies can be made to resolve the problem and the company can continue to trade. If debts are only with HMRC a Time To Pay agreement may be the appropriate solution.
If a formal process is required there is likely to be 1 of 3 outcomes.
- The procedure is a terminal process where the business is unable to be rescued. The procedure will be undertaken to effect an organised closure of the company to minimise the impact on stakeholders. It will be done predominantly through liquidation or administration.
- The procedure is used to rescue the Company. This is usually undertaken when there is a sound underlying business if not faced with the burden of historic liabilities. The most appropriate procedure is usually administration, with a view to marketing and selling the “good” core business, which can minimise the impact of insolvency, and save jobs. Another alternative might be a Company Voluntary Arrangement(CVA), which in effect is a contract between a company and its creditors, where, for example, debts can be repaid over time taken from future trading profits.
- The third option is a combination of the two options above. It is a middle ground where often the size of the business, especially Small to Medium Enterprises, has limited value to a third party and is unlikely to be worthwhile in terms of cost for creditors to put the Company into administration.
In this instance, a CVA isn’t appropriate and normally the only option is liquidation. In this scenario, an agent will market the business and realise assets, but it’s unlikely any third-party interest will arise.
As long as the connected party (usually directors, shareholders or management) make an offer for what a qualified agent considers to be a fair value, the assets will be sold to this party.
Historically, there was a process called “phoenixing” – whereby the original company would be terminated overnight and the new company could start trading the very next day. However, legislation is now in place to stop this from happening to stop incumbent directors from acquiring assets including a company name, without ensuring that fair value is achieved.
Assets must be bought at their market value. In addition, the transaction must be fully disclosed to creditors and there are separate provisions about the re-use of company names which, if not adhered to, can result in a director losing limited liability protection in the new company. As such it’s crucial that where this sort of liquidation is envisioned that advice is sought from Insolvency Practitioner to ensure that all steps of the processes are undertaken correctly.
WHAT ARE THE TWO TYPES OF INSOLVENCY?
As outlined above, the main two types of insolvency are Balance Sheet Insolvency and Cash-Flow Insolvency.
WHAT ARE THE THREE TYPES OF LIQUIDATION?
Compulsory liquidation is a formal insolvency procedure which results in a company being forcibly closed. The compulsory liquidation process is typically initiated by creditors of a limited company through a winding-up petition (WUP). A WUP notifies a company that a petition has been lodged to bring about the closure of the business and the liquidation of its assets. This process is usually creditor lead. Read more about Compulsory Liquidation vs Voluntary Liquidation.
Creditors Voluntary Liquidation
A Creditors’ Voluntary Liquidation (CVL) is a process that allows a company to voluntarily cease trading. This commonly occurs when the Directors have concluded that the company is insolvent and cannot continue. This process is usually director lead. Read our complete guide to CVL
A Members’ Voluntary Liquidation (MVL) is a formal process for closing down a solvent company in a cost-effective way. This process is often utilised as an exit planning tool when a profitable company has reached the end of its useful life. It is considered a solvent process and chiefly used for tax efficiency purposes.
WHAT’S THE DIFFERENCE BETWEEN LIQUIDATION AND INSOLVENCY?
Liquidation is a specific form of insolvency – one of the formal insolvency processes applicable to companies.
HOW LONG DOES THE INSOLVENCY PROCESS TAKE?
Ultimately each insolvency takes as long as necessary to complete. A Creditors Voluntary Arrangement (CVA) and an Individual Voluntary Arrangement (IVA) usually take 5 years but can be shorter.
Each case is unique and its duration will be guided by its circumstances. For example, retentions which are not due for several years after the date of insolvency may require a case to remain open to collect those funds for the benefit of creditors.
WHAT IS THE DIFFERENCE BETWEEN RESCUING A COMPANY & RESCUING A BUSINESS?
In the UK the term “company” is used to refer to a limited company – a formal legal entity registered at Companies House. The term “company” and “business” are often used interchangeably, although the term “business” tends to refer to sole traders who do not have a limited company but trade under a brand or style.
Many people don’t need to be a limited company – there are advantages and disadvantages to becoming a limited company.
Crucially if you are a sole trader, and you are facing financial distress your personal assets, including your home, can be recouped in bankruptcy and similar proceedings to pay off sole trader business debts.
With a limited company, this is not the case, as the company is a separate legal entity to the directors and therefore their assets are protected from being realised to meet the company’s debts.
If your company is in financial distress, consulting a professional such as an Insolvency Practitioner will minimise any problems and their help may realise assets more quickly. These highly experienced professionals will also liaise with creditors on the client’s behalf and take over the running of the process.
Understandably, both personal and company financial distress can be very distressing for the individual and/or company director and place them under significant pressure.
By seeking prompt advice from an Insolvency Practitioner, you can be supported through this difficult process by experts who understand the pressures you are facing and have experience in working swiftly to deliver a strategy to resolve the issues you face.
Chamberlain & co offers a free initial one-hour consultation which is discrete and can be held via telephone, face-to-face meeting, or through a digital medium such as Microsoft Teams. All matters are discussed confidentially, and the team is used to making discrete enquiries on a name basis when working with you to produce a strategy to resolve your issues.
As with all insolvency practitioners, Chamberlain & Co are committed to delivering best advice in all scenarios, and the teamwork has been recognised regularly at the Yorkshire Accountancy Awards and Turnaround, Rescue and Insolvency Awards.
You can contact us by calling 0113 242 0808; or by emailing us at advice@chamberlain-co.co.uk or by completing our online contact form here