BLP WS12/13
Insolvency
Identify when a company is insolvent
Why is important to know when a company has become insolvent?
Practical considerations
o Lack of an ability to trade – buying new stock, paying wages etc.
o Buy back – cannot out of profits/capital – statement of solvency
Directors
o The duty of directors to act in the best interests of the company changes on insolvency duty
now owed to creditors
o Directors may be liable for wrongful trading if the company is insolvent.
Loan finance
o Insolvency is likely to be an event of default which will enable holders of security to enforce their
security.
The company may be wound up
o Creditors must prove a company is unable to pay its debts for the court to wind up the company.
When is a company insolvent?
s122(1)(f) Insolvency Act 1986:
A company may be wound up by the court if it is “unable to pay its debts”.
When a company will be “unable to pay its debts” is defined by s123.
This is the main ground that a creditor must prove in order for the court to wind up the company.
s123 – A company is deemed unable to pay its debts: NB - in exam go through both (a) and (b)
(1)(a): If a creditor:
Is owed £750 or more.
Has served a statutory demand on the company requiring the company to pay the sum and
The company has, for three weeks thereafter, failed to pay or come to an alternative arrangement with
the creditor.
(1)(b): If a creditor obtains a judgment against the company AND tries to enforce it, but the debt remains
unsatisfied.
I.e. you have tried to send in the bailiffs and failed to recover. But costly/uncertain/long– go to court
(1)(e): If the company is unable to pay its debts when they fall due (the “cash flow” test).
On balance of probabilities (more likely than not) company doesn’t have resources to discharge those
debts that will fall due in the reasonably near future.
Look for indicative factors such as the company having to agree to restructure payments to creditors.
Communications e.g. emails from the company may provide evidence that the company cannot pay its
debts – need to adduce evidence so time consuming and less certain
(2): If the total value of the company’s assets is less than the amount of its liabilities (the “balance sheet”
test).
Be mindful that the balance sheet is a snapshot- it is entirely possible the value of assets (e.g. due to bad
debts, change in valuation of assets such as premises, means that this is misleading).
This test is therefore rarely used, as:
It is difficult for the creditor to obtain the necessary accounting information.
It is easy for the company to argue that the figures are out of date or subject to re-evaluation.
s123(1)(a) and s123(1)(b) are arguably easier to prove as the creditor need show no further
evidence than the statutory demand or unsatisfied judgment.
Eurosail: Makes clear that balance sheet test is not purely mathematical exercise – take
account of events beyond reasonable near future – more likely to be accurate.
If a company is "unable to pay its debts" under any of the s123 tests, a petition by a creditor (amongst others) for the
company to be placed into compulsory liquidation is likely to be successful.
1
,BLP WS12/13
NB - in exam, if they ask you if the Directors are liable first thing you say is that the company and directors have
separate legal personality, so they aren’t usually liable for debts of the company.
Directors’ duties on insolvency
Duty to s172 CA 2006
promote Directors have a duty to promote the success of the company – increase long term value of
success of the company’s shares for the members as a whole
company o Based on the fiduciary duty to act in good faith in the best interests of the company (Re
Smith and Fawcett Ltd)
o Must have regard to the factors in s172(1): (subjective rather than objective duty – did
the director do what the director thought would best promote the success of the
company?)
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
© the need to foster the company’s business relationships with suppliers,
customers and others,
(d) the impact of the company’s operations on the community and the
environment,
(e) the desirability of the company maintaining a reputation for high standards
of business conduct, and
(f) the need to act fairly as between members of the company.
s172(3) provides that this duty is subject to “any enactment or rule of law requiring
directors… to consider or act in the interests of creditors of the company”.
o The effect of this is to “shift” the duty to promote success of “the company” to “the
creditors” when the company enters insolvency (real not remote risk of insolvency)
– recover as much as possible for them/preserve assets
o The provision does not state when creditors’ interests are to be considered. This is
left to the common law.
s174 CA 2006
Directors still have a duty to exercise reasonable care, skill and diligence
o This duty will be breached if the director is incompetent or negligent and falls below
the required standard of behavior
o Test is in two parts:
1. objective element: what should a person in that position know?
2. subjective element: what should that person, with their experience and
expertise know?
o Can’t escape liability through delegation, inactivity or manipulation.
Wrongful A director of a company is not usually liable for the debts of that company, but may be personally
trading liable on the insolvency of the company if their behaviour falls below the required standard.
s214 Insolvency Act 1986:
s214(2): If a company is insolvent (a)
and a director (c)
knew OR ought to have known, that there was no reasonable prospect that the company
would avoid insolvent liquidation (b)
THEN: a director may be liable under s214(1) to “make such contribution to the company’s assets as
the court thinks proper” from own personal assets (liquidator or administrator can make order for
wrongful trading)
o Subjective and objective threshold s214(4) … what ought to have been known (s214(2)(b))
know is what would be known or ascertained, or reached or taken, by a reasonably diligent
person having both:
a) (subjective) The general knowledge, skill and experience that may reasonably be expected
of a person carrying out the same functions as are carried out by that director in relation
to the company, and
b) (objective) the general knowledge, skill and experience that that director has
o Liquidator will seek overwhelming evidence of insolvency of which any director should have
been aware:
a) insolvency on a balance sheet basis;
2
, BLP WS12/13
b) creditor pressure;
c) late filing of accounts;
d) any qualification on the accounts by the auditors;
e) the practice of paying the creditors only when they issue proceedings or statutory
demands; or
f) numerous judgments against the company
Defence: s214(3): The court may not make wrongful trading order if satisfied that the director “took
Practical steps EVERY step with a view to minimising the potential loss to the company’s creditors”
for directors What’s already been done and what would satisfy every step? What hasn’t been done?
when o On insolvency, the directors therefore should be:
insolvency Taking professional advice ASAP – i.e. legal and accountancy
seems pending Minimizing further goods taken on credit – do not take on any more debt
Rigorously pursue and collecting debts
Negotiate installment for creditors
Keeping full minutes (evidence)
Updating accounts regularly to establish and monitor the financial position of the
company
Keeping the board fully updated with matters
Changing terms and conditions – immediate payment
Should you resign as a director? You do not need to – if over time, the company
is not salvageable, can
Take steps to put the company into liquidation
Talk to creditors, see if they will wait for payment or come to a compromise
Enter into a company voluntary arrangement (CVA) - pay less than the full
amount owed
Appoint an administrator
o If wrongful trading is established, the personal contribution will be compensatory rather
than punitive
Director’s disqualification
Application to disqualify
The liquidator, Secretary of State or a creditor may apply to have a director disqualified under the Company Directors
Disqualification Act 1986 (CDDA) to protect the public.
This lasts for 2-15 years.
A director may be disqualified for:
s.4(1) = fraud during winding-up
s.10 = wrongful or fraudulent trading
s.6(1) = for being an unfit person to run a company
o Sch 1, parts 1 and 2 = a director will be deemed unfit to run a company if ‘they are they cause of
any material contravention by a company or overseas company of any applicable
legislation’/‘causes of insolvency’
If involved in FC/undervalue but NOT preferences = unfit to run a company
s.239 = preferences
s.245 = avoidance of floating charges
s.245 = transaction at an undervalue
Removal of a Director Reminder
s.168(1) CA 2006 Permits company’s shareholders to remove a director of their company by passing an OR (over
50%) at a GM.
s.510(1) CA 2006 Permits the shareholders to remove the auditor of their company by passing an OR at a GM.
3
Insolvency
Identify when a company is insolvent
Why is important to know when a company has become insolvent?
Practical considerations
o Lack of an ability to trade – buying new stock, paying wages etc.
o Buy back – cannot out of profits/capital – statement of solvency
Directors
o The duty of directors to act in the best interests of the company changes on insolvency duty
now owed to creditors
o Directors may be liable for wrongful trading if the company is insolvent.
Loan finance
o Insolvency is likely to be an event of default which will enable holders of security to enforce their
security.
The company may be wound up
o Creditors must prove a company is unable to pay its debts for the court to wind up the company.
When is a company insolvent?
s122(1)(f) Insolvency Act 1986:
A company may be wound up by the court if it is “unable to pay its debts”.
When a company will be “unable to pay its debts” is defined by s123.
This is the main ground that a creditor must prove in order for the court to wind up the company.
s123 – A company is deemed unable to pay its debts: NB - in exam go through both (a) and (b)
(1)(a): If a creditor:
Is owed £750 or more.
Has served a statutory demand on the company requiring the company to pay the sum and
The company has, for three weeks thereafter, failed to pay or come to an alternative arrangement with
the creditor.
(1)(b): If a creditor obtains a judgment against the company AND tries to enforce it, but the debt remains
unsatisfied.
I.e. you have tried to send in the bailiffs and failed to recover. But costly/uncertain/long– go to court
(1)(e): If the company is unable to pay its debts when they fall due (the “cash flow” test).
On balance of probabilities (more likely than not) company doesn’t have resources to discharge those
debts that will fall due in the reasonably near future.
Look for indicative factors such as the company having to agree to restructure payments to creditors.
Communications e.g. emails from the company may provide evidence that the company cannot pay its
debts – need to adduce evidence so time consuming and less certain
(2): If the total value of the company’s assets is less than the amount of its liabilities (the “balance sheet”
test).
Be mindful that the balance sheet is a snapshot- it is entirely possible the value of assets (e.g. due to bad
debts, change in valuation of assets such as premises, means that this is misleading).
This test is therefore rarely used, as:
It is difficult for the creditor to obtain the necessary accounting information.
It is easy for the company to argue that the figures are out of date or subject to re-evaluation.
s123(1)(a) and s123(1)(b) are arguably easier to prove as the creditor need show no further
evidence than the statutory demand or unsatisfied judgment.
Eurosail: Makes clear that balance sheet test is not purely mathematical exercise – take
account of events beyond reasonable near future – more likely to be accurate.
If a company is "unable to pay its debts" under any of the s123 tests, a petition by a creditor (amongst others) for the
company to be placed into compulsory liquidation is likely to be successful.
1
,BLP WS12/13
NB - in exam, if they ask you if the Directors are liable first thing you say is that the company and directors have
separate legal personality, so they aren’t usually liable for debts of the company.
Directors’ duties on insolvency
Duty to s172 CA 2006
promote Directors have a duty to promote the success of the company – increase long term value of
success of the company’s shares for the members as a whole
company o Based on the fiduciary duty to act in good faith in the best interests of the company (Re
Smith and Fawcett Ltd)
o Must have regard to the factors in s172(1): (subjective rather than objective duty – did
the director do what the director thought would best promote the success of the
company?)
(a) the likely consequences of any decision in the long term,
(b) the interests of the company’s employees,
© the need to foster the company’s business relationships with suppliers,
customers and others,
(d) the impact of the company’s operations on the community and the
environment,
(e) the desirability of the company maintaining a reputation for high standards
of business conduct, and
(f) the need to act fairly as between members of the company.
s172(3) provides that this duty is subject to “any enactment or rule of law requiring
directors… to consider or act in the interests of creditors of the company”.
o The effect of this is to “shift” the duty to promote success of “the company” to “the
creditors” when the company enters insolvency (real not remote risk of insolvency)
– recover as much as possible for them/preserve assets
o The provision does not state when creditors’ interests are to be considered. This is
left to the common law.
s174 CA 2006
Directors still have a duty to exercise reasonable care, skill and diligence
o This duty will be breached if the director is incompetent or negligent and falls below
the required standard of behavior
o Test is in two parts:
1. objective element: what should a person in that position know?
2. subjective element: what should that person, with their experience and
expertise know?
o Can’t escape liability through delegation, inactivity or manipulation.
Wrongful A director of a company is not usually liable for the debts of that company, but may be personally
trading liable on the insolvency of the company if their behaviour falls below the required standard.
s214 Insolvency Act 1986:
s214(2): If a company is insolvent (a)
and a director (c)
knew OR ought to have known, that there was no reasonable prospect that the company
would avoid insolvent liquidation (b)
THEN: a director may be liable under s214(1) to “make such contribution to the company’s assets as
the court thinks proper” from own personal assets (liquidator or administrator can make order for
wrongful trading)
o Subjective and objective threshold s214(4) … what ought to have been known (s214(2)(b))
know is what would be known or ascertained, or reached or taken, by a reasonably diligent
person having both:
a) (subjective) The general knowledge, skill and experience that may reasonably be expected
of a person carrying out the same functions as are carried out by that director in relation
to the company, and
b) (objective) the general knowledge, skill and experience that that director has
o Liquidator will seek overwhelming evidence of insolvency of which any director should have
been aware:
a) insolvency on a balance sheet basis;
2
, BLP WS12/13
b) creditor pressure;
c) late filing of accounts;
d) any qualification on the accounts by the auditors;
e) the practice of paying the creditors only when they issue proceedings or statutory
demands; or
f) numerous judgments against the company
Defence: s214(3): The court may not make wrongful trading order if satisfied that the director “took
Practical steps EVERY step with a view to minimising the potential loss to the company’s creditors”
for directors What’s already been done and what would satisfy every step? What hasn’t been done?
when o On insolvency, the directors therefore should be:
insolvency Taking professional advice ASAP – i.e. legal and accountancy
seems pending Minimizing further goods taken on credit – do not take on any more debt
Rigorously pursue and collecting debts
Negotiate installment for creditors
Keeping full minutes (evidence)
Updating accounts regularly to establish and monitor the financial position of the
company
Keeping the board fully updated with matters
Changing terms and conditions – immediate payment
Should you resign as a director? You do not need to – if over time, the company
is not salvageable, can
Take steps to put the company into liquidation
Talk to creditors, see if they will wait for payment or come to a compromise
Enter into a company voluntary arrangement (CVA) - pay less than the full
amount owed
Appoint an administrator
o If wrongful trading is established, the personal contribution will be compensatory rather
than punitive
Director’s disqualification
Application to disqualify
The liquidator, Secretary of State or a creditor may apply to have a director disqualified under the Company Directors
Disqualification Act 1986 (CDDA) to protect the public.
This lasts for 2-15 years.
A director may be disqualified for:
s.4(1) = fraud during winding-up
s.10 = wrongful or fraudulent trading
s.6(1) = for being an unfit person to run a company
o Sch 1, parts 1 and 2 = a director will be deemed unfit to run a company if ‘they are they cause of
any material contravention by a company or overseas company of any applicable
legislation’/‘causes of insolvency’
If involved in FC/undervalue but NOT preferences = unfit to run a company
s.239 = preferences
s.245 = avoidance of floating charges
s.245 = transaction at an undervalue
Removal of a Director Reminder
s.168(1) CA 2006 Permits company’s shareholders to remove a director of their company by passing an OR (over
50%) at a GM.
s.510(1) CA 2006 Permits the shareholders to remove the auditor of their company by passing an OR at a GM.
3
