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Corporate Insolvency
- Module
- Company Law
- Institution
- Kings College London (KCL)
Comprehensive notes on Company Law in the UK: Corporate Insolvency.
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Company LawRevision Notes
CORPORATE INSOLVENCY
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INTRODUCTION
What is ‘insolvency’?
The term ‘insolvent’ means that a company is unable to meet its liabilities as and when they fall due, or
that its debts exceed its assets (i.e. company or an individual reaches a point where it has so much debt and
it is not earning enough for it to pay the debt back).
Therefore, it is the end of the life of a company – though a company can come to its end without being
insolvent (this is known as voluntary winding up).
Key terminology
(i) Winding up: This is the process of dissolving a company. While winding up, a company ceases to do
business as usual. Its sole purpose is to sell off stock, pack off creditors and distribute any remaining
assets to partners or shareholders.
(ii) Insolvent liquidation/winding up: The company is unable to pay it debts, because it is insolvent, and
thus it is going to be wound up.
! This term is synonymous to liquidation.
Why do companies face financial difficulties or become insolvent?
(i) When companies are chained to debts: This is seen in the cases of zombie companies where
companies earn enough money to contribute operating and service debt but are unable to pay off their
debt (i.e. companies are essentially chained to their debt). Such companies, given that they just scrape
by meeting overheads (wages, rent, interest payments on debt), have no excess capital to invest to spur
growth.
RELEVANCE TO INSOLVENCY: Zombie companies are typically subject to higher borrowing costs
(interest and other costs incurred by an enterprise in relation to the borrowing of funds) and may be one
just event (e.g. market disruption or a poor quarter performance) away from insolvency or a bailout.
(ii) Incompetent management is syphoning corporate assets and is acting to the detriment of the
company.
(iii) Difficulty catching up with technological advancement: It can be technological advancement or a
change in a market’s demands. When consumers begin doing business with other companies offering
larger selections of products and services, the company loses profits if it does not adapt to the
marketplace. The expenses exceed revenues and bills remain unpaid.
(iv) Undercapitalised company: When starting a company, in such cases, the starting capital may not be
sufficient. This leads to either (1) not being able to carry out the scale of activities as intended (2) to
borrow (not having enough assets infringes your ability to borrow). The lack of revenue therefore might
not be able to keep with the expenses, leaving bills unpaid.
(v) Internal audit is not on their toes: For example, the accounting manager may improperly create
and/or follow the company’s budget, resulting in overspending. Expenses add up quickly when too much
money is flowing out and not enough is coming into the business.
(vi) External factors: Pandemics, natural disasters, economic crises.
,Company Law
Revision Notes
Insolvency vs. Bankruptcy
INSOLVENCY BANKRUPTCY
This is a type of financial distress, meaning the This is an actual court order that depicts how an
financial state in which a person or entity is no insolvent person or business will pay off his
longer able to pay the bills or other obligations. creditors, or how he will sell his assets in order
to make the payments.
A person or corporation can be insolvent
without being bankrupt, even if its only a
temporary situation. If that does extend longer
than anticipated, it can, however, lead to
bankruptcy.
Structure
PART A: DETERMINING THE POINT OF INSOLVENCY
The point at which insolvency is determined.
Tests that enable to find said point.
The point at which legal consequences attach.
PART B: PROCESSES THAT A COMPANY MIGHT ENTER WHEN IN FINANCIAL DIFFICULTY
Two processes may be undertaken:
A) CORPORATE RESCUE: Two procedures were introduced by the Insolvency Act 1986 (IA 1986) aimed at
implementing the objective of corporate rescue.
(i) the administration order; and
(ii) the company voluntary arrangement (CVA).
B) DISSOLUTION OF THE COMPANY THROUGH WINDING UP (OR LIQUIDATION): This is achieved in
three ways:
(i) Members’ voluntary winding-up
(ii) Creditors’ winding-up
(iii) Compulsory winding-up
C) ALTERNATE MECHANISMS: CORPORATE RESTRUCTURING
Achieved in Schemes of Arrangement (CA 2006).
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, Company Law
Revision Notes
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PART A: DETERMINING THE POINT OF INSOLVENCY
At which point is a company insolvent?
The point at which a company is unable to pay its debts : The date of this is important as it can
determine the type of process (see below) that one is willing to undertake.
! Note: The company’s life ends after insolvency proceedings are concluded and the company’s name is taken
off the register.
What does ‘inability to pay debts’ mean’?
This is established in s. 123(1), IA 1986 as the following:
(i) Specific tests per s. 123(1)(a) and (b):
(a) if a creditor (by assignment or otherwise) to whom the company is indebted in a sum exceeding £750 then
due served on the company, by leaving at the company’s registered office, a written demand (in the
prescribed form) requiring the company to pay the sum so due and the company has for 3 weeks thereafter
neglected to pay the sum or to secure or compound for it to the reasonable satisfaction of the creditor, or …
IN OTHER WORDS: The following criteria has to be satisfied (i.e. a breakdown).
- The creditor leaves a written demand.
- In a specific format/prescribed form.
- Presents it at the company’s registered office.
- The demand must say there is a sum that is due over £750 for three weeks.
- Debt is not cleared to the reasonable satisfaction of the creditor
(b) if in England and Wales, execution or other process issued on the judgment, decree or order of any court in
favour of a creditor of the company is returned unsatisfied in whole or in part, or …
IN OTHER WORDS: There is a judgment from court that is not satisfied.
(ii) General tests per s. 123(1)(e) and (2):
(e) if it is proved to the satisfaction of the court that the court is unable to pay its debts as it falls due.
IN OTHER WORDS/EXPLANATION: This is called the cash-flow test/’commercial insolvency test. A
company may be described as insolvent if it is unable to pay its debts as they fall due. In other words, even
though its overall asset position may not be in deficit (i.e. balance sheet solvent), it has cash-flow problems which
prevent it from paying its way (for instance, it may be difficult to liquidate an asset because of market conditions
or charges being imposed on them).
! Note: This is the most common reason for the making of a compulsory winding up order (s. 122(1)(f), IA 1986).
(2) A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value
of the company’s assets is less than the amount of its liabilities, taking into account the contingent and
prospective liabilities
IN OTHER WORDS/EXPLANATION: This is called the ‘balance sheet’ test/insolvency. A company may be
said to be insolvent in this manner if the value of its assets is less than the amount of its liabilities. Since the
company may be a going concern (a business that is operating and making a profit), an assessment of
insolvency in this sense will depend upon the business judgment of those concerned.
For this purpose, it is proper to take into account of the company’s contingent and prospective liabilities, although
the value of these will necessarily be difficult to estimate.
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