Chapter - 11 Insolvency
1. Insolvency: Insolvency is a state of financial distress in which a person or business is
unable to pay its debts as they fall due. When a company becomes insolvent due to poor
cash flow or an inability to meet external obligations, it may enter administration or
liquidation.
2. Administration: Administration is a formal insolvency procedure in which a company is
placed under the control of an administrator to help it overcome financial difficulties
and, where possible, continue trading as a going concern.
3. Liquidation: Liquidation is the legal process of bringing a company’s business to an
end by winding up its affairs and distributing its assets to claimants. It involves selling
the company’s assets to settle liabilities when the company is insolvent or when it is
decided to cease operations.
4. Voluntary Liquidation: Voluntary liquidation is a self-initiated winding up of a
company approved by its shareholders. It occurs when the company’s members decide
that there is no reason to continue business operations. A company may be wound up
by an ordinary resolution where the period fixed for its duration has expired or where
its articles so provide; in all other cases, a special resolution is required.
5. Types of Voluntary Liquidation: There are 2 types of voluntary liquidation member’s
voluntary liquidation and creditors’ voluntary liquidation.
Members’ Voluntary Liquidation (MVL)
• A formal process to wind up a solvent company.
• All company affairs are finalized and surplus assets are distributed to members.
• Company is deregistered after completion of the process.
Commencement of MVL
• Directors assess the company’s financial position.
• Directors agree that all debts can be paid within 12 months.
• Director’s sign and lodge a Declaration of Solvency.
• A general meeting of members is called.
• Members pass the required resolution and appoint a liquidator.
Key Points
• Winding up starts from the date of passing the resolution.
• Making a false declaration of solvency is a criminal offence.
• A licensed insolvency practitioner is appointed as liquidator.
Duties of the Liquidator
• Realize the company’s assets.
• Settle claims of creditors.
• Obtain tax clearance.
• Distribute surplus assets to members.
Completion
• Liquidator prepares final accounts and report.
• Final meeting of members is held.
• Registrar is informed of the report and meeting.
• Company is dissolved, usually within 3 months.
Creditors’ Voluntary Liquidation (CVL)
• Applies when a company is insolvent.
• Company is unable to pay debts as they fall due.
• Liabilities exceed assets.
Commencement of CVL
• Directors realize the company has no reasonable prospect of survival.
• Members pass a resolution to wind up the company.
• Company ceases trading promptly to protect creditors.
Key Points
• Winding up begins from the date of passing the resolution.
• No declaration of solvency is required.
• Directors must act under the Companies Act to protect stakeholders.
Procedural Requirements
• Members appoint a liquidator.
• Directors submit a statement of affairs.
• Notice of appointment sent within 7 working days.
• Creditors’ meeting held within 14 days.
Appointment of Liquidator
• Creditors may approve the members’ liquidator.
• Creditors can appoint a different liquidator if 10% or more object.
• A liquidation committee (up to 5 members) may be formed.
Completion
• Liquidator submits final report to members, creditors, and registrar.
• Company is dissolved, usually within 3 months.
Conversion of MVL into CVL (P.T.R.)
• Occurs when debts cannot be paid within the period stated in the declaration of solvency.
• Liquidator must convert MVL into CVL immediately.
• CVL procedures must then be followed.
6. Grounds for winding up in compulsory liquidation: Compulsory liquidation begins
when a petition is presented to the court and a winding-up order is made by the court.
Grounds on which a petition may be presented:
• The company has passed a special resolution requiring the court to wind it up.
• A public limited company (PLC) has failed to obtain a trading certificate within 12
months of incorporation.
• The company has not commenced business within 12 months of incorporation.
• The company’s main or stated objects cannot be achieved.
• The company is unable to pay its debts, including where:
o A creditor owed at least £750 serves a written demand; and
o The company fails to pay, secure, or compound the debt within 21 days.
• A member petitions the court on just and equitable grounds, such as:
o Loss of mutual trust and confidence
o Deadlock in management (making it impossible to run the company effectively.)
o Oppressive or unfairly prejudicial conduct toward members (subject to the court
finding the claim genuine)
• If the court considers winding up inappropriate, it may apply alternative remedies instead.
7. Who can petition for compulsory liquidation:
a. The company itself
b. The Official Receiver (The Official Receiver is a government officer
who acts as an officer of the court in insolvency proceedings.)
c. The Department for Business, Energy and Industrial Strategy (BEIS)
d. A contributory (a person who is liable to contribute to the company’s
assets in the event of winding up (usually a present or past shareholder).)
e. A creditor owed at least £750
8. Effects of winding up: Winding up is deemed to commence from the date the petition is
presented (in compulsory liquidation).
a. All legal proceedings against the company are stayed, and no new proceedings
may be started without permission of the court.
b. Actions to recover debts against the company are suspended.
c. Business operations cease, except where work is required to complete work in
progress (WIP) for the benefit of liquidation.
d. Floating charges crystallize, becoming fixed charges over the company’s assets.
e. Directors’ powers are suspended, although they may remain in office.
f. All employees are automatically dismissed, but may be re-employed by the
liquidator to assist in the winding-up process.
9. Process of wind up: when the formal winding up order is issued from court the official
receivers become liquidator and the receiver must conduct the meeting to appoint
licensed insolvency practitioner within 3 months, then creditors approve the
liquidator within three month and then he realizes the assets and distributes the
proceeds and the liquidator then return to the court and court passes an order dissolving
the company. The liquidator then files his reports to the registrar and the company is
dissolved from the date of order after valid verification.
10. Application of assets: The liquidator must pay the debts in order which are given below:
Fixed Charge Holders
• Paid first from the assets subject to the fixed charge.
• Example: mortgage over land or building.
• They are paid outside the general liquidation pool.
Expenses of the Liquidation
• Includes:
o liquidator’s remuneration,
o legal costs,
o costs of realizing assets.
• Paid before most creditor claims.
Preferential Creditors
These have priority by law and include:
• Employees:
o wages and salaries due for up to 4 months, subject to a maximum of £800 per
employee (ACCA figure),
o all accrued holiday pay (no monetary cap).
• Certain pension contributions (e.g. occupational pension schemes).
Other Creditors
• Tax department, Tort victims, “Any secured creditors”.
Floating Charge Holders
• Paid after preferential creditors.
Unsecured Creditors Examples: trade creditors, credit card companies, landlords,
suppliers.
They are paid pari passu.
Post-Liquidation Interest
• Interest on debts accruing after liquidation.
• Paid only if surplus funds remain after unsecured creditors.
Members (Shareholders)
Paid last, and only if all creditors are paid in full:
• declared but unpaid dividends,
• return of capital according to class rights,
• any remaining surplus distributed among members.
11. Administration: An insolvency practitioner known as administrator is appointed to
manage affairs and property of a company with aim to rescue company from financial
difficulties, to achieve better result for creditors or realize property to pay one or more
secured or preferential creditors. The last option remedy is only available when it is not
possible to rescue the company from financial difficulties and feels no better results can be
achieved in favor of creditor or doesn’t harm the interest of any creditors as a whole.
12. Appointment and Effects of Administration:
Who may appoint an Administrator: An administrator may be appointed:
a. By the court, on the application (petition) of: the company, the directors, or a
creditor.
b. Out of court, by: the company or its directors, or a qualifying floating charge
holder.
Effect of Appointment of Administrator
a. Once an administrator is appointed: Any outstanding winding-up petition is
dismissed or suspended.
b. No resolution to wind up the company is valid.
c. Directors’ powers are suspended, but they may continue to act with the
administrator’s consent.
There is an automatic moratorium, meaning: creditors cannot start or continue legal
proceedings, secured creditors cannot enforce security, no enforcement of charges,
retention of title clauses (contractual term under which a seller keeps ownership (title) of
goods until the buyer has paid the full purchase price.), or hire-purchase agreements
without consent of the administrator or court.
Status and Duties of the Administrator
a. The administrator acts as an agent of the company, not of individual creditors.
b. He must act in the best interests of creditors as a whole.
c. He has wide management powers to achieve the purpose of administration.
Powers of the Administrator
The administrator may:
a. continue or stop the business,
b. hire and dismiss employees,
c. sell company assets,
d. borrow money,
e. bring or defend legal proceedings.
Disposal of Charged Assets:
a. Assets subject to a floating charge may be sold without consent, subject to priority
rules.
b. Assets subject to a fixed charge: generally, require court permission or charge-
holder consent. Secured and preferential creditors may be paid without court order.
Payment to unsecured creditors requires court approval.
Notice and Documentation Requirements
The administrator must notify: the registrar, the company, creditors, and other
stakeholders within 7 days of appointment.
All company documents must state that:
a. the company is in administration, and
b. the administrator’s details are shown.
Administrator’s Proposals
The administrator must prepare a statement of proposals explaining how he intends to
rescue the company or achieve administration objectives. This must be sent to creditors
within 8 weeks of appointment. The proposals must be approved by creditors.
Creditors’ Meetings
Creditors may form a creditors’ committee (normally 3–5 members). The administrator
must hold a creditors’ meeting within 6 weeks of appointment (unless dispensed with).
If proposals are not approved, the court may: dismiss the administrator, or make any
order it considers appropriate.
Completion and Duration of Administration
Administration ends when: its purpose has been achieved, or the administrator is
discharged by the court. The standard duration is 12 months. It may be extended: with
court approval, or with consent of secured creditors. The administrator may apply for
discharge at any time. He must notify the registrar, creditors, and stakeholders upon
discharge.