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| Bankruptcy, winding up, receivership and administration |
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http://www.citicredit.asia |
Introduction
This chapter covers several subjects but the linking factor is very severe financial difficulties for a company or for an individual. In the case of bankruptcy or of the winding up of an insolvent company, at least some creditors will not receive payment in full. This will probably also happen in the case of receivership and it may happen in the case of administration. Receivership involves the appointment of an administrative receiver but it is not the same as administration.
The similarity in the terms can be misleading and the two things should not be confused.
Unfortunately everything in this chapter may be relevant to a person seeking to obtain payment of unpaid debts. Indeed, an experienced collector is almost bound to have encountered some of the problems. You should know what happens and do what you can to protect your position, although the scope for doing this may be very limited. The subjects covered are big and it is not possible to cover all aspects of them. This chapter provides an outline, but it may be necessary to consult a more extensive work or to obtain professional advice.
The chapter concludes with a reproduction of the four page form ‘Statutory Demand on a Company'.
The Enterprise Bill
This book is intended for publication in early 2003, which means that the Enterprise Bill is a complicating factor for this chapter. At the time of writing it seems likely that the Act will receive Royal Assent very late in 2002.
Secondary legislation will follow and the Act will be implemented in stages between Spring 2003 and Spring 2004. Of course the Bill could fail to reach the statute book, though this seems unlikely. Significant amendments are a definite possibility and the details of the secondary legislation will be important.
The Bill is a large one and it deals with many more topics than those embraced by this chapter. However, the following is a brief summary of its key provisions in the areas of bankruptcy, winding up, administrative receivership and administration:
• The stigma and consequences of bankruptcy will be reduced for most bankrupts. Those not judged to have been reckless or criminal will be discharged after one year (or even less in some cases), instead of three years as happens now. Many of the irrelevant and outdated restrictions that currently apply to bankrupts will be removed. It will be possible, for example, for a non-culpable bankrupt to be a member of parliament. Some commentators have expressed surprise at this, but many people take the view that the quality of the legislature will not be diminished.
• The consequences of bankruptcy will be maintained or increased for a minority of bankrupts judged to have been culpable. These bankrupts will have to comply with bankruptcy restriction orders for between two years and fifteen years.
• Income payment orders will run for a period of three years, irrespective of the date of discharge from bankruptcy. These will ensure that bankrupts make an affordable contribution to their debts out of their income.
• The Crown's preferential right to recover unpaid taxes ahead of ordinary creditors in winding up and bankruptcy will be abolished.
It is expected that secondary legislation will ensure that a proportention of the money that would have gone to the Crown will be available for unsecured creditors, rather than it all going to secured creditors.
• There will be measures to restrict the use of administrative receivership where a single secured creditor has effective control. The single secured creditor is usually a bank.
• There will be greater emphasis on administration orders and there will be detailed changes in this area.
The proposed abolition of crown preference has been very widely welcomed and this will no doubt be the response of most readers of this book, although employees of the Inland Revenue and Customs and Excise may have some regrets. It will result in more money being available for unsecured creditors, and it will reduce the incentive of the Inland Revenue and Customs and Excise to act hastily in instigating winding up and bankruptcy proceedings. However, there must be a risk that ring-fencing some of the savings for unsecured creditors will be bureaucratic, with semi-random consequences according to the amount of tax owed and the relative weight of secured and unsecured creditors. We will see.
It is expected that administration will be used more and receivership less.
This too has been generally welcomed because there may be more prospects of saving companies and because the unsecured creditors may do better.
No doubt the banks will still succeed in safeguarding their interests.
Bankruptcy and winding up
Let us first of all make sure that the terms are properly understood. Bankruptcy applies to a person or a general partnership, whereas winding up applies to a registered company. The bankruptcy of a general partnership involves the bankruptcy of each partner. The terms are widely misunderstood, sometimes by people who should know better. These are often the same people who wrongly regard the words accountant and auditor as being virtually interchangeable. In particular, ‘bankruptcy' is sometimes used as a generic term for the financial difficulties of a person, partnership or company. This is not correct. One more point before moving on: winding up may be for a number of reasons. Solvent companies may be wound up as well as insolvent companies and when this happens all the creditors eventually get paid in full.
In Chapter 2 it was explained that, so long as the debt is at least £750, it is possible to go straight for winding up or bankruptcy without first issuing a claim and obtaining judgment. This section shows in detail how it is done.
In Chapter 9 it was explained that winding up or bankruptcy can be an enforcement option if the defendant does not pay after judgment has been obtained, and this section explains the consequences of doing that.
Before the detailed study it is worth repeating a point made in Chapter 2. A credible threat of winding up or bankruptcy proceedings can be extremely effective in persuading a customer to pay. In fact a customer that can pay and that does not want to be wound up or made bankrupt will almost invariably do so or make a serious proposal. This does of course depend on the customer believing that it is a serious threat which will be carried out if necessary. The threat, let alone the reality, will probably seriously upset the customer and kill any chances of further business. This probably does not matter because further business is unlikely to be wanted anyway.
The courts will give even-handed justice and they will give due consideration to a petition presented by a very small supplier to have a FTSE 100 company wound up. Of course FTSE 100 companies do not actually get wound up as the result of a petition presented by a very small supplier.
Instead they pay the amount owing, which is a very satisfactory outcome. Alternatively they show that the claimed debt is not owing. This route is available to small suppliers and they should sometimes take it, especially if they are felling vindictive, but they would be well advised to be very sure of their grounds and the procedure. To get it wrong might have expensive consequences.
The threat of winding up or bankruptcy may well produce the money, but actually carrying out the threat has certain disadvantages. They are:
• the creditor that brings the petition does not get priority;
• there are significant up-front costs: they are recoverable out of the proceeds as a first priority, but it may take a long time;
• it can be a messy and protracted business;
• preferential debts get paid before ordinary debts and if money is short, there might not be enough for your debt.
If judgment has not been obtained and winding up or bankruptcy is therefore an enforcement measure, the first step is to serve a statutory demand on the person or company that owes the money. There are different forms, one for bankruptcy and one for winding up, but they have many similarities.
A specimen example of a statutory demand on a company is shown at the end of this chapter. The forms may be obtained from a legal stationer.
The recipient of a statutory demand has 18 days from service to apply to have it set aside. Otherwise a person or company has 21 days in which to respond.
After 21 days from service of the statutory demand has elapsed, and provided that payment has not been made and there has been no application for the statutory demand to be set aside, the creditor may present a petition.
This is either a winding up petition or a bankruptcy petition and it may be presented to the High Court or to one of many (but not all) county courts.
An affidavit must be presented in support of the petition which must be advertised in the Gazette. The petition will then be heard by the court which may accept it, reject it or adjourn the hearing. The petitioner must show that the stated sum is unambiguously owing and that the correct procedure has been followed.
The following is an outline summary of what happens next:
• upon the issue of a bankruptcy order or winding-up order the Official Receiver takes provisional charge. In the case of a company this automatically relieves the directors of their powers;
• creditors are asked to lodge details of their claims. This will enable them to vote and to participate in the distribution;
• a meeting of creditors is held and this appoints the liquidator of a company;
• the liquidator or the Official Receiver takes steps to realise the assets;
• payments are made to the creditors. This is according to certain rules and precedence as shown in the next section. Final distribution can take a very long time, sometimes several years.
For this reason one or more interim distributions may be made;
• eventually a limited company is struck off the register.
Order of priority in the distribution of funds
One is tempted to misquote George Orwell's Animal Farm - ‘all creditors are equal, but some creditors are more equal than others'. Secured creditors are paid out of the proceeds of their security. If this is insufficient, they rank as ordinary creditors for the deficiency. If there is a surplus, it is available for the creditors generally. Charging orders come into this category and these were examined in Chapter 9. Banks (and others) that are secured by a fixed charge debenture are secured by the assets covered. Apart from this, available funds are applied in the following order:
1 the expenses of the bankruptcy or winding-up;
2 preferential debts (but not interest due after the bankruptcy or liquidation);
3 debts secured by a floating charge (but not interest);
4 ordinary debts (but not interest);
5 interest on preferential and ordinary debts;
6 any remaining surplus to the ‘bankrupt' or to the members of the company.
Most unpaid suppliers are likely to rank as ordinary debts. If the assets are insufficient to pay off a category in full, each debt is paid at the rate of x pence in the pound and debts in a lower category get nothing. Preferential debts rank equally amongst themselves and (in summary) are:
• arrears of employee's wages or salaries up to a period of four months, but subject to a limit for each employee;
• accrued holiday pay for employees;
• PAYE and national insurance, and also deductions from sub-contractors for a period of up to a year;
• VAT owing for the previous six months;
• general betting duty, bingo duty and car tax in arrears for a period up to a year;
• money owing to third parties in connection with debts which would have been preferential had they not been paid by the third parties.
It is likely that crown preference will soon be abolished. This will mean that PAYE, national insurance, deductions from sub-contractors and VAT will rank as ordinary debts.
Receivership and its consequences
An administrative receiver may be appointed under the authority of a fixed charge and, if this is the case, his authority only extends to assets covered by the fixed charge. If he is appointed under the authority of a floating charge, his authority is over all assets and he has the power to run the company.
Most bank debentures are in the form of a fixed and floating charge and they give the receiver the power to take control of all the assets and to manage the company. The directors are relieved of their powers during the course of this type of receivership.
The appointment of a receiver is often, but not always, made by a bank and the circumstances in which a receiver may be appointed depend on the wording of the debenture. A receiver must be a licensed insolvency practitioner and must act in a professional manner, with due regard to the interests of creditors in general and members of the company. However, it should not be forgotten that the first duty of a receiver is to protect the interests of the people who appointed him. Their interests are not the same as the interests of the creditors in general and the unsecured creditors may be disadvantaged.
One of the duties of an administrative receiver is to draw up a report and send it, amongst others, to all known creditors. This will include an estimate of how much (if anything) is expected to be available for preferential creditors and how much (if anything) is expected to be available for unsecured creditors. At the end of the receivership the company may well be put into liquidation and if this happens, the receiver will hand any available funds to the liquidator. If the company is not to be wound up, the receiver relinquishes control and hands control of the company back to the directors, though this does not happen very often.
Imminent legislation is likely to reduce the number of receiverships and increase the number of administration orders, under which unsecured creditors sometimes fare better. Details were given earlier in this chapter.
The appointment of an administrative receiver is almost certainly bad news for an unpaid ordinary creditor. It means that the company has got problems, probably severe problems and quite possibly terminal problems. It also means that assets that would have been available to fund the payment due to him have been taken out of the pool of assets that may be used for that purpose.
It means that he is probably going to be saddled with a bad debt, although this is not always the outcome. Unfortunately there is not much that can be done about it, though he should receive information from the receiver.
No legal action may be commenced or continued against the company and no execution may be levied against the company or its goods. This sounds, and is, gloomy, but before leaving the subject it is worth mentioning two strategies that just may be of some use to an unsecured creditor.
1 Retention of title
The appointment of an administrative receiver does not prevent the exercise of retention of title rights. This is unlikely to be of use to a claimant who has already started an action because, if it was possible to do it, recovery of goods would presumably already have been accomplished. On the other hand, it might be of use to a supplier who had made supplies in the not too distant past.
Receivers are not known to show excessive compassion in recognising retention of title claims and they will make a supplier show that a claim is valid.
You might be able to bluff the company but this will not work with a receiver. This is fair enough and you must be able to show that you are right, but having done so do not be put off. You should assert your claim early and forcefully, and you should threaten the receiver with legal action if necessary.
This does work as the writer knows from personal experience. Prompt action is important because, in these circumstances, goods have a bad habit of going missing.
2 Future deliveries
An administrative receiver has many powers but he does not have the power to make suppliers enter into fresh contracts. They will only do this if they want to do so. The receiver may wish to carry on trading, at least for a short time, and he may badly need further supplies. He will not order with personal liability but he will be very unlikely to place new orders for which payment will not be made. This may give key suppliers a bargaining position and they may be in a position to refuse unless some progress is made with the old debts. Circumstances vary and the possibilities should not be overstated, but it is worth consideration for a few suppliers. Unfortunately it is unlikely to help most suppliers and the receiver may see things differently.
Administration and its consequences
The signing of an administration order is not usually good news for creditors. However, a main objective is to serve the interests of the creditors in general and there may be a happy outcome, though a significant number do end in the insolvent winding up of the company. Imminent legislation should ensure that in future there will be more administration orders and less receiverships and this was explained earlier in the chapter.
An application for an administration order may be made by the directors, one or more of the creditors, or by a combination of the directors and the creditors. In practice most applications are made by the directors. The court may only grant an administration order if it is satisfied that both the following apply:
• the making of an administration order would have a real chance of achieving one or more of five stated objectives; and
• the company is unable to pay its debts or is likely to be unable to pay its debts.
A company is ‘unable to pay its debts' if any of the following four conditions apply:
• it has received a demand in the prescribed form for a debt of at least £750, and it has not made payment for a period of at least three weeks;
• execution or other processes issued on a judgment decree or order of any court in favour of a creditor of the company is unsatisfied in whole or in part;
• the company is unable to pay its debts as they fall due;
• the amount of the company's assets is less than the amount of its liabilities.
The court must be satisfied that the granting of an administration order would be likely to achieve one or more of the following five purposes:
• to enable the whole company to survive as a going concern;
• to enable part of the company to survive as a going concern;
• to sanction a compromise or arrangement;
• to approve a voluntary arrangement;
• to enable a favourable realisation of the company's assets to take place, more favourable than would be the case with winding-up procedures.
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The phrase ‘likely to achieve' does not mean that achievement is certain or even that it is probable. It means that the court must believe that there is a definite, realistic prospect and that the chance is more than a negligible one.
An administration order will specify for which, or for which combination of, purposes it is granted. The administrator will be limited to trying to achieve these specific purposes. He will not be permitted to try and achieve any of the other purposes.
When a petition is presented, and in the period until it is heard, creditors are bound by the following restrictions:
• no liquidation proceedings may be commenced;
• no debt recovery or enforcement proceedings may be commenced and such proceedings that are in existence are frozen;
• property subject to hire purchase or lease agreements may not be repossessed;
• no security may be enforced;
• no goods subject to retention of title clauses may be repossessed.
The court may give special permission that overrides all but the first of these restrictions. If it does not grant an order then, of course, the restrictions cease. If the court does grant an administration order the administrator runs the company whilst the order is in force.
Whilst an administration order is in force the restrictions continue to apply.
The administrator may not, without leave of the court, sell or dispose of goods subject to hire purchase, lease or retention of title. In practice the court may give permission, but order the administrator to account for the proceeds to the creditor concerned.
The administrator must, within three months of the date of the order, call a meeting of creditors and present his detailed proposals to it. The meeting of creditors may accept the proposals, reject the proposals, or (with the consent of the administrator) amend the proposals.
An administration order gives the company a period of protection from its creditors. It is for their benefit which may or may not make it easier to bear. The fact that retention of title clauses may not be enforced can in some cases be very important.
Wrongful trading
Directors may be guilty of wrongful trading if they carry on trading when they know, or ought to know, that there is no reasonable prospect of avoiding insolvent liquidation. The courts have he job of interpreting the word ‘reasonable' and it can be a matter of fine judgment.
The liquidator must, in the case of an insolvent liquidation, make a report to the Department of Trade and Industry. It is usual for him to write to all creditors to ask if there is anything concerning the directors' conduct that should be drawn to his attention.
If a court decides that a director has been guilty of wrongful trading, it may disqualify him from being a director for between two and fifteen years. In fact these powers are used sparingly and the required level of proof is high.
The courts are sometimes criticised for not taking a tougher line, and there have been scandals concerning directors who have been involved with many failed companies.
If wrongful trading is proved, you may be able to set aside limited liability and make directors personally liable for debts. This is a separate matter from disqualification, and one does not necessarily follow from the other.
Again, the burden of proof is high, and it does not happen very often. |
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