Insolvency Work Shop 1

When is a Company Insolvent?Defines.123 Tests to prove a Co. is Insolvent P.302

Directors ' Duties P.303

A company may be ordered to be wound up by the court when it is unable to pay off its debts as they fall due (i.e. when the Co. is insolvent) (Insolvency Act 1986 "IA"s.122(1)(f) and s123(1)(e)) A company is deemed unable to pay its debts (i.e. insolvent) in the following circumstances:

1. (s.123(1)(a)) Statutory demand: if the company is indebted to a creditor for more than PS750 and due notice to pay has been served on the company and the company has not complied with the demand for three weeks (21 days) (this is the most commonly used method)

2. (s.123(1)(b)) Creditor obtains judgment: a creditor gets a judgment against the company and tries to enforce it but the debt remains unsatisfied in whole or in part

3. (s.123(1)(e)) Cash-flow test: the Co. is unable to pay its debts as and when they fall due
? If debtor Co.'s can pay its creditor only after its own debtors have paid the debtor Co.
? Good indicator is the current ratio (current assets / current liabilities). But this isn't the definitive test because it may give a positive ratio
? Consider: is the BS's stock and debtor values true representations or bloated?

4. (s.123(2)) Balance Sheet test: the total value of the company's assets is less than the amount of its liabilities
? Ascertained by taking net assets / liabilities on the BS
? Take into account contingent and prospective liabilities
? Note overvaluation of fixed assets and low-realisation value of stock, so adjust
? It is intended to apply and illustrate where a company has reached a 'point of no return' (Eurosail)
? Remember that a BS is only a snapshot of one day in the life of the company Upon finding out that their company is insolvent, a D should take the following practical steps:

1. Immediately seek professional advice (to assess the prospects of recovery)

2. Be alert to those creditors who may serve a statutory demand or obtain judgment

3. Do not take on any more debt (risk breach of duty/wrongful trading under s.214 IA)

4. Keep full minutes and update accounts regularly

5. Aggressively pursue any debtors

6. Discuss and analyse the situation with the Board

7. Do not take any more salary (shows good faith, reasonableness and s.172 commitment)

1. s.172: Promote the Success of the CompanyIn a way that benefits the members as a whole but note that on insolvency, the Interests of creditors supersede members (s.172(3))(West Mercia Safteywear)

2. s.173: Exercise Independent Judgment

3. s.174: Reasonable Care, Skill and DiligenceObjective: the knowledge, skill and experience that may reasonably be expected of a person carrying out the functions of the director in question 1

Insolvency Work Shop 1

Subjective: with the particular knowledge, skill and experience that the director in question has Ds may undergo potential actions against them for fraudulent IA s.214 or wrongful trading s.213(P.159)). Ds have a defence under IA s 214(3) (D tookevery steep to minimise the potential loss to the Co creditors after D became aware that Co. was insolvent or risking insolvency) and s 238(5) (transactions entered into in good faith for the purpose of carrying on the business and there were reasonable grounds for believing it would benefit the Co.)

Options for an Insolvent Company

Options for Secured and Unsecure d Creditors apart from liquidati on:

1. Debt Restructuring (renegotiating or debt for equity with the lenders)

2. Refinancing (increase overdraft provisions, asset finance or granting equity stakes in Co.)

3. Informal agreements with creditors (payment by instalment)

4. Compulsory Voluntary Arrangement (CVA) (P.318) + See note

5. Administration (P.312) + See note

6. Liquidation (MVL; CVL; CL) (Liquidation should be the last option) (3 stage
= Collect & sell assets + Distribute assets to creditors + Dissolve the Co. (return form to Reg. of Co.))

1. Secured Creditors: P.320

2. Unsecured Creditors: They rank first in insolvency procedures, Rank 2nd after secured creditors thus thus usually OK but to avoid insolvency options are: procedures they can:

1. Serve Statutory Demand (s.123(1)

1. start receivership proceedings (a)); or (LPA) even if the Co. not under

2. Sue the Co. (s.123(1)(6)) or insolvency procedure,

3. Apply to court to put Co. into

2. Charge-holder appoint a receiver administration or, 4. Suggest a CVA when Co. in breach of terms of thebut will have to wait long to get Loan Agreement paid,

3. The receiver acts only for themay have to accept part/small charge-holder pay

4. See book for more P.320or both Note that only creditors with a floating charge can appoint an administrator (fixcharge holders cannot). Administrative Receivership was aimed at protecting Secured Creditor's position rather than rescuing Co but it was abolished and only applies for charges created before 15 Sep 2003.

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