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A Practical Guide to Insolvency Procedures: What Private Company Directors Need to Know
Laura Bridson & James Whittaker
Navigating risk within insolvency scenarios
Whilst a company is solvent, company directors owe various statutory duties as specified by the Companies Act 2006 to the company’s shareholders (which can often be the same people).
For example, directors owe a statutory duty to act in the best interests of the company.
However, where the company is insolvent (or likely to become insolvent) then these statutory duties are owed by the directors to the company’s creditors as opposed to its shareholders.
That means that once the company is insolvent, or likely to become insolvent the directors have a duty to act in the best interests of the company’s creditors from that point onwards.
If they do not, the if the company subsequently enters an insolvency process such as administration or liquidation, then the directors run the risk of being made personally liable.
The most often claim that a director may face would be for misfeasance / breach of duty / breach of trust for causing the company a loss to the detriment of the company’s creditors.
Where any claim is brought as breach of trust and it can be identified that the director has personally benefitted from the transaction then there may also be no limitation period on any claim which a subsequently appointed administrator or liquidator may bring.
There is also the risk of director disqualification proceedings / compensation order proceedings being brought separately (which can also be brought if a director just proceeds to take steps to dissolve the company without a prior formal insolvency procedure concluding).
In addition with effect from 22 July 2020, HMRC can being proceedings to make directors and other persons involved in tax avoidance, evasion or phoenixism jointly and severally liable for a company’s tax liabilities if there is a risk that the company may deliberately have entered into insolvency.
Whereas it might be easy to identify a company which has become insolvent (such as if it has received an incontestable demand letter which is left unpaid) it can be harder to spot a company which is likely to become insolvent.
Why Early Advice Matters
Due to the risks to directors as identified above, a director acting reasonably and cautiously would be well advised to engage with suitable professionals as soon as they consider that the company may likely become insolvent.
Not only does early engagement potentially mitigate the risk of possible subsequent challenge to the directors conduct / disqualification proceedings early intervention may also permit a restructuring / turnaround of the company for the mutual benefit of all stakeholders.
Understanding the Main Insolvency Procedures
- Company Voluntary Arrangements (CVAs)/ Scheme of Arrangement
This is a possible rescue remedy whereby a company in financial difficulty can come to a repayment agreement (or other compromise) with the company’s creditors while continuing to trade. This is ideal for businesses that remain viable as it provides breathing room for the company to stabilise operations and potentially avoids a terminal insolvency procedure such as liquidation.
A Scheme of Arrangement is similar to a CVA, however rather than a voluntary process between the company and its creditors, it is a court-sanction agreement and usually are only used by large corporations such as Scottish Life and Cineworld.
- Administration
Administration allows a company to be protected from creditors potentially enforcing their debts as there is a freeze on creditor action whilst an administrator takes over the management of the company’s day-to-day affairs with a view to reorganising the company or potentially selling the company’s assets, often by way of a “pre-pack” sale, which subject to an evaluator’s report, can be a sale back to prior directors. It can be utilised to save jobs.
- Liquidation (Insolvent or Solvent)
Liquidation occurs when a liquidator is appointed to take control of the company’s assets, sell them, and use the proceeds to pay the company’s debts. The company ceases trading under the liquidation process and is wound up once liquidation has taken place.
Liquidation can be instigated by the court granting an order to wind up the company (through a winding up petition) or can be voluntary through the company’s members deciding to place the company into a Creditors’ Voluntary Liquidation.
There is also a solvent liquidation mechanism (members voluntary liquidation) where the director swears a statement of solvency that the company’s debts can be paid within 12 months. This mechanism can permit shareholders to efficiently extract profits, often tax-efficiently once there is no further purpose for the company.
4. Receivership
Receivership involves the court or a secured creditor appointing a receiver (often an insolvency practitioner) to take control of a company’s assets (often a property) to manage or sell them for the benefit of the secured creditor.
- Part 1A Moratorium
A Part 1A Moratorium allows a company in financial difficulty to have breathing room of an initial 20 business days to attempt to organise their affairs, trade out of financial difficulties, or pursue other rescue options available etc. by preluding creditors from bringing enforcement action against the company.
Supporting Your Next Steps
Bermans’ Insolvency & Financial Rescue team is recognised by the Legal 500 for clear, pragmatic guidance delivered across a wide range of sectors. Whether you’re a director, lender or insolvency practitioner, we can help you understand your options and move forward with confidence.
Please contact Laura Bridson from the Insolvency Team.