Chapter 10 - Insolvency law Exam Questions with Complete Solutions.

Chapter 10 - Insolvency law Exam Questions with Complete Solutions 1 Administration 1.1 The purpose of administration - There are three key purposes of administration in order set below: (state the first 2) - Correct Answers: 1) To rescue the company as a going concern. 2) If this is not reasonably practicable, to achieve a better result for the company's creditors as a whole than would be likely with a winding-up 1 Administration 1.1 The purpose of administration - There are three key purposes of administration in order set below: (state the third) - Correct Answers: - If neither is reasonably practicable, and provided the administrator does not unnecessarily harm the interests of the creditors as a whole, then to realise the company's assets to make a distribution to one or more preferential or secured creditors. 1 Administration 1.1 The purpose of administration - Advantage - Correct Answers: - The key advantage of administration is to give the company breathing space to resolve its problems. - If administration is successful the creditors should enjoy a better return in relation to past debts and the benefit of an ongoing client 1 Administration 1.1 The purpose of administration - Effect - Correct Answers: - There is a moratorium for the company to resolve financial difficulties. - If this cannot be achieved the administrator will arrange for the company to be placed into creditors' voluntary liquidation 1 Administration 1.2 Appointment of an administrator 1.2.1 Who may appoint an administrator - Correct Answers: 1) The company acting by ordinary resolution 2) The directors acting by a majority 3) One or more creditors 1 Administration 1.2 Appointment of an administrator 1.2.1 Who may appoint an administrator 4) Qualifying floating charge holders who can show the following: - Correct Answers: - Amounts to a charge over the whole or substantially the whole of the company's property - The floating charge must contain power to appoint an administrator (or administrative receiver) - A QFCH may apply even if the company is in liquidation - Must notify any other QFCH 1 Administration 1.2 Appointment of an administrator 1.2.2 Appointment out of court - Correct Answers: - No appointment can be made out of court if the company is in liquidation or administration. - The procedure is slightly different depending who makes the application. - Creditors cannot make an appointment out of court 1 Administration 1.2 Appointment of an administrator 1.2.2 Appointment out of court - State the procedure for the following applicant: - Company / Directors - Correct Answers: Must give 5 days' notice to any floating chargeholder 1 Administration 1.2 Appointment of an administrator 1.2.2 Appointment out of court - State the procedure for the following applicant: - Qualifying floating charge holder - Correct Answers: Must give two days' prior notice to any prior QFCH before any appointment is made. 1 Administration 1.2 Appointment of an administrator 1.2.2 Appointment out of court State the procedure for the following applicant: - Must file in court - Correct Answers: - Notice of appointment - Statutory declaration as to lawfulness of appointment and enforceability of the charge - Statement by administrator that purpose of administration likely to be achieved and that he consents to the appointment 1 Administration 1.2 Appointment of an administrator 1.2.3 Appointment in court - Correct Answers: - A court must be satisfied that the company is, or is likely to become, unable to pay its debts and that the order is reasonably likely to achieve the purpose of the administration. - Any party can use the court route. 1 Administration 1.2 Appointment of an administrator 1.2.3 Appointment in court - The following applies when the company seeks an administration order: - Correct Answers: - The company is or is likely to be unable to pay its debts and - An administration order is reasonably likely to achieve the purpose of administration - Must give notice of application to QFCH (below) who may intervene A floating charge holder must also show that the floating charge is a qualifying floating charge and in enforceable 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - The administrator must act in accordance with the following timeline: - Within 7 days - Correct Answers: - File notice of his appointment with the Registrar of Companies - Require any of the company's officers and employees to provide a statement of affairs (who have 11 days to comply with any such request) 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - The administrator must act in accordance with the following timeline: - Within 8 weeks - Correct Answers: Submit a statement of his proposals for achieving the aim of administration to: - The Registrar - The company's creditors - The company's members 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - The administrator must act in accordance with the following timeline: - Within 8 weeks (further point) - Correct Answers: - The administrator should seek creditor acceptance of their proposals by deemed consent procedures. - The administrator is also required to invite creditors to form a creditor's committee and to ask for nominations to such a committee. 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - The administrator must act in accordance with the following timeline: - One year after appointment - Correct Answers: The administrator's appointment is terminated unless extended by the court or (once only) by a prescribed majority of the creditors. 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Further information - Correct Answers: - The consequences of administration - The administrator takes on the powers previously enjoyed by the directors and generally 'may do anything necessarily expedient for the management of the affairs, business and property of the company'. 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Powers of an administrator: (4 points) - Correct Answers: - Remove or appoint a director - Call a meeting of members or creditors - Apply to court for directions regarding the carrying out of his functions - Make payments to secured or preferential creditors 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Powers of an administrator: (2 points) - Correct Answers: - Make payments to unsecured creditors, if the administrator feels that to pay the unsecured creditor will assist the achievement of the administration (for example, if the company has been denied further supplies by a major supplier unless payment is tendered), and otherwise with the permission of the court - Present or defend a petition for the winding up of the company 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Powers of an administrator (applying to court): - Correct Answers: Any creditor or member of the company may apply to the court if they feel that the administrator has acted or will act in a way that has harmed or will harm his interest. The court may take various actions against the administrator. 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Consequences of administration (date from filing of petition for administration order) - State the effect for the following consequence: - Moratorium (first 2 points) - Correct Answers: - No resolution or court order to wind up the company is possible - No enforcement of fixed charges or other security over the company's property (except with the consent of the administrator or the court) 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Consequences of administration (date from filing of petition for administration order) - State the effect for the following consequence: - Moratorium (next 2 points) - Correct Answers: - No recovery of property which the company has on a HP or leasing arrangement or enforcement of retention clauses (without the consent of the administrator or the court) - No other legal proceedings (including forfeiture of a lease) can be commenced against the company (except with the consent of the administrator or the court 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Consequences of administration (date from filing of petition for administration order) - State the effect for the following consequence: - Assets subject to a floating charge - Correct Answers: The administrator can sell property which is subject to a floating charge and use the proceeds for the business without obtaining the chargee's consent (s 70 Sch B1 1A 1986) 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Consequences of administration (date from filing of petition for administration order) - State the effect for the following consequence: - Assets on HP or subject to a fixed asset charge - Correct Answers: The administrator can sell such assets with approval of the court and proceeds must be used to pay off the owner or chargee (§ 72 Sch B1 1A'86) 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Consequences of administration (date from filing of petition for administration order) - State the effect for the following consequence: - Directors - Correct Answers: - Directors' powers are suspended but they remain in office. - The administrator may remove or appoint directors 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Consequences of administration (date from filing of petition for administration order) - State the effect for the following consequence: - Employees - Correct Answers: Employees are not automatically dismissed (since the administrator is the agent of the company which continues to be the employer) but the administrator may terminate contracts of employment 1 Administration 1.2 Appointment of an administrator 1.2.4 The duties of the administrator - Consequences of administration (date from filing of petition for administration order) - State the effect for the following consequence: - Transactions at an undervalue and precedence - Correct Answers: These may be avoided. 2 Receivership 2.1 Administrative receiver - Correct Answers: An 'administrative receiver' is appointed by a floating charge holder and is essentially a manager with control over the whole, or substantial part, of the company's property and wide powers over its business 2 Receivership 2.2 Fixed charge receiver - Correct Answers: - May be appointed by the holder of a fixed charge over land in the event of the borrower's default. - His role is to collect rent and/or sell the property. - He does not need to be a qualified insolvency practitioner and, in practice, will often be a surveyor or other property specialist. 2 Receivership 2.2 Fixed charge receiver - May concern - Correct Answers: - His main concern is to realise the property for the benefit of the lender but he also owes a duty of care to the borrower to act prudently and to have regard to his interests (but not to go to extensive lengths to enhance the value of the property before selling it, - e.g. by pursuing planning applications or renewing leases, for example). 2 Receivership 2.2 Fixed charge receiver - Final point - Correct Answers: The appointment of a receiver will normally cause floating charges to crystallise and become fixed charges (although they are ranked as floating charges on a winding up, since they were created as such) 3 Company voluntary arrangement ("CVA") - Correct Answers: CVAs were introduced by the Insolvency Act 1986 and apply when a company and its creditors make an agreement as to how its debts are to be paid and in what proportions 3 Company voluntary arrangement ("CVA") - Possible options include (first 3) - Correct Answers: - Composition of debts e.g. 60 p in the £, or - Time period of payment (usually 3-5 years), - Equity swop, 3 Company voluntary arrangement ("CVA") - Possible options include (remaining 2) - Correct Answers: - The key benefit of a CVA is that the company continues trading. - Companies can apply for a moratorium whilst they prepare a plan for creditors. This is initially 28 days but can be extended with agreement of the creditors 3 Company voluntary arrangement ("CVA") 3.1 Procedure (first 3 points) - Correct Answers: - A nominee is appointed (either by a solvent company or the administrator/ liquidator). - The nominee reports to court on likelihood of success. - Binds all unsecured creditors (not fixed charge holders). 3 Company voluntary arrangement ("CVA") 3.1 Procedure (remaining 2 points) - Correct Answers: - Creditor approval is required. Physical creditor meetings are not required unless the creditors specifically request one - Any creditor can appeal to court within 28 days if unfairly prejudiced or if there has been a procedural irregularity. 4 Liquidation - Correct Answers: Liquidation is when a company is officially wound up following the steps outlined in the Companies Act. 4 Liquidation 4.1 Procedures for voluntary liquidation - State the information on solvency - Correct Answers: Members - Suitable only where the company is solvent Creditors - Suitable where the directors are unable to make a declaration of solvency 4 Liquidation 4.1 Procedures for voluntary liquidation - State the information on resolution - Correct Answers: Member - Commenced by a special resolution of the members (commences at date of resolution) Creditors - Shareholders pass resolution to wind up the company. The directors nominate liquidators under the deemed consent procedure. 4 Liquidation 4.1 Procedures for voluntary liquidation - State the information on directors role for members - Correct Answers: Directors give a declaration of solvency (If they cannot, the process automatically becomes a creditors voluntary liquidation, as noted in right hand column) 4 Liquidation 4.1 Procedures for voluntary liquidation - State the information on directors role for creditors - Correct Answers: Directors call a creditors' meeting within 14 days of the proposed resolution giving 7 days' notice of the meeting to creditors 4 Liquidation 4.1 Procedures for voluntary liquidation - State the information on 'within 14 days of resolution' - Correct Answers: - Notice in the London Gazette within 14 days of the resolution - Company appoints liquidator by ordinary resolution 4 Liquidation 4.1 Procedures for voluntary liquidation - State the information on meeting for creditors - Correct Answers: - Director's present a statement of the company's affairs - Creditors may appoint a liquidator (but must act to do so, or the directors' choice will be deemed to stand) and, if so, their choice will take priority over the company's choice. - Members and creditors form a liquidation committee to assist the liquidator 4 Liquidation 4.1 Procedures for voluntary liquidation - Point on members voluntary winding up - Correct Answers: - In a members' voluntary winding up the creditors play no part, since the assumption is that their debts will be paid in full. - However, as noted members' voluntary liquidation may become a creditors' voluntary liquidation where the liquidation process is not progressing to the satisfaction of the company's creditors. 4 Liquidation 4.1.1 Appointment of the liquidator in creditors voluntary liquidation - Correct Answers: - During the period prior to the creditors' meeting the directors nominate a liquidator and give notice to the creditors of that nomination. - The creditors must make a decision on the nomination of the liquidators after three days of the delivery of the directors' nomination. - If less than 10% of the creditors in value object, the proposal is deemed to be approved. 4 Liquidation 4.1.2 Declaration of solvency - Correct Answers: - This is a statutory declaration that the directors have made full enquiry into the affairs of the company and are of the opinion that it will be able to pay its debts in full, together with interest (at the applicable rate), within a specified period not exceeding 12 months. - It is a criminal offence punishable by fine or imprisonment for a director to make a declaration of solvency without having reasonable grounds for it. 4 Liquidation 4.1.2 Declaration of solvency - The declaration must: (first 2 points) - Correct Answers: - Be made by all the directors or, if there are more than two, by a majority of them - Include a statement of the company's assets and liabilities as at the latest practicable date before the declaration is made 4 Liquidation 4.1.2 Declaration of solvency - The declaration must: (remaining 2 points) - Correct Answers: - Made not more than five weeks before the resolution to wind up is passed and - Delivered to the registrar within 15 days after the meeting. 4 Liquidation 4.2 Compulsory liquidation - Correct Answers: - A company may be obliged to wind up by the court on the petition of, usually, a creditor or member. - It tends to be a less straightforward and more time-consuming and expensive process than a voluntary winding-up. 4 Liquidation 4.2 Compulsory liquidation 4.2.1 Grounds - Correct Answers: A petition may be brought for a compulsory winding up on one of seven statutory grounds (s 122 IA '86), 4 Liquidation 4.2 Compulsory liquidation 4.2.1 Grounds - The most significant are: state the explanation for the following grounds: - That the company is unable to pay its debts (first 2 points) - Correct Answers: - A creditor must (in petitioning on the grounds that the company is unable to pay its debts) show either - That he is owed more than £750 and has served on the company at its registered office a written demand for payment and the company has neglected, either to pay the debt or to offer reasonable security for it within 21 days, or 4 Liquidation 4.2 Compulsory liquidation 4.2.1 Grounds - The most significant are: state the explanation for the following grounds: - That the company is unable to pay its debts (next 2 points) - Correct Answers: - That he has attempted to enforce a judgment against the company by execution on the company's property but it has failed to satisfy the debt, or - That, taking into account the contingent and prospective liabilities of the company, it is unable to pay its debts as they fall due or that its assets are less than its liabilities. 4 Liquidation 4.2 Compulsory liquidation 4.2.1 Grounds - The most significant are: state the explanation for the following grounds: - That it is just and equitable to wind up the company - Correct Answers: - This ground is usually relied on by a member who is dissatisfied with the directors or controlling shareholders over the management of the company - (for example, where there is management deadlock or where relations within a quasi-partnership break down). It must be shown that no other remedy is available. 4 Liquidation 4.2 Compulsory liquidation 4.2.1 Grounds - The department of business and trade: - Correct Answers: The Department for Business and Trade (formerly the BEIS Department for Business, Energy and Industrial Strategy) may petition for the compulsory winding up of a company 4 Liquidation 4.2 Compulsory liquidation 4.2.1 Grounds - The department of business and trade, in the following situations - Correct Answers: - If a public company has not obtained a trading certificate within one year of incorporation. - Following a report by Department for Business and Trade inspectors that it is in the public interest and just and equitable for the company to be wound up. 4 Liquidation 4.2 Compulsory liquidation 4.2.1 Grounds - Final point - Correct Answers: - On a compulsory winding up, the court will usually appoint the official receiver (an officer of the court) as liquidator, although he may be replaced by an insolvency practitioner at a later date. - The official receiver must investigate (s 132) the causes of the failure of the company, and generally, its promotion, formation, business dealings and affairs 4 Liquidation 4.2 Compulsory liquidation 4.2.2 Consequences - Correct Answers: The liquidation is deemed to have commenced at the time (possibly several months earlier) when the petition was first presented 4 Liquidation 4.2 Compulsory liquidation 4.2.2 Consequences, following consequences (first 3 points) - Correct Answers: - Any disposition of the company's property and any transfer of its shares subsequent to the commencement of liquidation is void unless the court orders otherwise. - Any legal proceedings in progress against the company are halted (and none may be commenced) unless the court gives leave. - Any seizure of the company's assets after commencement of liquidation is void. 4 Liquidation 4.2 Compulsory liquidation 4.2.2 Consequences, following consequences (next 2 points) - Correct Answers: - The employees of the company are automatically dismissed and the liquidator assumes the powers of management previously held by the directors. - Any floating charge crystallises. 4 Liquidation 4.2 Compulsory liquidation 4.2.2 Consequences, following consequences (final 2 points) - Correct Answers: - The assets of the company may remain the company's legal property but under the liquidator's control, unless the court orders the assets to be vested in the liquidator - The business of the company may continue, but it is the liquidator's duty to continue it with a view only to realisation, for instance by sale as a going concern. 4 Liquidation 4.3 Powers of liquidation - Once a liquidator is appointed, whether in a voluntary or a compulsory winding up, his role is to: - Correct Answers: - Settle the list of contributories (i.e. members who have a liability to contribute in the event of a winding up) - Collect and realise the company's assets - Discharge the company's debts - Redistribute any surplus to the contributories according to the entitlement rights attached to their shares 4 Liquidation 4.3 Powers of liquidation - On his appointment - Correct Answers: On his appointment, the powers of the directors cease save to the extent that they are permitted to continue by the liquidator or (in a voluntary winding up) by the company or creditors as appropriate. 4 Liquidation 4.3 Powers of liquidation - Once the liquidation is complete, the liquidator must act as follows: (first point) - Correct Answers: - In a voluntary winding up, he must prepare an account showing how the winding up has been dealt with and lay it before a meeting of the members and/or creditors. - Within the following week he should then file details with the Registrar who will enter the details on the company's file and the company will be deemed to be dissolved three months thereafter 4 Liquidation 4.3 Powers of liquidation - Once the liquidation is complete, the liquidator must act as follows: (other point) - Correct Answers: - In a compulsory winding up, the liquidator must go back to the court which then makes an order dissolving the company. - He then files the order and the Registrar records on the company file that the company is dissolved as from the date of the order. 4 Liquidation 4.3 Powers of liquidation 4.3.1 Avoidance of charges - State the explanation for the following transaction: - Charges - Correct Answers: - Any charges not registered within 21 days are void against the liquidator and creditors (and the chargee becomes an unsecured creditor) - A floating charge created within 12 months prior to winding up (or 2 years if given to a connected person) may be void or voidable 4 Liquidation 4.3 Powers of liquidation 4.3.1 Avoidance of charges - State the explanation for the following transaction: - Transactions at an undervalue (2 years before liquidation or administration) - Correct Answers: A gift or a transaction by which the company gives greater value than it receives 4 Liquidation 4.3 Powers of liquidation 4.3.1 Avoidance of charges - State the explanation for the following transaction: - Transactions at an undervalue (2 years before liquidation or administration) - Unless the company enters into it - Correct Answers: - In good faith - For the purpose of carrying on its business - Believing on reasonable grounds that it will benefit the company 4 Liquidation 4.3 Powers of liquidation 4.3.1 Avoidance of charges - State the explanation for the following transaction: - Preferences 6 months unconnected - Correct Answers: A transaction which benefits one creditor or guarantor of its debts on an insolvent liquidation 4 Liquidation 4.3 Powers of liquidation 4.3.1 Avoidance of charges - State the explanation for the following transaction: - Preferences (2 years) - Correct Answers: Made with the intention of producing that result 4 Liquidation 4.4 Priority of charges - Correct Answers: - Where different charges over the same property are given to different creditors, their priority must be determined. - Thus, if charges are created over the same property to secure a debt of £5,000 to X and £7,000 to Y and the property is sold yielding only £10,000 then either X or Y is paid in full and the other receives only the balance remaining out of £10,000 realised from the security (unless they rank equally). 4 Liquidation 4.4 Priority of charges - Terms - Correct Answers: Floating - Equitable charge Fixed - Legal charge 4 Liquidation 4.4 Priority of charges Order of payment (first 2) - Correct Answers: 1) Legal charges rank according to the order of creation (i.e. the one created first takes priority). 2) Equitable charges (broadly floating charges) also take priority according to the order of creation 4 Liquidation 4.4 Priority of charges Order of payment (next 2) - Correct Answers: 3) A legal charge created before an equitable one has priority 4) An equitable charge created before a legal charge will only take priority over the latter if, when the latter was created, the legal charge had notice of the equitable charge 4 Liquidation 4.4 Priority of charges - Negative pledge clause - Correct Answers: - A creditor to whom a floating charge is given may seek to protect himself against losing his priority, by including in the terms of his floating charge a prohibition against the company creating a fixed charge over the same property, which would otherwise take priority (sometimes called a 'negative pledge clause'). 4 Liquidation 4.4 Priority of charges - Negative pledge clause - however point - Correct Answers: - . In the absence of such a clause, however, the fixed charge will rank first since, although created later, it attaches to the property at the time of creation (whereas the floating charge attaches at the time of crystallisation). - Once a floating charge has crystallised it becomes a fixed charge and a fixed charge created subsequently ranks after it 4 Liquidation 4.5 Priorities on liquidation - Correct Answers: A liquidator in a compulsory winding up must, and in a voluntary winding up is likely to, adhere to the following prescribed 4 Liquidation 4.5 Priorities on liquidation - Must adhere to the following prescribed order for disturbing the company's assets: - (first 2) - Correct Answers: - Costs including the costs of getting in the assets, liquidator's remuneration and all costs incidental to the liquidation procedure - Secondary preferential debts - to HMRC in relation to taxes collected by a business on their behalf (ie PAYE and NI) 4 Liquidation 4.5 Priorities on liquidation - Must adhere to the following prescribed order for disturbing the company's assets: - (3rd one) - Correct Answers: Preferential debts - Employees' wages (for a prescribed period and subject to a prescribed maximum) - Accrued holiday pay - Contributions to an occupational pension fund 4 Liquidation 4.5 Priorities on liquidation - Must adhere to the following prescribed order for disturbing the company's assets: - (4th, 5th) - Correct Answers: - Floating charges - Subject to ring-fencing - Unsecured ordinary creditors 4 Liquidation 4.5 Priorities on liquidation - Must adhere to the following prescribed order for disturbing the company's assets: - (final 2) - Correct Answers: Deferred debts - For example dividends declared but not paid and interest accrued on debts since liquidation Members - Any surplus (meaning that the company is in fact solvent) is distributed to members according to their rights under the articles or the terms of issue of their shares. 4 Liquidation 4.5 Priorities on liquidation - Ring fencing - Correct Answers: A percentage of assets is 'ring-fenced' for unsecured creditors where there is a minimum fund for distribution of £10,000 4 Liquidation 4.5 Priorities on liquidation - Ring fencing (next 2 points) - Correct Answers: - 50% of the first £10,000 of floating charge realisations - 20% of the floating charge realisations thereafter (up to a maximum 4 Liquidation 4.5 Priorities on liquidation - Ring fencing (final 2 points) - Correct Answers: - Secured creditors with fixed charges (and indeed floating charges) may appoint a receiver to sell the charged asset, passing any surplus to the liquidator. In the event of a shortfall they must prove for the balance as unsecured creditors. - A floating charge holder who faces a shortfall on his secured debt (which is therefore treated as unsecured) cannot share in the ring fenced part available to unsecured creditors.