Learning Outcomes
After reading this article, you will be able to explain the key legal procedures and practical implications of insolvency for both businesses and individuals in England and Wales. You will understand different insolvency procedures, the concept of bankruptcy, creditor rights in winding up, the distinction between corporate and personal insolvency, and commonly examined statutory frameworks for SQE2.
SQE2 Syllabus
For SQE2, you are required to understand insolvency procedures from a practical and legal standpoint. Revision should focus on:
- the key statutory insolvency processes available for companies, LLPs, and individuals in financial distress
- differences between personal and corporate insolvency, including the legal and practical impact on stakeholders
- procedures for bankruptcies, individual voluntary arrangements (IVAs), corporate voluntary arrangements (CVAs), administration, receivership, and liquidation
- the prioritisation of creditor claims, role of insolvency practitioners, and clawback of transactions
- legal effects of insolvency on contracts, directors’ duties, and partner liability
- grounds and processes for challenging historic transactions (incl. preferences and undervalues)
- director and partner personal liability in relation to wrongful and fraudulent trading
Test Your Knowledge
Attempt these questions before reading this article. If you find some difficult or cannot remember the answers, remember to look more closely at that area during your revision.
- What is a ‘preference’ in insolvency law, and in what circumstances can a preference be set aside?
- In a creditors’ voluntary liquidation, how are the company’s remaining funds distributed among creditors?
- What key practical differences exist between bankruptcy of an individual and company liquidation?
- When might a director or partner be made personally liable for the debts of an insolvent business?
Introduction
For SQE2, a practical understanding of insolvency is important to advise both commercial and individual clients. You will often be tested on liabilities for insolvent individuals and entities, the consequences for directors and partners, and the procedural impact of different insolvency routes. Insolvency law directly affects the rights of all stakeholders when a business or person cannot pay their debts as they fall due.
Overview of Insolvency
Insolvency law governs what happens when a person or business cannot pay its debts. Procedures and consequences differ depending on whether the debtor is an individual, partnership, LLP, or company.
Key Term: insolvency
The inability of a person or business to pay their debts as they fall due, or a situation where liabilities exceed assets.
Personal Insolvency Procedures
Bankruptcy
Bankruptcy is the statutory process whereby an individual’s assets are realised by a trustee in bankruptcy, with the proceeds distributed to creditors in a prescribed order. Bankruptcy can be initiated by the debtor or a creditor owed over £5,000.
Key Term: bankruptcy
A statutory process in which an insolvent individual’s assets are taken and applied by a trustee to pay creditors in priority order, with the debtor usually released from most debts after one year.
Individual Voluntary Arrangement (IVA)
An IVA is a binding agreement between the individual and creditors supervised by an insolvency practitioner, typically involving reduced payments over a set period. It avoids the restrictions of bankruptcy and requires creditor approval.
Key Term: Individual Voluntary Arrangement (IVA)
A formal arrangement overseen by an insolvency practitioner under which an insolvent individual’s creditors accept a compromise on payment of debts.
Effects of Personal Insolvency
Bankrupts may lose home and other assets (except essential tools and household items), face restrictions on working in certain roles, and their income above a minimum can be subject to court-ordered payments to creditors.
Distribution of Assets in Bankruptcy
On bankruptcy, creditor claims are paid in the following order: (1) costs of bankruptcy, (2) preferential debts (such as certain employee wages and HMRC claims), (3) ordinary unsecured creditors, (4) postponed creditors (such as certain family members).
Corporate Insolvency Procedures
Corporate insolvency procedures differ from those for individuals due to companies and LLPs having separate legal personality and limited liability.
Corporate Voluntary Arrangement (CVA)
A CVA is a compromise reached between a company and its creditors, often involving reduced debt payments over time. It binds unsecured creditors if agreed by the requisite majority.
Key Term: Company Voluntary Arrangement (CVA)
A statutory procedure enabling an insolvent company to agree a binding compromise on debts with creditors, supervised by an insolvency practitioner.
Administration
Administration is used to rescue a company or achieve a better result than immediate liquidation for creditors. An administrator (licensed insolvency practitioner) takes control of the company and may run, reorganise, or sell it.
Key Term: administration
A statutory procedure in which an insolvency practitioner is appointed to manage a company with the aim of achieving a rescue or maximising returns to creditors.
Receivership
A receiver (often a bank’s agent) can be appointed by a secured creditor over particular assets, primarily to recover that creditor's debt.
Liquidation
Liquidation leads to a company’s assets being realised and distributed in a prescribed order, at the end of which the company is dissolved. There are three main liquidation routes:
- Compulsory liquidation (ordered by the court)
- Creditors’ voluntary liquidation (CVL—started by the company, but run by creditors)
- Members’ voluntary liquidation (MVL—started and run by a solvent company’s members)
Key Term: liquidation
The process by which a company’s assets are collected and distributed in a set order to creditors, followed by the company’s dissolution.
Creditor Priorities and Clawback of Transactions
The order of payment, referred to as the ‘waterfall’, in most liquidations is:
- Costs of the liquidation
- Preferential creditors (including certain employee claims and HMRC)
- Floating charge holders (after ring-fencing a statutory portion for unsecured creditors)
- Unsecured creditors
- Any surplus to shareholders
Key Term: floating charge
A security interest over a class of changing assets, such as stock or receivables, which becomes fixed on default or insolvency.Key Term: preferential creditor
A creditor with priority status (such as employees or HMRC for certain taxes) who is paid before unsecured creditors on insolvency.
Challenging Historic Transactions
An insolvency practitioner may seek to set aside particular transactions carried out before insolvency for the benefit of the general pool of creditors.
Key Term: preference
A transaction placing a creditor in a better position than others on insolvency, which may be set aside if done within the relevant statutory period and with the requisite intention.Key Term: transaction at an undervalue
A gift or sale for significantly less than the proper value, which may be voidable if entered into before insolvency and certain statutory criteria are met.
Directors’ and Partners’ Personal Liability
Directors (and LLP partners, in some circumstances) risk personal liability for company debts if they allow wrongful or fraudulent trading or if they are found unfit under specific statutory criteria.
Key Term: wrongful trading
Where directors continue trading when they knew or ought to have known there was no reasonable prospect of avoiding insolvent liquidation, unless they can show every step was taken to minimise creditor loss.Key Term: fraudulent trading
Conducting business with intent to defraud creditors or for any fraudulent purpose.Key Term: disqualification
A statutory order preventing a person from acting as a director or being involved in company management for a specified period due to misconduct or unfitness.
Key Steps in Corporate Insolvency Procedures
- Negotiation/Informal Workout: Parties may first seek voluntary agreements to reschedule debt or accept part-payment.
- Formal Procedures Initiated:
- For individuals: IVA or bankruptcy.
- For companies/LLPs: CVA, administration, receivership, liquidation.
- Appointment of Insolvency Practitioner: Required for all formal procedures.
- Asset Realisation and Distribution: Assets are liquidated and paid out according to statutory priority rules.
- Investigation and Potential Clawback: Review of transactions with possible reversal of preferences or undervalues.
- Conclusion: For companies/LLPs, dissolution; for individuals, discharge from bankruptcy/restrictions lifted.
Worked Example 1.1
A company grants a floating charge over its assets to a director for an old loan, 9 months before entering liquidation. The company was insolvent at the time of the charge. Can the director rely on this security in insolvency?
Answer:
No, the floating charge is void against the liquidator as it was granted within 12 months of insolvency for no new consideration to a connected person. The old debt is treated as unsecured.
Worked Example 1.2
An individual, Carl, owes £8,000 spread across three credit cards and cannot pay them. One creditor serves a statutory demand and Carl does not pay within 3 weeks. What legal process may occur and in what order will Carl’s assets be distributed?
Answer:
The creditor can petition for Carl’s bankruptcy. Carl’s non-exempt assets will vest in a trustee in bankruptcy and be applied: first to costs, then to any preferential creditors, and finally to the unsecured creditors (the credit card companies), who will likely receive only a proportion of what is owed.
Revision Tip
For SQE2, be alert to the differences in consequence and process between personal and corporate insolvency—use the technical language precisely and summarise priority rules, practical steps, and statutory time limits often examined.
Key Point Checklist
This article has covered the following key knowledge points:
- distinction between personal and corporate insolvency, with key processes and statutory frameworks
- definition and triggers for bankruptcy and liquidation
- core roles of insolvency practitioners, administrators, and liquidators
- procedures for and consequences of CVAs, IVAs, administration, receivership, and liquidation
- order of priority for distributing assets in bankruptcy and liquidation
- director (or partner) personal liability for wrongful, fraudulent trading, or unfit conduct
- clawback of preferences and transactions at undervalue, with key time periods and legal criteria
- effects of insolvency on contracts, employees, and key stakeholder rights
Key Terms and Concepts
- insolvency
- bankruptcy
- Individual Voluntary Arrangement (IVA)
- Company Voluntary Arrangement (CVA)
- administration
- liquidation
- floating charge
- preferential creditor
- preference
- transaction at an undervalue
- wrongful trading
- fraudulent trading
- disqualification