The UK’s has an established legal framework covering the insolvency process, which has continued to evolve, including to address the financial pressures resulting from the Covid 19 pandemic.
Role of the Insolvency Act 1986
The main source of law in the UK is the Insolvency Act 1986, which provides much of the legal basis for personal and corporate solvency.
Its purpose was to consolidate earlier laws and to provide a comprehensive way of dealing with insolvency and where possible, to allow companies to recover. It also established voluntary ways of liquidating firms that were more flexible and avoided lengthy and costly court proceedings. Further, there were aims to bring the UK more into line with insolvency practices within the European Union.
What is Covered by the Insolvency Act 1986?
- Company Voluntary Arrangements
A Company Voluntary Arrangement is an alternative procedure that would otherwise be placed into compulsory or voluntary liquidation. It must be registered at Companies House and it is used as a way for creditors to be repaid – potentially at reduced levels – while the business is permitted to continue trading. The insolvency practitioner takes on a supervisory role to ensure repayments made for a period of up to five years
The Insolvency Act 1986 contains the procedure for a company entering administration, which was later updated by the Enterprise Act 2002. A company in administration is protected temporarily from creditors seeking repayment while there is an investigation into its future viability. This means that its management is replaced by an insolvency practitioner, who has a statutory duty to attempt to rescue the company or obtain the best result possible for creditors.
This is also known as administrative receivership and it is a legal process where a receiver is appointed by a floating charge holder as a means to recover a debt. It can be used if the debt is £750 or more on a debenture created before 15 September 2003. However because of the 2003 date it is now rarely used – most debts are far more recent – and this change in the law was as a result of the Enterprise Act 2002, which sought again to increase the likelihood of company rescues. Unlike administration, receivership is not focused on saving the business.
- Winding up
Winding up a business can be either voluntary or compulsory and it can take a number of different forms:
Members’ voluntary winding up
This is a process to bring a solvent company to a close, with directors required to make a sworn declaration that the business is able to pay its taxes and creditors.
Creditors’ voluntary winding up
This is the formal closing of a business by a licensed insolvency practitioner who acts as liquidator. It is often taken in the face of ongoing creditor pressure and to avoid compulsory court action. Both members and creditors winding up requires approval by at least 75% of creditors or shareholders voting at an official meeting.
Winding up by the court
This is where a creditor petitions the court if they are owed £750 or more and it has not been paid for more than 21 days. It accepted that the business is insolvent, the court authorises the liquidation of the company.
The Act also introduced a prioritisation of creditors, where some are paid ahead of others and these are:
· Secured creditors who have a fixed charge over a particular asset.
· Preferred creditors – typically employees and tort victims
· Creditors with floating charges
· Unsecured creditors
Provisional Liquidation order
Although uncommon, these can be granted if there is believed to be a serious threat to the company’s assets being sold off and it takes power away from directors as a matter of urgency.
Wrongful Trading and Fraudulent Trading
Wrongful trading under the Insolvency Act 1986 relates to directors that allowed trading to continue when they realised that the business would be unable to pay its debts. Wrongful trading is a civil offence but it still carries penalties and the director could lose their rights to limited liability and so be personally liable for debts owed to creditors. They could also face disqualification for up to 15 years, plus fines.
Fraudulent trading is a criminal offence and has more serious consequences, compared to wrongful trading. Fraudulent trading is proven if it can be shown the director deliberately planned to defraud creditors. The offence is also applicable to any persons who were knowing parties to the crime.
A director found to have committed such an offence can be held liable to make contributions to the company’s assets usually based on the loss suffered by the fraudulent trading. Penalties include imprisonment for up to 10 years, fines and being personally liable for the debts.
The Insolvency Rules 2016
These came into force in 2017 and the key purpose was to update the 1986 law, by reflecting more modern business practices.
Changes included reducing or removing the need for creditors’ meetings and encouraging the use of email for communication, which can be opted in and out of. Debts of under £1,000 could also be agreed for inclusion on the schedule of creditors, providing they are shown as owing by the insolvent business.
Other Laws Resulting to Insolvency
There are a number of other laws after the 1986 Act that are relevant to the insolvency process, including:
Company Directors’ Disqualification Act 1986
This means that directors that breach company law duties or commit fraud can be prevented from holding directorships for up to 15 years.
Employment Rights Act 1996
This provides for compensation for lost earnings when an employer is liquidated and there is no money left to pay staff. Employees have the right to claim for unpaid wages from the National Insurance fund, up to an £800 limit.
The Pensions Act 2004
This Act provides powers to protect pensions for employees who worked for a liquidated company through the Pension Protection Fund.
Companies Act 2006
The Companies Act 2006 also contains some important aspects relating to insolvency. It states that directors’ primary duties are to act in good faith and in the case of insolvency, consider creditors’ interests over shareholders. Claims can be brought against directors by creditors, including those who are unsecured, and they can also be held personally liable for losses where ‘misfeasance’ has occurred. It also includes fraudulent trading as a criminal offence.
The Banking Act 2009
Following the financial crisis of 2007-2008. this created an insolvency regime for the banking sector and allows banks to be taken over by the Government in exceptional circumstances.
Small Business Enterprise and Employment Act 2015
This law introduced some changes, including the Secretary of State having new powers to seek compensation orders against a disqualified director. It also extended the period for bringing disqualification proceedings from two years to three. An administrator can now also bring actions for wrongful and fraudulent trading, which was previously a power only available to liquidators.
An administrator is also able to extend their term in office or up to a year by consent from creditors, which was up from six months.
Meanwhile, a creditor who is owed a debt of up to £1,000 no longer needs to prove this formally to participate in the process and receive a distribution, providing the debt is noted by the insolvent company.
The Corporate Insolvency and Governance Act 2020
This is the most recent legislation that affects insolvency and it came into force on 26 June 2020. It introduced important new permanent restructuring tools and measures to temporarily relieve financial pressure on firms resulting from the pandemic such as on wrongful trading and winding up. It constituted the largest change to the UK’s corporate insolvency regime in over 20 years. Its provisions include:
The act allows an extendable 20 working day period giving businesses protection from creditor action while they seek professional restructuring advice. It must be overseen by a licenced insolvency practitioner.
New Restructuring Plan
This is similar to existing Schemes of Arrangement which needs to be sanctioned by the court and which binds creditors to the plan. It seeks to find a compromise between the company, creditors and shareholders, is currently being used by larger companies but this may change in the future as the process becomes more established and costs reduce.
The Act also provides temporary relief until 30 September 2021, which puts a hold on winding up petitions and from wrongful trading charges, where the firm can show its difficulties arise from trading conditions related to the COVID-19 pandemic.