The Creditors Guide to Insolvency

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During the recent worldwide financial instability a number of our customers have found themselves to be a creditor of an insolvent entity, i.e. owed money by a company in liquidation or receivership. Many of these customers have approached us for support and advice and to ask what can be done to mitigate their losses. This short guide is intended to answer the most important questions that a creditor of an insolvent company has: Will I get the money I am owed? To answer this question first we need to understand exactly what is meant by the term insolvency. What is Insolvency? The dictionary definition of insolvency is When a company can no longer meet its debt obligations with another firm or institution. This deceptively simple statement can have a devastating effect for a creditor. There are a number of different types of insolvency, broadly speaking these are divided into two types dependent on the type of business involved: Individuals and partnerships Limited liability organisations

Individuals and Partnerships

There are three main insolvency types for this sector. These are: Bankruptcy Individual voluntary arrangement (IVA) Informal debt management plan. Bankruptcy Most applications for bankruptcy are instigated by the debtor, this will take the form of a petition on the grounds that the debtor is unable to clear their liabilities. Alternatively a creditor may issue a written demand for payment (a statutory demand) and then make an application to the court to begin bankruptcy proceedings. If the proceedings are defended a hearing will take place, and dependent on the outcome the court may adjudge the individual bankrupt. Bankruptcy proceedings can not be instigated for an amount less than 750.00 excluding interest. Instigating bankruptcy proceedings to recover outstanding funds is generally not recommended as they can be both expensive and time consuming. Once bankruptcy has been confirmed by the court, the official receiver becomes receiver of all the debtors assets. Subsequently, the official receiver will undertake an investigation to gain an understanding of the reasons for the insolvency. A statement of affairs is then created

and distributed to the creditors. Normally within 12 weeks of the bankruptcy order, a meeting of creditors is called. However, this does not normally happen unless it is likely that a professional third party trustee will be appointed. It is the official receivers job to not only gain a full understanding of the reasons for the insolvency but also to realise the bankrupts assets so that a dividend can be paid to the creditors. Creditors will be expected to make a claim to the official receiver or licensed insolvency practitioner dealing with the bankruptcy, who will then investigate your claim and if agreed it will then theoretically rank for a dividend to be paid at the end of the insolvency. The level of this dividend paid is calculated after deduction of costs incurred by the insolvency practitioner or official receiver along with any secured of preferential creditors claims. In practice however, the amount of funds remaining after costs and secured payments have been cleared often mean that no dividend will be paid. Individual Voluntary Arrangement One of the insolvency practices that has grown rapidly during the recent credit crunch is the Individual Voluntary Arrangement or IVA. Individuals entering into an IVA can potentially avoid bankruptcy, subject to the terms of the IVA being fully complied with. Initially, the debtor will approach an insolvency practitioner, who specialises in this process. An interim order will be applied for at the courts to protect the estate of the debtor, whilst the scheme proposal is being prepared. The proposal is then forwarded to the creditors, which covers: The reasons for the arrangement (why they cannot pay their debts). Details of all the debtors assets and what will happen to them. How the liabilities of the company will be dealt with, in particular preferential and secured creditors, along with details of any debts due to associates or the debtor. The duration of the arrangement (this is typically between 36 and 60 months). The name of the proposed insolvency practitioner who will be dealing with this matter (known as the supervisor). The remuneration of the supervisor. If the business is to continue trading and on what terms. For a voluntary arrangement to proceed a 75% majority of creditors must agree to the terms. A report should be sent out every 12 months to creditors and if the debtor fails to comply with the terms of the voluntary arrangement, the supervisor is at liberty to petition the courts for the bankruptcy of the debtor.

Informal Voluntary Arrangement This follows a similar format to a voluntary arrangement. However, it does not carry the protection of the court. Therefore, any creditor is at liberty to commence independent bankruptcy or regular court proceedings against the debtor, unless a written agreement exists to the contrary.

Limited Liability Organisations

There are a number of formal insolvency types for corporate bodies (limited, plc or LLP companies). The main ones are as follows:Compulsory Liquidation Creditors Voluntary Liquidation Members Voluntary Liquidation Receivership Administrative Receivership; Law Of Property Receivers Company/Corporate Voluntary Arrangement Administration Order Informal Schemes A limited liability company or limited liability partnership (limited, plc or LLP) can be subject to any of the above forms of insolvency. Compulsory Liquidation Compulsory Liquidation normal occurs after a creditor, a shareholder or stockholder, a director, the department of trade and industry, the official receiver or the Bank of England presents a petition to the courts for the compulsory winding up of the company. A petition by creditors is the most common type of petition. This is normally served and advertised and a date is subsequently set for a hearing. A petition by the department of trade and industry is normally presented because the company is conducting business contrary to the public interest. The official receiver may petition if it is not in the interest of creditors to continue with a voluntary liquidation. The Bank of England only gets involved with recognised banks or deposit taking institutions. A winding up order is subsequently made by the courts and the official receiver takes control of the company and the assets of the company. The official receiver will undertake an investigation of the trading activities of the company and its directors within 12 weeks. A meeting of creditors must be called and a report must be presented to creditors.

There is an opportunity for a creditors committee to be appointed to oversee the activities of the official receiver and any appointed liquidator. The insolvency practitioner is then responsible for the realisation of assets, agreeing creditors claims and distributing a dividend to creditors. Creditors Voluntary Liquidation This is normally as a result of the instructions of the directors of the company, where it is know that a company cannot meet its debts. The same procedure then follows as in company liquidation. Members Voluntary Liquidation This is a somewhat unusual process and the unique aspect of this type of liquidation is that the company is actually solvent during the liquidation. All the debts owing to the company must be paid in full. This process normally occurs when a third party buys the company for its business activities. Often the purchased company is absorbed within the purchasing company. Alternatively it is used where the company is to cease trading, perhaps due to the retirement of the director/shareholders of the company. Receiverships Administrative Receiverships Receiverships only normally only arise where there is a charge on the company assets (normally known as a debenture or floating charge) and there has been a breach in terms of the charge. The charge holder therefore appoints a receiver to liquidate the assets of the company to enable repayment of an outstanding loan or facility. The administrative receiver has the power to continue trading the business and will normally do so for a short period of time with a view of selling the business as a going concern, thus maximising the return to the charge holder. Subsequently, the receivers would file a notice of ceasing to act with the companys registrar and a liquidation proceedings often follow. Law of Property Receivers These receivers generally only have an interest in property. However, they have the power to evict a business currently operating within the property upon which the charge holder holds the charge. This will often cause the business to cease trading. Company Voluntary Arrangement (CVA) A company voluntary arrangement works in a very similar way to an IVA. A proposal is submitted to the companys creditors and on agreement of 75% of the creditors the CVA is issued. Providing the company honours the terms to the end of the arrangement, the

debts owing prior are forgiven. At the end of the CVA a dividend is normally payable to secured creditors and on occasion also to unsecured creditors. If the company defaults on the arrangement, provisions are in place for the supervisor of the arrangement to commence liquidation proceedings. Administration Order An administration order is normally granted where there may be an opportunity to rescue the company as a going concern, which may provide a better result to creditors than formal winding up proceedings. Occasionally arrangements can be put in place and the business can simply continue trading. Normally however, the business of the company would be sold to a third party as a going concern. The original company is then placed into liquidation The important thing about an administration order is that it offers a level of protection to the insolvent company which prevents any creditors commencing legal proceedings. Informal Schemes Insolvent companies can come to an arrangement with creditors without the protection of the courts. An insolvency practitioner or debt management company deals with this on behalf of the company and a proposal is put to the creditors that the debt will be paid off over a period of time. However, there is no provision for automatic liquidation proceedings to follow in default and there is no protection to the company to stop any aggrieved creditor commencing their own court or insolvency proceedings.

What can you do to mitigate your loss?

You should always: 1. Make a formal claim as a creditor, supporting your claim with copy invoices, contracts etc. If any funds remain this will ensure you receive a dividend. 2. Make any reservations of title claim to the liquidators or insolvency practitioner. If your terms of sale so provide for the return of your goods 3. Reclaim any VAT paid from HM Revenue and Customs 4. Consider attending the meeting of creditors. You have a right to do so as a creditor of the company. This will allow you to ask any uncomfortable or embarrassing questions to the directors of the company regarding the business failure.

What else can be done to help reduce your companys losses?

1. You should always read the report to creditors. Phoenix companies often take over the trading business of the failed company, it may be a further sales opportunity for your organisation, after satisfactory credit vetting of course.

2. There may well be an opportunity for you to buy stock or business equipment etc. Resulting out of the failure of your clients business, which may well save your company a considerable amount of money. 3. Consider the purchase of other assets of the business I.e. ongoing contracts or client lists etc. 4. Learn from the experience. The customer has gone bust and there is a significant possibility that you will not receive any monies from this debtor. Ask yourself the following questions: Could you have managed the situation more efficiently? Did you wait too long to begin recovery procedures? Can your business survive a further bad debt? Will the next time be the catalyst for your own company failure? If you have answered yes to any of the above questions, then it may be time to call in the professionals. Have you read about our in house consultancy & training services?