An introduction to English insolvency procedures (and practical action to take)

What construction businesses need to know

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An introduction to English insolvency procedures (and practical action to take)

An introduction to English insolvency procedures (and practical action to take)

What construction businesses need to know

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October 29, 2020

The stringent regulations introduced to avoid the spread of the Coronavirus (COVID-19) pandemic caused widespread disruption across UK sites. The consequent commercial challenges were too great for some businesses − despite government measures to help those facing financial difficulty. Inevitably, insolvencies followed.

As we face a second lockdown, the outlook looks grim for others too. With some temporary COVID-19 measures (such as furloughing) likely to end soon, businesses must prepare for insolvency in their supply chains. Monitoring site activity and your trade partners for signs of distress is essential. Collaboration and early action to support those partners and protect your business is highly recommended.

In this briefing, we explain the most common formal restructuring and and insolvency processes in England:

Administration
Liquidation (or "winding-up")
Other processes

We also explain the following insolvency issues of interest to those dealing with a counterparty in an insolvency process:

Communication between the liquidator/administrator and creditors
How creditors claim against a counterparty in administration/liquidation
What is the pari passu principle and in what order are creditors paid?

Finally, we provide some practical action steps for those managing construction projects when one party is in financial difficulty.

Administration
Liquidation (or "winding-up")
Communication between the liquidator/administrator and creditors
What is the pari passu principle and in what order are creditors paid?
Other insolvency processes
Practical action for those managing construction projects when one party is insolvent

For an explanation of why insolvency and disputes proliferate in the construction industry during times of economic downturn, see Monitoring your supply chain for signs of insolvency: promote collaboration and keep projects on track. This briefing includes a checklist listing the warning signs that a party might be insolvent.

Administration
What is administration?	Administration is the main formal rescue procedure in England and Wales. There are three ways to appoint an administrator, namely: the company, a creditor, court official or existing insolvency officeholder applies to the court for an administration order; or a holder of a "qualifying floating charge" appoints out of court (via electronic filing to the court); or the company itself or its directors appoint out of court (again, electronically).
The court has discretion to order an administration	The court always has a discretion as to whether to make an administration order. To do so, the court must be satisfied that "the company is, or is likely to become, unable to pay its debts" as defined in Section 123 of the Insolvency Act 1986 (the Act). The court must also be satisfied that the administration appointment is reasonably likely to achieve its purpose.
The three statutory objectives of administration	The statutory purposes of an administration are compulsory. Ranked in order of priority, they are: to rescue the company as a going concern; to achieve a better result for creditors as a whole compared to a liquidation; and to realise property to distribute to the company's secured or preferential creditors. These purposes are ranked in order of priority. Only if the administrator "thinks" the first purpose is not reasonably practicable will the second purpose of the administration apply and so on.
Key benefit: the moratorium	Once in administration, the company benefits from a "moratorium" immediately, either on the appointment of an administrator (whether in or out of court) or by way of interim moratorium when someone (1) applies to court for an administration order (but before the court makes the actual order) or (2) files a notice of intention to appoint an administrator out of court.
The effect of the moratorium	The administration moratorium gives the distressed company breathing space during which it is protected from its creditors in a number of crucial ways. Creditors cannot bring or continue legal proceedings against the company or its assets without the administrator's or court's permission. Shareholders cannot pass a winding-up resolution. Securities against the company cannot be enforced, nor can goods be repossessed. Winding-up petitions will either be dismissed or suspended. An administrator can also require a fixed charge receiver appointed by a secured creditor to leave office.
What does the administrator do?	An administrator will work out a plan for the company based on the statutory objectives – often to sell the business as a going concern if it cannot continue to trade – which is then put to the creditors for approval by a simple majority. If approved, the administrator will carry out the plan and then leave office. The administrator is not traditionally the one who pays out realisations to creditors (this tends to be a subsequent liquidator) but can do so. The administrator is an officer of the court and acts as the company's agent. An administrator can allow directors to exercise such management roles as appropriate but will usually take over control of the company. The administrator can also pay secured and preferential creditors and distribute to unsecured creditors with the court's permission.
Potentially … on to liquidation	Within 12 months (or longer if extended), and after the administrator has either achieved the administration's objectives or decided they are no longer achievable, the administrator will move the company into liquidation.
Note – if you are a creditor of a distressed company	You can end contracts but, if you breach a contract with the distressed company, it can still sue you. The moratorium often prevents you the creditor from enforcing your rights. If the company breaches or fails to perform its contractual obligations, you cannot sue.

Liquidation (or "winding-up")
What is the effect of a liquidation?	A traditional liquidation or "winding-up" usually ends a company's existence. A liquidation can last years and ends in the company's dissolution. A company in liquidation continues to exist: it does not end until the liquidator dissolves it.
What happens in liquidation?	The liquidator: gathers in the company's assets; calculates its liabilities; unwinds any objectionable transactions according to insolvency laws; reports on the conduct of the relevant officers; divides the assets among the creditors according to the set priority laid out in the Act; and, finally, dissolves the company.
What are the three types of liquidation?	A Members' Voluntary Liquidation (MVL) is a solvent liquidation (i.e. where the company is able to pay its debts). A Creditors' Voluntary Liquidation (CVL) is an insolvent liquidation: the company is unable to pay its debts within the meaning of Section 123 of the Act. It is started by the shareholders (not the creditors) who pass an extraordinary resolution to wind up the company and an ordinary resolution to appoint a liquidator. The directors must call a creditors' meeting within 14 days of the shareholders' meeting at which the creditors decide whether to approve the members' choice of the liquidator or substitute a liquidator of their own choice (hence the name "CVL"). In a Compulsory Liquidation, a creditor (usually) presents a petition to court to wind up the company. However, the company, its directors, the Secretary of State, a voluntary liquidator, an administrator or an administrative receiver may also petition. If satisfied the company is unable to pay its debts within the meaning of Section 123 of the Act, or it is just and equitable to do so, the court can make a compulsory winding-up order. The Official Receiver acts as liquidator until the creditors' first meeting.
What is the effect of a liquidation?	A liquidation effectively ends the company. The liquidator takes control and the directors' powers end. In addition: the court stays (i.e. pauses) all actions against the company in a compulsory liquidation and may stay actions against the company in an MVL or a CVL; there are limits on re-use of the company name; no one may enforce rights on goods, land or debt; employment contracts impliedly end (except on voluntary liquidation); other contracts usually end expressly on their terms; a liquidator can disclaim (i.e. end) any onerous contracts; and secured creditors can (and should) realise their security and usually prove as unsecured creditors for any balance.

Communication between the liquidator/administrator and creditors
Notices to creditors (and filing a proof of debt in the insolvency process)	The liquidator/administrator must inform the known creditors of the company that the insolvency procedure has started. Creditors will be required to give official notice of their claims against the company (the timing for which will depend on the particular process) – see how creditors make claims below. These notices (or "proofs of debt") decide a creditor's rights both to vote on certain aspects of the insolvency procedure and to be paid under the order of priority. An administrator must prepare proposals for the conduct of the administration within eight weeks of appointment and send them to all creditors whose claim and address is known. The creditors vote on the proposals at a creditors' meeting and the value of each creditor's vote is generally in proportion to the value of their claim.
How creditors make claims in an administration/liquidation	The procedure for a creditor to make a claim ("file a proof") is similar in administration and liquidation. Broadly speaking, any creditor wishing to take part in or be told of any later dividend should: notify the administrator/liquidator of their claim in writing; and specify the details of the documents proving the debt in the proof and may (but does not need to) enclose copies. The administrator/liquidator may require additional evidence, where necessary. A creditor does not need to file a proof but, if it does not do so before the first creditor's meeting, the opportunity to vote and influence the meeting's outcome will be lost. A proof can be filed later. If the company moves from administration to liquidation, proofs will be passed to the liquidator – a creditor who has filed a proof in the administration does not need to file a proof in the liquidation. If the creditor did not file a proof in any prior administration, it will need to file a proof in the liquidation.
Creditors' rights	If an administrator or liquidator rejects a proof in whole or in part, he/she must give reasons for the decision to the creditor. The creditor can then apply to the court to reverse or vary the decision.

What is the pari passu principle and in what order are creditors paid?
What is the pari passu principle?	An administrator/liquidator should divide the net assets of an insolvent entity equally among each class of creditors in proportion to the value of their claims (the pari passu insolvency principle). This principle can override contractual terms providing otherwise. Mandatory and statutory insolvency set-off rules provide that an administrator/liquidator must take an account of mutual credits, mutual debts or other mutual dealings between the company and any creditor in the administration/liquidation. The set-off rules are complex and the outcome will depend on the particular facts. For an assessment of the effect of these rules on you, and what is or may become payable, speak to one of the Key Contacts.
In what order of priority will creditors be paid?	The pari passu principle and mandatory insolvency set-off applies within classes of creditors. However, between classes of creditors, there is a defined order of payment known as the "waterfall". Where an administrator/liquidator distributes the assets, payments will generally be made in the following order: those owed insolvency procedure expenses (including the insolvency officeholder's pay); holders of fixed charges; preferential creditors (including employees for certain benefits and wages); unsecured creditors up to a maximum of £800,000 (on prescribed assets only); floating charge holders; unsecured creditors; and, lastly, shareholders.

What is the pari passu principle and in what order are creditors paid?

What is the pari passu principle?

An administrator/liquidator should divide the net assets of an insolvent entity equally among each class of creditors in proportion to the value of their claims (the pari passu insolvency principle). This principle can override contractual terms providing otherwise.

Mandatory and statutory insolvency set-off rules provide that an administrator/liquidator must take an account of mutual credits, mutual debts or other mutual dealings between the company and any creditor in the administration/liquidation.

The set-off rules are complex and the outcome will depend on the particular facts. For an assessment of the effect of these rules on you, and what is or may become payable, speak to one of the Key Contacts.

In what order of priority will creditors be paid?

The pari passu principle and mandatory insolvency set-off applies within classes of creditors. However, between classes of creditors, there is a defined order of payment known as the "waterfall".
Where an administrator/liquidator distributes the assets, payments will generally be made in the following order: those owed insolvency procedure expenses (including the insolvency officeholder's pay); holders of fixed charges; preferential creditors (including employees for certain benefits and wages); unsecured creditors up to a maximum of £800,000 (on prescribed assets only); floating charge holders; unsecured creditors; and, lastly, shareholders.

Other insolvency processes
Other processes	As well as any consensual and informal/contractual restructuring and compromise arrangements that a company may agree with its creditors, a company can propose a scheme of arrangement or Company Voluntary Arrangements by appointing an insolvency professional to oversee a compromise with its creditors. These are still relatively formal processes (governed by statute or sanctioned by the court), but are usually started by the company itself. A company may also take advantage of a new standalone moratorium procedure if it meets certain criteria. For more information on these processes, please contact one of the Key Contacts.

Other insolvency processes

Other processes

As well as any consensual and informal/contractual restructuring and compromise arrangements that a company may agree with its creditors, a company can propose a scheme of arrangement or Company Voluntary Arrangements by appointing an insolvency professional to oversee a compromise with its creditors. These are still relatively formal processes (governed by statute or sanctioned by the court), but are usually started by the company itself. A company may also take advantage of a new standalone moratorium procedure if it meets certain criteria.
For more information on these processes, please contact one of the Key Contacts.

Practical action for those managing construction projects when one party is insolvent
Monitor	Collate as much information as you can from and about the distressed business on the issues they face. Are they eligible for any government support?
Manage	Review your contracts: check the terms closely. What can you do now? Can you terminate? (Is it prudent to do so? Termination could lead to a number of consequences. Seek legal advice before acting.)
Mitigate	Plan for the worst. If the distressed business fails, do you have a replacement lined up? How quickly can you get them signed up? Have you assessed the costs? Continue to monitor the solvency of the current business but take prompt action if an insolvency appointment is made. The earlier you take action, the better the chances of avoiding disruption, keeping costs to a minimum and the project programme on track.