How does the law deal with the insolvency of a company?
The insolvency of companies, like individual bankruptcy, is now governed by the Insolvency Act 1986 (See: “Mainly for Students”). The Cork Committee had previously recommended that insolvency procedures for companies and for individuals be brought into closer correspondence.
When a company is insolvent the most usual course of action is that the company be wound up (an alternative description for this procedure is “being put into liquidation”). This entails the bringing of the business and the existence of the company to an end. Dissolution in the form of completion of the winding-up then follows.
It should be noted, however, that there are several reasons why a company may be wound up. The company may, for example, wish to cease trading or a minority shareholder may resort to winding-up as a remedy against the majority. In short, winding-up does not always involve insolvency. Conversely, where a company is insolvent other remedies may be sought.
A company is a creation of law. It can only be dissolved and its name removed from the Register of Companies (kept at Companies House) when the proper legal procedure has been completed.
Liquidation may be by court order (compulsory liquidation) or by the members of the company passing a resolution to wind-up (voluntary liquidation). Voluntary liquidation falls into two different categories. In a members’ voluntary winding-up the directors will have passed a statutory declaration of solvency to the effect that they believe the company will be able to meet its debts and obligations in full within 12 months. If the directors fail to make such a declaration, the winding-up will proceed as a creditors’ voluntary winding-up.
Compulsory liquidation
A compulsory liquidation is one ordered by the court. A petition will be presented to the court. This will be either the Chancery Division of the High Court or, if the company’s issued and paid-up share capital does not exceed £120,000, the county court within whose district the company has its registered office. The Insolvency Act 1986, section 122 (1), provides several grounds for winding up a company by court order. One such ground, contained in section 122(1)(f), is that the company is unable to pay its debts.
A company is deemed to be unable to pay its debts if any one of the following three circumstances is shown to exist:
(a) The petitioner has delivered to the company at its registered office a written demand for payment of a debt owing to him of at least £750 and within the ensuing three weeks the company has neither paid the debt nor given security for its payment;
(b) Judgment has been obtained against the company for debt and execution, ie the attempt to obtain payment out of the company’s assets remains unsatisfied.
(c) The court is satisfied, after taking account of contingent and prospective as well as immediate liabilities, that the company is unable to pay its debts: section 123.
In practice, the court applies the same minimum £750 limit in cases (b) and (c) as is actually prescribed in case (a). If the petition is based on an unsatisfied demand for payment the court will not make an order if the company denies liability and appears to have a reasonable defence to the claim. For example, in one case a petition based on a solicitor’s bill of costs before it was taxed was disallowed (Re Laceward [1] 1 All ER 254).
When the matter is being considered by the court, the company and other interested parties, such as other creditors, are entitled to be heard. If some creditors oppose the petition the court is likely to prefer the views of the creditors to whom the largest amount in aggregate is owing. However, much would depend on the individual circumstances of each particular case. If, for example, there appears to be a strong case for investigating the company’s affairs a petition may be granted as in Re Clandown Colliery Co [5] 1 Ch 369.
Effects of order for compulsory liquidation
If an order is made by the court, it has retrospective effect to the date on which the petition was presented. The Official Receiver, who is an official of the Department of Trade and Industry, will become provisional liquidator and will remain in office unless and until someone else is appointed liquidator. The more important legal consequences of an order for compulsory winding-up are:
(a) the effective dismissal of the directors and employees;
(b) a stay of any execution of a judgment against the company and of any legal proceedings in which the company is either plaintiff or defendant: section 130.
(c) a standstill on any disposition of assets or transfer of shares (unless approved by the court) from the date of commencement of the winding-up: section 127.
The Official Receiver may require the officers of the company to present a statement of affairs within 21 days of the date of receipt of the notice requiring the statement to be supplied. This statement must give details of the company’s assets, debts and liabilities, the names and addresses of creditors, details of securities held by the creditors, and any other relevant information.
The Official Receiver should investigate the cause of the company’s failure, if the company has failed, and generally the management, promotion, formation, business dealings and affairs of the company and, if appropriate, make a report to the court. He may apply to the court for public examination of any person who is an officer, liquidator, administrator, receiver or manager, or anyone who has been concerned in the management, formation or promotion of the company.
If the Official Receiver is requested by one half in value of the company’s creditors or three quarters in value of the company’s members (who are called “contributories” in a liquidation) he must apply for a public examination. This will be an examination in open court and the person summoned may be asked questions by the Official Receiver or by the liquidator or manager of the company’s property or by its creditors or members. The purpose of the public examination is, to obtain information about what has happened to, and the whereabouts of, any assets. Any person who is summoned and fails to attend the public examination will be guilty of contempt of court and the court may issue a warrant for his arrest and seizure of any books, records, money, or goods in his possession if there is no reasonable excuse for his failure to attend.
The Official Receiver may summon meetings of the contributories and creditors to choose a liquidator. He must decide whether or not to do this within 12 weeks of the making of the winding-up order and if he decides not to he must notify the court, the contributories and the creditors. One quarter in value of the creditors may require him to call a meeting. If meetings are called, the creditors and contributories may nominate a person to be liquidator, and if different people are nominated, the creditors’ nominee will generally take office.
The liquidator must (since the Insolvency Act 1985) be a qualified insolvency practitioner. This will be an individual who holds a certificate issued by the Secretary of State for Trade and Industry authorising him to act as an insolvency practitioner. It is a criminal offence for an unqualified person to act as a liquidator, administrator, or administrative receiver of a company.
The meetings of creditors and contributories may also establish a “liquidation committee” to act with the liquidator. If no such committee is appointed, the liquidator (not the Official Receiver) may summon meetings to establish one and must call meetings to do so if required by one tenth in value of the company’s creditors. However, the liquidation committee cannot act while the Official Receiver is liquidator: section 141.
Under the Insolvency Act 1986, section 202, the Official Receiver as liquidator may apply to the Registrar of Companies for early dissolution of the company where it appears to him that there are insufficient assets to cover the cost of winding-up and the company’s affairs do not require further investigation. He must give 28 days’ notice to creditors and contributories, who may object to the Secretary of State, of his intention to make this application. Unless the Secretary of State defers it, the company is automatically dissolved three months after the application is made to the Registrar.
Failing such an application, the liquidation will proceed for a compulsory winding-up in the same way as for a voluntary winding-up. This will be considered below.
Voluntary liquidation
Voluntary liquidation is effected by, and has its commencement from, the passing in general meeting of a resolution to wind up. The resolution may be of three types: section 83.
An ordinary resolution will be passed when the articles provide that the company is to be wound up when a specified purpose has been achieved or a specified period has elapsed. In practice this is rare.
An extraordinary resolution may be passed stating that by reason of the company’s liabilities it cannot carry on its business and should be wound up. This type of resolution requires merely 14 days’ notice, as in a situation of insolvency the decision to wind up may have to be taken urgently.
A special resolution specifies no grounds for winding-up and is used in any other case; for example, a solvent liquidation.
The distinction between a members’ voluntary liquidation and a creditors’ voluntary liquidation is the presence in the former type of liquidation of a declaration of solvency. This is a statutory declaration made by a majority of the directors stating that it is their belief that within the next 12 months the company will be able to pay its debts in full.
This declaration must be made not more than five weeks before the date of the resolution to wind up and must be delivered to the Registrar of Companies.
If the debts are not in fact paid in full within the specified period, the directors making the declaration are deemed to have made it without reasonable grounds until they prove that they did have such grounds. If they cannot justify themselves they are guilty of a criminal offence: section 89.
Creditors’ voluntary liquidation
Where a company resolves to wind up and the company is insolvent, the liquidation will therefore proceed as a creditors’ voluntary liquidation.
A creditors’ meeting must be held within 14 days of the resolution to wind up. A statement of affairs verified by affidavit by at least some of the directors must be laid before the creditors’ meeting, over which one of the directors will preside: sections 98 and 99. Notice of this meeting must be sent to all creditors at least seven days before the meeting and notice must also be published in the London Gazette: section 98.
At the meeting at which the members have resolved to wind up, a liquidator may be appointed by the members. This liquidator is entitled to act until the creditors’ meeting but with only limited powers. The creditors may at their meeting nominate a liquidator and, if this person is different from the person selected by the members, the creditors’ nominee becomes liquidator: section 100. The court may in exceptional circumstances, on the application of a member, creditor, or director, appoint the members’ nominee where there is a conflict. Just as in a compulsory liquidation, the liquidator must be a qualified insolvency practitioner.
The creditors may also at their meeting appoint a “liquidation committee” of not more than five people. The members, too, may nominate five people to act as members of this committee at the meeting resolving to wind up. However, if the creditors object to nominees of the members, these nominees cannot act unless they are given leave by the court: section 101. The role of the liquidation committee is as a body which represents both members and creditors and keeps a check on the liquidator and to which the liquidator can turn for guidance.
Once the liquidator has been appointed, the powers of the directors cease except in so far as the liquidation committee (or the creditors, if there is no committee) sanction: section 103. The liquidator must call meetings of both members and creditors each year: section 105. He must also call meetings of both members and creditors when the company’s affairs are fully wound up and he must send accounts to the Registrar, who will publish a notice in the London Gazette concerning the termination of the liquidation. (Part II will be published in our issue of September 3)