What happens when a company goes insolvent?
A company is considered insolvent if it cannot pay its debts as and when they fall due. Broadly speaking, there are three main types of insolvency: administration, liquidation and Company Voluntary Arrangement (CVA).
Only the court, the insolvent company or a Qualifying Floating Charge Holder can place a company into administration. The primary aim of the process is either to rescue of the company, to achieve a better result for creditors in comparison to other insolvency methods, or to realise property. During the administration period, a company may continue to trade and/or have its assets sold. Monies are then paid to creditors according to their status – secured creditors are paid first, then preferential, unsecured and finally shareholders/members.
Where the sale of a company’s assets are agreed before the administration has commenced and completed almost immediately after the start of the administration, this is commonly known as a pre-pack.
The liquidation of a company can either be a voluntary or compulsory. Unlike administration, a creditor of the company can petition for the insolvent company to be wound up. During a liquidation, company assets are realised i.e. turned into cash, and distributed to creditors to satisfy their debts. As with administration, creditors are paid out according to their status.
A liquidator has substantial power to investigate the affairs of the company and is permitted to bring legal claims where necessary for the benefit of creditors. Where a company has been wound up, the Liquidator has a duty to review the director’s conduct and is required to submit a report to the Insolvency Service of its findings.
Company Voluntary Arrangement (CVA)
An insolvent company can use a CVA to agree a payment plan with creditors over a fixed period of time. This method is often used when a company is able to trade out of its debt, for example because a large contract is due for payment in the near future. It is still necessary to use an insolvency practitioner in this process as a formal proposal will need to be drawn up.
A meeting of creditors is generally called and for the CVA to be approved, 75% of creditors in value must agree to its terms. If a CVA is accepted, it will bind all creditors, even those did not attend the meeting or who voted against it.