Business organisations and procedures - Insolvency (corporat...

Learning Outcomes

This article explains corporate and personal insolvency law and practice in England and Wales, including:

• the key statutory insolvency procedures for individuals, companies and LLPs, and when each is appropriate
• the distinction between corporate and personal insolvency and their differing legal and practical consequences for stakeholders
• the statutory tests and evidential routes for establishing insolvency, and how these underpin bankruptcy and winding-up petitions
• how moratoria, administration, CVAs, IVAs, DROs and restructuring tools operate in practice to rescue or orderly wind down debtors
• creditor rights and priorities in bankruptcy and liquidation, including the statutory distribution “waterfall” and the prescribed part
• the identification, analysis and potential challenge of antecedent transactions, such as preferences, transactions at an undervalue, extortionate credit and avoidance of certain floating charges
• the roles and powers of insolvency practitioners in realising assets, staying enforcement and maximising creditor returns
• circumstances giving rise to directors’ and partners’ personal liability, including wrongful and fraudulent trading exposure, misfeasance, and potential disqualification

SQE2 Syllabus

For SQE2, you are required to understand insolvency procedures from a practical and legal standpoint, with a focus on the following syllabus points:

• 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
• statutory insolvency tests (cash-flow and balance-sheet), statutory demands and petition thresholds
• moratoria (standalone and as part of administration/CVA) and the restructuring plan (Part 26A Companies Act 2006)
• supplier termination (ipso facto) restrictions under CIGA 2020 and practical consequences

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.

1. What is a ‘preference’ in insolvency law, and in what circumstances can a preference be set aside?
2. In a creditors’ voluntary liquidation, how are the company’s remaining funds distributed among creditors?
3. What key practical differences exist between bankruptcy of an individual and company liquidation?
4. 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. Expect to identify the most appropriate procedure, manage the immediate effects (such as stays on enforcement and ipso facto issues), and apply look-back rules to recover value for creditors.

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. Two statutory tests are central for companies: the cash-flow test (inability to pay debts as they fall due) and the balance-sheet test (liabilities, including contingent and prospective, exceeding assets). A creditor owed over £750 can also evidence a company’s inability to pay by statutory demand not met within 21 days or by unsatisfied execution of a judgment. For individuals, a creditor’s petition requires a debt of at least £5,000.

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.

When insolvency is probable or has occurred, directors’ duties shift to prioritise creditor interests, enforcement action may be stayed (in moratoria, administration and on bankruptcy), and insolvency practitioners gain powers to realise assets and undo suspect transactions to maximise creditor returns.

Personal Insolvency Procedures

Bankruptcy

Bankruptcy is the statutory process whereby an individual’s assets (the bankruptcy estate) vest in a trustee in bankruptcy, who realises and distributes proceeds to creditors in a prescribed order. Bankruptcy can be initiated by a debtor (online application to the Adjudicator) or by a creditor owed at least £5,000 who proves insolvency (typically by statutory demand or an unpaid judgment). Most bankrupts are automatically discharged after one year, but income contributions may continue for up to three years where appropriate.

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.

Key practical points:

• Proceedings and enforcement against the bankrupt are generally stayed; unsecured claims must be proved in the bankruptcy.
• The trustee may disclaim onerous property (e.g., leases) and challenge antecedent transactions to swell the estate.
• Certain debts are not released on discharge (e.g., most student loans, fines, some family law orders).
• The family home: the trustee has three years from the bankruptcy to deal with the bankrupt’s interest; if not, it will usually re-vest in the bankrupt (subject to exceptions).
• Income Payments Agreements/Orders can require surplus income contributions for up to three years post-bankruptcy.
• Misconduct can lead to Bankruptcy Restrictions Orders/Undertakings (BRO/BRU), extending restrictions for up to 15 years.

Individual Voluntary Arrangement (IVA)

An IVA is a binding arrangement supervised by an insolvency practitioner (the nominee then supervisor) under which an individual’s creditors accept a compromise—often reduced, staged repayments over several years. It avoids many restrictions of bankruptcy and helps preserve key assets (such as a home), but 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.

Approval requires 75% by value of creditors voting; if approved, it binds all unsecured creditors entitled to vote. The IVA can provide for variations and failure usually exposes the debtor to bankruptcy. IVAs commonly include windfall and equity-release provisions (e.g., remortgage at the end of the term if feasible).

Key Term: Debt Relief Order (DRO)
A low-cost, administrative alternative to bankruptcy for individuals with low income, low assets and debts under a statutory cap, giving a 12‑month moratorium after which qualifying debts are written off if circumstances have not improved.

DROs suit “no asset, no income” cases. They are available only where strict eligibility criteria are met and are administered by an approved intermediary; they impose restrictions similar to bankruptcy during the 12-month period.

Effects of Personal Insolvency

Bankrupts may lose their home and other non‑exempt assets (tools of trade and basic domestic needs are generally exempt), face restrictions on obtaining credit, acting as a company director, or managing a business, and may be subject to income contribution orders/agreements for up to three years. Pensions are usually protected where approved and not excessively funded. The Debt Respite Scheme (“breathing space”) can temporarily pause certain creditor enforcement outside of a formal insolvency.

Distribution of Assets in Bankruptcy

On bankruptcy, secured creditors are paid from their security first; the estate (unsecured asset pool) is distributed broadly as follows: (1) expenses of the bankruptcy (including the trustee’s remuneration and costs), (2) preferential debts (notably certain employee entitlements and some HMRC claims), (3) ordinary unsecured creditors rateably, and (4) postponed creditors (such as certain family debts). Interest on proved debts and any residual categories follow only if there is a surplus (rare).

Corporate Insolvency Procedures

Corporate insolvency procedures differ from those for individuals due to companies and LLPs having separate legal personality and limited liability. Directors manage entry into most procedures and must consider creditor interests once insolvency is likely.

Corporate Voluntary Arrangement (CVA)

A CVA is a company-wide compromise with unsecured creditors supervised by an insolvency practitioner. It can restructure debt, compromise arrears (including rent), and preserve the business.

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.

Voting: 75% by value of creditors voting must approve. There is an additional safeguard: a majority (by value) of unconnected creditors must not vote against the proposal. A CVA does not bind secured or preferential creditors without their consent. Small companies may access a moratorium in support of a CVA. Breach or failure typically leads to administration or liquidation.

Administration

Administration is used to rescue a company or achieve a better result for creditors than immediate liquidation. An administrator (licensed insolvency practitioner) takes control and benefits from a comprehensive moratorium, preventing most creditor enforcement.

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.

Key features:

• Objectives (in order of priority): (1) rescue the company as a going concern; failing that, (2) achieve a better result for creditors as a whole than in winding up; failing that, (3) realise property to make a distribution to secured or preferential creditors.
• Appointment: by court order or out‑of‑court by the company/directors or a qualifying floating charge holder.
• Effects: a moratorium stops most enforcement (including landlord action, security enforcement and legal proceedings) without consent of the administrator or the court.
• Outcomes: sale of the business (sometimes “pre‑pack”), CVA proposal, or exit to liquidation/dissolution if rescue is not viable.

Receivership

A receiver may be appointed by a secured creditor to enforce security. Two principal forms exist:

• Fixed charge (LPA) receivership: a receiver is appointed over specific assets to collect income or sell to repay the secured debt.
• Administrative receivership: appointment under a floating charge over substantially all assets (largely abolished for charges created after 15 September 2003; older security may still permit it).

Liquidation

Liquidation (winding up) 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.

Practical points:

• Compulsory liquidation often follows a creditor’s winding-up petition (supported by a statutory demand of at least £750 unpaid after 21 days, or an unsatisfied judgment).
• In CVL, shareholders resolve to wind up; creditors nominate the liquidator and supervise. If a declared MVL proves insolvent, it converts into a CVL.
• The liquidator may carry on the business temporarily to facilitate an orderly sale, disclaim onerous property (e.g., leases), investigate conduct, and challenge antecedent transactions.

Key Term: moratorium
A time-limited statutory breathing space during which most creditor enforcement and insolvency proceedings are stayed to facilitate rescue or restructuring. Available as a standalone procedure (Part A1 IA 1986) or as part of administration and some CVAs.

Standalone moratorium essentials: initial 20 business days, extendable by a further 20 business days by directors, and longer with creditor consent or the court. A monitor oversees the company, and directors remain in control.

Creditor Priorities and Clawback of Transactions

Understanding how recoveries are shared is essential both for advising stakeholders and for evaluating whether to pursue antecedent transaction claims.

The order of payment, referred to as the ‘waterfall’, in most liquidations is:

1. Costs and expenses of the liquidation (including the liquidator’s remuneration)
2. Preferential creditors (including certain employee claims and HMRC secondary preferential debts)
3. Ring‑fenced “prescribed part” carved out of floating charge realisations for unsecured creditors
4. Floating charge holders (to the extent not captured by the prescribed part)
5. Unsecured creditors (pari passu)
6. Statutory interest on proved debts (if surplus)
7. Shareholders (any residual surplus)

Fixed charge holders are generally paid from their collateral outside the estate before this waterfall applies.

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.

Key Term: prescribed part
A statutory ring‑fenced fund taken from net floating charge realisations for the benefit of unsecured creditors (currently subject to a cap, increased to £800,000 for relevant charges), calculated by formula.

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. Look-back periods, insolvency conditions and intention tests vary by remedy:

• Transactions at an undervalue (typically within 2 years pre-insolvency): gifts or transactions for significantly less than value, when the company was insolvent or became so as a result.
• Preferences (within 6 months for unconnected persons; 2 years for connected persons): acts putting a creditor in a better position on insolvency, requiring a “desire to prefer” (presumed for connected parties), plus insolvency condition.
• Extortionate credit transactions (look‑back typically 3 years): grossly exorbitant terms or unfairly oppressive to the debtor.
• Avoidance of certain floating charges: a floating charge created within 12 months (unconnected) or 2 years (connected) before insolvency is invalid to the extent it secures past indebtedness unless “new money” was provided; an insolvency test applies except for connected parties.
• Transactions defrauding creditors: a broader remedy where the purpose was to put assets beyond the reach of creditors or otherwise prejudice them; no formal insolvency or look-back limit but a purpose test applies.
• Dispositions after presentation of a winding‑up petition: dispositions of company property between petition and order are generally void unless validated by the court.

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.

In personal insolvency, similar concepts apply (e.g., transactions at undervalue and preferences) with tailored tests and timeframes.

Directors’ and Partners’ Personal Liability

Directors (and LLP members in some circumstances) risk personal liability for company debts if they allow wrongful or fraudulent trading, misapply company assets, or are found unfit under the disqualification regime. Liability can also follow for breaches of fiduciary and statutory duties in a misfeasance claim.

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 Term: misfeasance
A summary remedy against directors and others for breach of duty, misapplication of company property, or other misconduct in relation to the company (often pursued under s.212 IA 1986).

Additional practical exposures include restrictions on re‑use of a prohibited company name after insolvent liquidation and possible compensation orders post‑disqualification.

Ipso facto protections: suppliers are generally prevented from terminating supply or making insolvency an event of default once a company enters a relevant insolvency procedure; suppliers can seek relief for hardship, and payment of pre‑insolvency arrears cannot be made a condition of continued supply.

Key Steps in Corporate Insolvency Procedures

1. Negotiation/Informal Workout: Parties may first seek voluntary agreements to reschedule debt or accept part‑payment.
2. Formal Procedures Initiated:
   • For individuals: IVA, DRO, or bankruptcy.
   • For companies/LLPs: CVA, administration, receivership (limited circumstances), liquidation, or a restructuring plan/scheme of arrangement.
3. Appointment of Insolvency Practitioner: Required for all formal procedures (as nominee/supervisor, administrator, or liquidator).
4. Moratorium and Stabilisation (where available): Enforcement stays to create breathing space for rescue/restructuring.
5. Asset Realisation and Distribution: Assets are liquidated and paid out according to statutory priority rules, including any prescribed part.
6. Investigation and Potential Clawback: Review of transactions with possible reversal of preferences, undervalues, extortionate credit and avoidance of certain floating charges.
7. Conclusion: For companies/LLPs, dissolution or return to solvency; for individuals, discharge from bankruptcy and lifting of restrictions (subject to any BRO/BRU).

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, to the extent the charge secures past indebtedness. A floating charge granted within the vulnerability period is invalid except to the extent of “new money” given at or after its creation. The look‑back is 12 months for an unconnected lender and 2 years for a connected person (such as a director). Here, the director is connected and the company was insolvent, so the floating charge will be set aside except for any fresh value advanced at the time.

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 (threshold £5,000). 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.

Worked Example 1.3

A company pays off a director’s relative (an unsecured lender) in full two months before liquidation. At the time, the company was balance‑sheet insolvent and other unsecured creditors remained unpaid. Can the liquidator challenge the payment?

Answer:
Yes, as a potential preference. Payment within two years to a connected creditor that puts them in a better position on insolvency is challengeable if the company was insolvent (or became so as a result). A “desire to prefer” is presumed for connected parties. If established, the court can order repayment.

Worked Example 1.4

In a CVL, the liquidator realises assets: £500,000 from assets subject to a fixed charge, £1,200,000 from assets subject to a floating charge, and £300,000 of unencumbered assets. How are these sums broadly applied?

Answer:
Fixed charge proceeds go to the fixed charge holder (after any costs of realisation of those assets). From net floating charge realisations, a prescribed part is carved out for unsecured creditors (up to the statutory cap), with the balance paid to the floating charge holder. Unencumbered assets form the free estate for expenses, preferential creditors (employees and HMRC to the extent preferential), and then unsecured creditors rateably (supplemented by the prescribed part).

Worked Example 1.5

A bankrupt’s family home has equity and was not dealt with by the trustee for three years after the bankruptcy. What is the likely position?

Answer:
In most cases the bankrupt’s interest in the family home re‑vests automatically in the bankrupt after three years if not realised, charged, or otherwise dealt with by the trustee (subject to exceptions, e.g., if proceedings are issued or there is equity of exoneration/complexities). The trustee will usually lose the ability to realise the equity after that point.

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; statutory tests for corporate insolvency
• core roles of insolvency practitioners, administrators, and liquidators, and the effect of moratoria
• procedures for and consequences of CVAs, IVAs, administration, receivership, and liquidation
• order of priority for distributing assets in bankruptcy and liquidation, including the prescribed part
• supplier termination (ipso facto) restrictions and the practical impact on trading through insolvency
• director (or partner/LLP member) personal liability for wrongful or fraudulent trading, misfeasance, and prohibited name re‑use
• clawback of preferences, transactions at undervalue, extortionate credit, avoidance of certain floating charges, and void dispositions post‑petition, with key time periods and legal criteria
• effects of insolvency on contracts, employees, and key stakeholder rights
• DROs, IVAs and bankruptcy: thresholds, effects, and typical outcomes for individuals

Key Terms and Concepts

• insolvency
• bankruptcy
• Individual Voluntary Arrangement (IVA)
• Debt Relief Order (DRO)
• Company Voluntary Arrangement (CVA)
• administration
• moratorium
• liquidation
• floating charge
• preferential creditor
• prescribed part
• preference
• transaction at an undervalue
• wrongful trading
• fraudulent trading
• misfeasance
• disqualification