Routes to Corporate Insolvency

A comparative analysisRoyal Faculty of Procurators in Glasgow

15 March 2012Alan Munro, Partner, Anderson Fyfe LLP

alanmunro@andersonfyfe.co.uk

Seminar purpose

• Look at the various insolvency regimes available in Scotland

• Consider the advantages and disadvantages of each

• Consider the perspectives of the company (focussing on directors) on one hand and creditors (secured and unsecured) on the other

Overview

Insolvency Regimes:

• Members Voluntary Liquidation (MVL)

• Creditors Voluntary Liquidation (CVL)

• Liquidation

• Receivership

• Administration

• Creditors Voluntary Arrangement (CVA)

Remedies for Companies (1)• MVL –

• What is it?A tool for winding up a solvent registered company.Statutory declaration of solvency made by the directors (s89 IA 1986)Company resolves by special resolution to be wound up.

• When would you use this?Where the Company is solvent and it is intended to cease trading and distribute the assetsIdeally, would want cash to pay the creditors or have no creditors.Consent of or 5 business days’ notice to floating charge holder is required (s84(2A) and (2B))Can go on past a year if no creditors

• What are the benefits?Useful for implementing company restructuringMay be useful for tax planning purposes – especially for owner manager companies.Tax accountants are usually heavily involved in the planning and timing of the MVL.

• What are the drawbacks?Directors commit a criminal offence if they did not have reasonable grounds to make the declaration of solvency.Where the company does not pay its debts in full there is a presumption there were no reasonable grounds to make the declaration.If the company can’t pay its debts the MVL converts to a CVL.Better to use a CVL if there is any room for doubt on a company’s solvency.

Remedies for Companies (2)• CVL -• What is it?

A tool for winding up a company where a statutory declaration of solvency cannot be made.No reason is required for a CVL (s84 IA 1986).Company resolves by special resolution to be wound up.

• When would you use this?Gererally used when the company is insolvent.

• What are the benefits?Generally a quick and inexpensive option.Liquidator is appointed on day one, subject to ratificationMeeting of creditors called within 14 days of resolution to wind up.No need to incur legal fees cf compulsory liquidation.

• What are the drawbacks?Director has to attend and chair the creditors’ meeting – may be unattractive - Creditors meeting follows quickly after winding up – may be politically difficultConsent of or 5 business days’ notice to floating charge holder is required (s84(2A) and (2B)) – could cause delayTime constraints – calling an EGM, etc. (depending on articles) could be shareholders and directors who are unavailable –– it may be quicker to go to court depending on the company structureDirector must provide a sworn statement of affairs for the creditors’ meeting – not necessary in a liquidation (s131 IA 1986)Not a business rescue tool.

Remedies for Companies (3)• Compulsory Liquidation – • What is it?

Application to the court by directors or company to wind up.

• When would you use this?Very useful where combined with a provisional appointment for immediate relief on insolvency

• What are the benefits?A provisional liquidator could be put in place immediatelyParticularly useful where company under pressure e.g. expired charge or demandPolitically, puts the liquidator more at arms lengthDirector doesn’t have to chair the meeting of creditors

• What are the drawbacks?Incurs the legal cost of a petitionCourt petitions may draw more publicity than a CVL (due to advertisements)Liquidation will be the end of the existing business – generally not a rescue tool

Remedies for Companies (4)• Administration -• What is it?

Theoretically, a business rescue tool giving a company protection from creditors during a restructuring period.

• When would you use this?Ideal where the company has a viable business model.Three fold test in schedule B1, paragraph 3(1) – (a) rescuing the company as a going concern(b) achieving a better result for creditors than if the company were wound up(c) realising property to make a distribution to a secured or preferential creditor

• What are the benefits?Out of court procedure allows for swift access to a moratorium – including out of hours appointmentMoratorium protects against secured lenders, goods under HP, ejection by Landlord and stops legal action – except with authority of the courtCertain contracts may not terminate on administration but would on liquidationCan allow breathing space for a company to trade, restructure and emerge solvent (in theory)Allows time to restructure the business, hive out assets to new co. and leave the debt with the old co., generally saving jobsMeans dismissal of most winding up petitions and removal of any receiverPerception – not thought of as an insolvency event in the eyes of many stakeholders – especially directors

• What are the drawbacks?Can only be used to meet one of the 3 criteria in paragraph 3(1)In many cases liquidation will be a more appropriate remedyRisk that a floating charge holder will take over the process

Remedies for Companies (5)• CVA -• What is it?

A voluntary arrangement for repayment of debt binding upon creditors

• When would you use this?Where the company can continue to trade profitably but needs to compromise existing debt or has a temporary cash-flow shortage or will result in new working capital

• What are the benefits?The voluntary arrangements bind all creditors – cf a voluntary arrangement which doesn’t follow the statutory regime.Complete flexibility on how debts are to be repaid – part payment, deferred payment, different creditors getting different dividends, flexible repayment timescales, variation of interest, debt for equity swaps.Moratorium available for small companies while the CVA is being constructed."small company" - 2 of 3 - (i) turnover < £5.6m (ii) balance sheet < £2.8m (iii) less than 50 employeesWhere there is a moratorium there are similar protections against creditors as with an administrationNot a formal insolvency regime so will not trigger the usual insolvency defaults

• What are the drawbacks?Cannot compromise the rights of secured or preferential creditors without their consentNeeds consent of 75% in value or 50% in number of creditorsProspect that a capital injection will be needed to get creditors on board – depends who is making the injectionComplex, uncommon, expensive to construct the proposals – a lot of work for the IPPossibility of challenges from dissatisfied creditors leading to uncertainty (“unfair prejudice”, “procedural irregularity”)“Connected parties” cannot vote – may be a problem if e.g. a director’s loan is a major creditorNot suitable for companies with insurmountable debt – liquidation a better option.

Remedies for Creditors (1)

• Qualified Floating Charge Holders (QFCH)

• Ordinary Creditors

• Other stakeholders?

Secretary of state

Minority shareholders

• Focus is on the creditors

Remedies for Creditors (2)

• QFCH

• Receivership – mentioned in passing – only relates to pre 15 September 2003 floating charges

• Receiver acts in the interests of the appointing QFCH

• Receiver has wide powers both contractual and statutory

• Receiver only realises such assets as necessary to satisfy the QFCH.

Remedies for Creditors (3)• QFCH

• AdministrationBecoming the main route into insolvency for QFCH as receivership dies out

• When would you use this?Where a QFCH (usually a post 2003 Floating Charge) wishes to take control (via an Administrator) of a company.

• What are the benefits?

Allows the QFCH to control the appointment ahead of e.g. a creditor appointment of a liquidator.No need to show the company is insolventRelative speed and cost-effectiveness of the “out of court” appointment routeProspect of better recovery than in liquidation

• What are the drawbacks?Liquidation may be more cost effective – e.g. if the debtor company is not trading and simply has an asset to sell

Remedies for Creditors (4)• QFCH

• Liquidation

• When would you use this?Where the company has no assets or trade which would justify an administration instead.

• What are the benefits?Potentially a lower cost option where a “fire sale” of assets is inevitable

• What are the drawbacks?QFCH could lose control over the liquidator’s costs which would be determined by the court. Unlikely in practise.

Remedies for Creditors (5)• Ordinary Creditors

• Liquidation/provisional appointment

• When would you use this? – Interim appointmentWhere there is clear evidence the company cannot pay its debts

Ideally an expired charge for payment or statutory demand which is unsatisfiedWhere the company has substantial assets which would likely produce a dividend on liquidationWhere a petition has prospects of forcing payment

• When would you use this? – Provisional appointmentWhere there is prima facie evidence of insolvency or dissipation of assets

• What are the benefits?The threat of liquidation will likely establish whether or not a company is in fact able to pay its debtA provisional liquidator can make enquiries as to whether there are any recoverable assets if the company is wound upWhere a company can pay, the winding up petition often prompts full or part payment

• What are the drawbacks?It is very important not to use the winding up process for heavy handed debt recoveryIf there is any suggestion a debt is disputed, constitute by statutory demand or charge for payment firstIf the company is actually bust, there is no guarantee of any paymentNo OR in Scotland – the creditor will have to agree to underwrite the liquidator’s costs

Remedies for Creditors (6)• Ordinary Creditors

• Administration

• When would you use this?The circumstances must be extremely rareRecent example where HMRC sought administration order in relation to a football club

• What are the benefits?Where the company would effectively have no saleable assets on winding up, this could be an alternative

• What are the drawbacks?Creditor would have to agree to underwrite the Administrator’s costs.An ordinary creditor is a very long way down the list in the distribution of assets.

Administration –when is administration not administration

• Out of court appointments• Defective appointment –

• Invalidates the appointment but curable in certain circumstances

• Failure to intimate:Holders of a floating chargeThe Company itselfThe FSA – s362A of the Financial Services and Markets Act 2000

• MINMAR – directors meeting not properly convened• Kaupthing – wrong form used• Safest to enrol a paragraph 11 petition?

Exit Strategies from Administration

• Liquidation

• CVA

• Solvent trading

Theoretical example