INTRODUCTION: INSOLVENCY & INSOLVENCY PROCEDURES
1. The Corporation: Outline
1.1 Formation of companies and fundamental principles of company law
In order to appreciate the particular exigencies associated with corporate insolvency it is
necessary to understand some of the legal rules relating to incorporation, which is simply a
process by which companies are formed and registered. Once incorporation has taken place,
certain legal outcomes follow which will become extremely important should the company later
become insolvent.
1.2 The Implications of Incorporation
1.2.1 Separate Corporate Personality
CA 2006 s 16 Effect of registration
(1) The registration of a company has the following effects as from the date of
incorporation.
(2) The subscribers to the memorandum, together with such other persons as
may from time to time become members of the company, are a body corporate
by the name stated in the certificate of incorporation.
(3) That body corporate is capable of exercising all the functions of an
incorporated company.
Ownership of assets
One specific point to note here is that the separate corporate personality doctrine necessarily
leads to the conclusion that the company (and not its individual members/shareholders) is the
owner of any corporate assets, and, as a corollary, it is the company which is solely liable for
corporate debts.
1.2.2 Limited Liability
Meaning of Limited Liability
IA 1986 s 74(1) When a company is wound up, every … member is liable to
contribute to its assets any amount sufficient for payment of its debts and
liabilities, and the expenses of the winding up…
(2) This is subject as follows –
(d) in the case of a company limited by shares, no contribution is required
from any members exceeding the amount (if any) unpaid on the shares in
respect of which he is liable as a present or past member.
“To say that liability is ‘limited’ means that the investors in a corporation are not liable for
more than the amount they chip in … No one risks more than he invests.” Easterbrook
and Fischel, The Economic Structure of Corporate Law, Harvard University Press, 1991),
p. 40.
Implications of Limited Liability
Salomon v A Salomon & Co Ltd [1897] AC 22
“The unsecured creditors of A Salomon and Co Ltd may be entitled to sympathy, but they
have only themselves to blame for their misfortunes. They trusted the company, I
1
, suppose, because they had long dealt with Mr Salomon, and he had always paid his way,
but they had full notice that they were no longer dealing with an individual…” Per Lord
Macnaghten
2. Corporate Insolvency: Outline
2.1 Incurring Debt / Liabilities
- Any kind of debt is incurred routinely due to trading
Loan capital is important to limited companies. It is especially important to small limited
companies, which may have started life as sole proprietorships or family businesses, only to be
incorporated at a later date. In such circumstances the equity investment, or share capital of
the company is, essentially, the proportion of its members’ personal wealth that they can afford
to contribute to the company, and this may be a small amount. In order to be able to afford to
enter into trading operations companies need funds, and these are frequently raised by way of
a loan.
It should be acknowledged, however, that it is not only small private companies that make use
of loan capital: on the contrary, most companies, including the biggest public limited
companies, will have borrowed to some extent, whether or not borrowing is strictly necessary
to finance the business. This may be because loan capital has certain tax advantages over
equity capital (basically, companies can claim relief from corporation tax against interest
payments on a loan). Further, the capital structure of most very large companies is afforded
invaluable flexibility by the availability of loan capital.
2.2 Forms of Loan Capital / Debt
- Debt: To get working capital
2.2.1 Institutional Finance
Overdrafts / Fixed-term loans
A company may approach its bank for an overdraft facility. This allows the company to
‘overdraw’ on its account up to a certain maximum limit (which will be a matter of contract
between the company and the bank), and the agreement provides for a rate of interest to be
payable on the amount by which the company is overdrawn.
Alternatively, a company may borrow a specific sum of money for a specific period at a specific
rate of interest. The major difference between overdrafts and fixed term loans is the fact that
the former will usually be repayable on demand, whereas a bank cannot call for repayment of
the latter before the date fixed for repayment (unless the contract includes an accelerated
repayment clause). It is crucial to appreciate that the terms upon which money is lent derive
almost exclusively from the agreement between lender and borrower: it is a matter of contract.
Laissez-faire approach
- Fixed-term loans subsist until the end of the loan
Advances by way of assignment of debts
It is not uncommon for companies to raise money by assigning their debts. Money owed to a
company by its own creditors is often generically termed book debts and, like any other asset,
book debts can be transferred to a third party. There is a large industry providing corporate
finance in this manner (sometimes known as factoring, receivables financing or invoice
discounting) and it is becoming an increasingly popular means of raising funds. Essentially, the
2
,company assigns its right to debts owed to it to a third party (the assignee) in return for a cash
advance. The third party can agree to collect the debts itself, or the company may collect the
debts, in which case it remains indebted to the assignee for the amount of the advance. Any
such collected funds will not become part of the company’s assets, but will be held on trust for
the financier.
The above is a very simplified explanation of how institutional finance may be provided. In the
case of larger companies the debt structure is likely to be much more complex, as companies
may issue ‘bonds’, access ‘mezzanine’ finance, or enter the debt markets generally. Such
companies tend to use a multiplicity of institutional finance forms and to ‘borrow’ from a large
number of institutional financiers.
2.2.2 Trade Debt
Supplying on credit terms
Their trading partners advance another, less transparent form of loan capital to companies.
Companies order goods or services from other companies or individuals. The terms upon which
such supplies are made frequently afford the recipient company a period of time in which to
make payment (a credit period). It is therefore the case that a company ordering goods will
take delivery of them and then be allowed time within which to pay (120 days’ worth of time if
you’re Carillion…).
Paying for supplies in advance
Customers of the company can also become its creditors. Payment in advance for goods or
services means that the company has the customer’s money before it provides the product or
services purchased.
2.2.3 Involuntary creditors (where there is no voluntary agreement)
The above examples of loan capital contributors can all be described as voluntary. The terms
of the contract into which they enter clearly envisage that the company will, to a greater or
lesser extent, owe them goods or money, and they can be said to accept this consequence by
reason of their entry into the contract. Their position is to be contrasted with involuntary
creditors, who come to be owed money by the company without their express or implied
agreement. Two examples suffice to illustrate the difference.
Tort Victims
- Damages may be awarded
Tax Authorities
Companies pay taxes in arrears (typically corporate taxes). Their tax bills are calculated by
reference to profits already made, and they are therefore able to employ the amount of tax
they will have to pay at a future date in the course of their business. Further, the company may
simply pay its tax bill late, and so ‘extend’ its use of the ‘revenue authority’s money’ (which is,
in effect, public money, so the image of the downtrodden taxpayer getting one over on the
revenue by repeatedly paying his taxes late is, perhaps, less of a golden legend than might at
first appear).
Value Added Tax (VAT) / PAYE
Moreover, companies may even collect someone else’s tax on behalf of the revenue. Employees
of companies are frequently subject to the ‘Pay As You Earn’ (PAYE) system of tax, whereby
their employer deducts from their pay the amount of income tax due and remits it to the
revenue on a monthly basis. The same principle applies in relation to Value Added Tax (VAT).
3
, When a company sells goods or supplies a service it adds an amount (usually 20% of the price
of the goods or the service) to the customer’s bill, and is then obliged to account for that
amount to the Customs and Excise on a quarterly basis. In both the above cases, the company
has the use of somebody else’s money, albeit for a short time, and without strictly speaking
having contracted for that use.
Whether the ‘advance’ of money to a company is voluntary or involuntary, those advancing it
may all be classed under the generic heading of creditors. They are all owed money by the
company, and if the company is able to pay them then the law has very little to say about the
matter for our purposes. It is important to appreciate from the outset that the law we shall be
examining only really ‘kicks in’ in the context of company insolvency. In other words, it may
regulate loan transactions outside of insolvency, but its impact is only felt when insolvency
intervenes.
2.3 Insolvency Law & Procedures
2.3.1 Sources of Insolvency Law
IA 1986 (hereinafter IA), IR 2016 (hereinafter IR) Insolvency Act 1994, Insolvency Act
2000, Enterprise Act 2002.
- The Rules supplement the Act
Companies Act 2006, Company Directors Disqualification Act 1986
2.3.2 Types of Insolvency Procedures
IA 1986 s 247 “Insolvency” and “go into liquidation”.
(1) In this Group of Parts, except in so far as the context otherwise requires,
“insolvency”, in relation to a company, includes the approval of a voluntary
arrangement under Part I, the appointment of an administrator or
administrative receiver.
(2) For the purposes of any provision in this Group of Parts, a company goes
into liquidation if it passes a resolution for voluntary winding up or an order
for its winding up is made by the court at a time when it has not already gone
into liquidation by passing such a resolution.
There are, therefore, 5 different insolvency procedures mentioned by IA 1986 s 247, these
being, the company voluntary arrangement (CVA), *administration, administrative
receivership, *voluntary winding up, *winding up by the court (see below).
3. The Justifications for Insolvency Law
3.1 The Cork Report: Aims of Modern Insolvency Law (commissioned in 1977-1979)
“We believe that the aims of a good modern insolvency law are these:
(a) To recognise that the world in which we live and the creation of wealth depend upon a
system founded on credit and that such a system requires, as a correlative, an
insolvency procedure to cope with its casualties;
(b) To diagnose and treat an imminent insolvency at an early rather than a late stage
(c) To relieve and protect where necessary the insolvent, and in particular the individual
insolvent, from any harassment and undue demands, whilst taking into consideration
the rights which the insolvent (and where an individual, his family) should legitimately
continue to enjoy; at the same time, to have regard to the rights of creditors whose own
position may be at risk because of the insolvency;
4
1. The Corporation: Outline
1.1 Formation of companies and fundamental principles of company law
In order to appreciate the particular exigencies associated with corporate insolvency it is
necessary to understand some of the legal rules relating to incorporation, which is simply a
process by which companies are formed and registered. Once incorporation has taken place,
certain legal outcomes follow which will become extremely important should the company later
become insolvent.
1.2 The Implications of Incorporation
1.2.1 Separate Corporate Personality
CA 2006 s 16 Effect of registration
(1) The registration of a company has the following effects as from the date of
incorporation.
(2) The subscribers to the memorandum, together with such other persons as
may from time to time become members of the company, are a body corporate
by the name stated in the certificate of incorporation.
(3) That body corporate is capable of exercising all the functions of an
incorporated company.
Ownership of assets
One specific point to note here is that the separate corporate personality doctrine necessarily
leads to the conclusion that the company (and not its individual members/shareholders) is the
owner of any corporate assets, and, as a corollary, it is the company which is solely liable for
corporate debts.
1.2.2 Limited Liability
Meaning of Limited Liability
IA 1986 s 74(1) When a company is wound up, every … member is liable to
contribute to its assets any amount sufficient for payment of its debts and
liabilities, and the expenses of the winding up…
(2) This is subject as follows –
(d) in the case of a company limited by shares, no contribution is required
from any members exceeding the amount (if any) unpaid on the shares in
respect of which he is liable as a present or past member.
“To say that liability is ‘limited’ means that the investors in a corporation are not liable for
more than the amount they chip in … No one risks more than he invests.” Easterbrook
and Fischel, The Economic Structure of Corporate Law, Harvard University Press, 1991),
p. 40.
Implications of Limited Liability
Salomon v A Salomon & Co Ltd [1897] AC 22
“The unsecured creditors of A Salomon and Co Ltd may be entitled to sympathy, but they
have only themselves to blame for their misfortunes. They trusted the company, I
1
, suppose, because they had long dealt with Mr Salomon, and he had always paid his way,
but they had full notice that they were no longer dealing with an individual…” Per Lord
Macnaghten
2. Corporate Insolvency: Outline
2.1 Incurring Debt / Liabilities
- Any kind of debt is incurred routinely due to trading
Loan capital is important to limited companies. It is especially important to small limited
companies, which may have started life as sole proprietorships or family businesses, only to be
incorporated at a later date. In such circumstances the equity investment, or share capital of
the company is, essentially, the proportion of its members’ personal wealth that they can afford
to contribute to the company, and this may be a small amount. In order to be able to afford to
enter into trading operations companies need funds, and these are frequently raised by way of
a loan.
It should be acknowledged, however, that it is not only small private companies that make use
of loan capital: on the contrary, most companies, including the biggest public limited
companies, will have borrowed to some extent, whether or not borrowing is strictly necessary
to finance the business. This may be because loan capital has certain tax advantages over
equity capital (basically, companies can claim relief from corporation tax against interest
payments on a loan). Further, the capital structure of most very large companies is afforded
invaluable flexibility by the availability of loan capital.
2.2 Forms of Loan Capital / Debt
- Debt: To get working capital
2.2.1 Institutional Finance
Overdrafts / Fixed-term loans
A company may approach its bank for an overdraft facility. This allows the company to
‘overdraw’ on its account up to a certain maximum limit (which will be a matter of contract
between the company and the bank), and the agreement provides for a rate of interest to be
payable on the amount by which the company is overdrawn.
Alternatively, a company may borrow a specific sum of money for a specific period at a specific
rate of interest. The major difference between overdrafts and fixed term loans is the fact that
the former will usually be repayable on demand, whereas a bank cannot call for repayment of
the latter before the date fixed for repayment (unless the contract includes an accelerated
repayment clause). It is crucial to appreciate that the terms upon which money is lent derive
almost exclusively from the agreement between lender and borrower: it is a matter of contract.
Laissez-faire approach
- Fixed-term loans subsist until the end of the loan
Advances by way of assignment of debts
It is not uncommon for companies to raise money by assigning their debts. Money owed to a
company by its own creditors is often generically termed book debts and, like any other asset,
book debts can be transferred to a third party. There is a large industry providing corporate
finance in this manner (sometimes known as factoring, receivables financing or invoice
discounting) and it is becoming an increasingly popular means of raising funds. Essentially, the
2
,company assigns its right to debts owed to it to a third party (the assignee) in return for a cash
advance. The third party can agree to collect the debts itself, or the company may collect the
debts, in which case it remains indebted to the assignee for the amount of the advance. Any
such collected funds will not become part of the company’s assets, but will be held on trust for
the financier.
The above is a very simplified explanation of how institutional finance may be provided. In the
case of larger companies the debt structure is likely to be much more complex, as companies
may issue ‘bonds’, access ‘mezzanine’ finance, or enter the debt markets generally. Such
companies tend to use a multiplicity of institutional finance forms and to ‘borrow’ from a large
number of institutional financiers.
2.2.2 Trade Debt
Supplying on credit terms
Their trading partners advance another, less transparent form of loan capital to companies.
Companies order goods or services from other companies or individuals. The terms upon which
such supplies are made frequently afford the recipient company a period of time in which to
make payment (a credit period). It is therefore the case that a company ordering goods will
take delivery of them and then be allowed time within which to pay (120 days’ worth of time if
you’re Carillion…).
Paying for supplies in advance
Customers of the company can also become its creditors. Payment in advance for goods or
services means that the company has the customer’s money before it provides the product or
services purchased.
2.2.3 Involuntary creditors (where there is no voluntary agreement)
The above examples of loan capital contributors can all be described as voluntary. The terms
of the contract into which they enter clearly envisage that the company will, to a greater or
lesser extent, owe them goods or money, and they can be said to accept this consequence by
reason of their entry into the contract. Their position is to be contrasted with involuntary
creditors, who come to be owed money by the company without their express or implied
agreement. Two examples suffice to illustrate the difference.
Tort Victims
- Damages may be awarded
Tax Authorities
Companies pay taxes in arrears (typically corporate taxes). Their tax bills are calculated by
reference to profits already made, and they are therefore able to employ the amount of tax
they will have to pay at a future date in the course of their business. Further, the company may
simply pay its tax bill late, and so ‘extend’ its use of the ‘revenue authority’s money’ (which is,
in effect, public money, so the image of the downtrodden taxpayer getting one over on the
revenue by repeatedly paying his taxes late is, perhaps, less of a golden legend than might at
first appear).
Value Added Tax (VAT) / PAYE
Moreover, companies may even collect someone else’s tax on behalf of the revenue. Employees
of companies are frequently subject to the ‘Pay As You Earn’ (PAYE) system of tax, whereby
their employer deducts from their pay the amount of income tax due and remits it to the
revenue on a monthly basis. The same principle applies in relation to Value Added Tax (VAT).
3
, When a company sells goods or supplies a service it adds an amount (usually 20% of the price
of the goods or the service) to the customer’s bill, and is then obliged to account for that
amount to the Customs and Excise on a quarterly basis. In both the above cases, the company
has the use of somebody else’s money, albeit for a short time, and without strictly speaking
having contracted for that use.
Whether the ‘advance’ of money to a company is voluntary or involuntary, those advancing it
may all be classed under the generic heading of creditors. They are all owed money by the
company, and if the company is able to pay them then the law has very little to say about the
matter for our purposes. It is important to appreciate from the outset that the law we shall be
examining only really ‘kicks in’ in the context of company insolvency. In other words, it may
regulate loan transactions outside of insolvency, but its impact is only felt when insolvency
intervenes.
2.3 Insolvency Law & Procedures
2.3.1 Sources of Insolvency Law
IA 1986 (hereinafter IA), IR 2016 (hereinafter IR) Insolvency Act 1994, Insolvency Act
2000, Enterprise Act 2002.
- The Rules supplement the Act
Companies Act 2006, Company Directors Disqualification Act 1986
2.3.2 Types of Insolvency Procedures
IA 1986 s 247 “Insolvency” and “go into liquidation”.
(1) In this Group of Parts, except in so far as the context otherwise requires,
“insolvency”, in relation to a company, includes the approval of a voluntary
arrangement under Part I, the appointment of an administrator or
administrative receiver.
(2) For the purposes of any provision in this Group of Parts, a company goes
into liquidation if it passes a resolution for voluntary winding up or an order
for its winding up is made by the court at a time when it has not already gone
into liquidation by passing such a resolution.
There are, therefore, 5 different insolvency procedures mentioned by IA 1986 s 247, these
being, the company voluntary arrangement (CVA), *administration, administrative
receivership, *voluntary winding up, *winding up by the court (see below).
3. The Justifications for Insolvency Law
3.1 The Cork Report: Aims of Modern Insolvency Law (commissioned in 1977-1979)
“We believe that the aims of a good modern insolvency law are these:
(a) To recognise that the world in which we live and the creation of wealth depend upon a
system founded on credit and that such a system requires, as a correlative, an
insolvency procedure to cope with its casualties;
(b) To diagnose and treat an imminent insolvency at an early rather than a late stage
(c) To relieve and protect where necessary the insolvent, and in particular the individual
insolvent, from any harassment and undue demands, whilst taking into consideration
the rights which the insolvent (and where an individual, his family) should legitimately
continue to enjoy; at the same time, to have regard to the rights of creditors whose own
position may be at risk because of the insolvency;
4
