Insolvency: Company administration

The Insolvency Act 1986 sets out that a company is legally insolvent when it does not have enough assets to meet all its debts, or is unable to pay its debts when they fall due. Company directors are responsible for recognising when their company becomes insolvent, and they can be held legally responsible for continuing to trade whilst insolvent.

When a company becomes insolvent, it must follow an insolvency procedure. The insolvency procedure in its modern form exists to offer resolution to both the insolvent party and its creditors. The process aims to discharge an insolvent company’s liabilities (such as debts or contractual obligations), and the settlement of a creditor’s claims.

Often, companies will enter an insolvency procedure which gives an opportunity to rescue the company. The other option is liquidation, after which the company ceases to exist. Some of the most popular procedures with an opportunity to rescue the company are administration and company voluntary arrangements (CVA).

Administration

Administration is an insolvency procedure run for the benefit of all creditors. During administration, a statutory moratorium prevents creditors from taking legal action against company assets while a rescue plan is worked out. The administrator has the power to “trade on” the business whilst seeking a buyer for it, meaning they can continue to operate and trade the business.

The Insolvency Act 1986 sets out that there are two routes into administration:

• by a court order made at a formal hearing; this hearing would follow an application by one or more creditors of the company, the company itself, the company directors, an insolvency practitioner acting for that company in a CVA, or by certain regulatory bodies
• by the company itself, or qualifying floating charge holders (any creditor holding a specific type of debt over substantially all of the company’s assets) lodging a series of prescribed documents at court (the simple “out-of-court route”)

Moratorium

The administration process includes a statutory moratorium to protect the company from enforcement action by creditors. The moratorium suspends the power of creditors to take certain actions against the company in administration or its property. For example, unless permission is granted by the court or the administrator, no legal process may be instituted or continued against a company protected by a statutory moratorium. An interim moratorium with the same protections as the statutory moratorium will apply from the moment an application is made for an administration order, or a notice of intention to appoint an administrator is filed in court.

The administrator

Once in administration, the company is placed under the day-to-day control and management of the administrator.

All appointed administrators must be qualified insolvency practitioners (IPs). An administrator is an agent of the company to which they are appointed and they have a legal responsibility to all company creditors. They are also an officer of the court and as such, have a duty to act in good faith. They must be, and be seen to be, independent and impartial in their management of the company and dealings with its assets.

The costs incurred by the administrator are paid from the company’s assets. All company property comes under their control. The administrator has the power to do anything “necessary or expedient for the management of the affairs, business and property of the company”.

Pre-pack administration

Some companies choose to use a pre-packaged administration. This is a planned insolvency procedure where the sale of all or part of a company’s business is negotiated with a purchaser before an administrator is appointed. The sale is then completed on the appointment of the administrator.

Pre-packs allow administrators to realise the assets of an insolvent company, and to allow the viable parts of the business to continue operating away from the unviable parts. The proceeds of sale are usually used to repay creditors to prevent them from seizing the company’s assets and to protect the company from being wound up.

The purchaser could be either a third party or a connected party such as the existing company management. A pre-pack can only be used where the insolvency practitioner, who has a legal responsibility to all company creditors, agrees that using a pre-pack offers the best possible return for the company’s creditors.

Company voluntary arrangement (CVA)

An alternative to a pre-pack or a standard administration procedure is the CVA. A CVA is a legal agreement between the company and its creditors, enabling the repayment of unsecured creditors, either in part or in full, over a defined period. A CVA does not affect the rights of secured creditors or preferential creditors unless they agree to the proposals. The existing management can stay in place under a CVA and the company can continue trading.

Secured creditors loan money with the condition that the creditor can claim certain of the company’s assets if it becomes insolvent. Unsecured creditors do not have this condition, and are last to receive compensation if a company is liquidated. Preferential creditors have some legal priority over other unsecured creditors for payment; for example, HM Revenue and Customs is a preferential creditor for certain tax debts.

In some cases, administration is used as an initial step to enable the company to implement a CVA. If the proposed CVA is approved by the members (shareholders) of the company (50% of members must vote in favour) and by its creditors (75% of the creditors by value must vote in favour), the CVA will come into force, and the administration will end.

A proposal for a CVA must nominate a qualified insolvency practitioner to act as the supervisor of the process. The terms of the CVA are then carried out in much the same way as any other commercial contract. If all creditors are paid what the CVA has promised, the CVA will come to an end (that is, the CVA will have been successful).

In the event it is unsuccessful, for example if the company fails to keep up with its agreed payments, a CVA agreement will have provisions on how to deal with its termination. This will often lead to the company entering a subsequent insolvency procedure.

Further reading

Library briefing, Compulsory liquidation of a company,

Library briefing, Phoenix trading and liability of directors

Library briefing, Regulation of Insolvency Practitioners (IPs)

Library briefing, Bankruptcy,

Library briefing, Debt Relief Orders

Library briefing, Individual Voluntary Arrangements (IVAs)