Quick guide to corporate insolvency

Over the past six months stories about retailers and businesses "going into liquidation," "calling in receivers", "going into administration", and "going under" have been all over the newspapers, but many readers may be wondering what these terms actually mean.

Since 2002 the government has been promoting a 'rescue culture' following the introduction of new insolvency laws which ease the rescuing and restructuring of struggling businesses to improve recovery rates. Previously, businesses were, more often than not, automatically closed down and their assets sold off to pay creditors.

The insolvency laws are intended to ensure directors of insolvent businesses are dealt with appropriately and that both debtors and creditors requirements are met.

A company is officially insolvent if its cash flow dries up and it cannot pay its debts when they are due, or if its balance sheet shows that its assets are less than its liabilities.

Once a company has been declared insolvent there are several options:

1. Administration can help an insolvent company that has a saleable business. The initial stage of administration involves a period of statutory moratorium, during which creditors cannot take action against the firm and administrators can attempt to restructure the business or create a way to more efficiently sell the company's assets.

Administrators have a legal obligation to try to promote and sell the firm or any parts that are worth saving, as a going concern. Failing this, the administrator must establish the best realisation of the firm's assets to ensure they are worth more to creditors than if the company was in liquidation.

If this is not possible, the administrator should make sure any assets that can be recovered go towards paying the most secured, preferential creditors.

2. The next option, which applies to companies that have no chance of being sold as a going concern, is liquidation or 'winding up.' Shareholders usually appoint a liquidator, in the case of a creditor's voluntary liquidation, to take care of the firm's assets and distribute them to the creditors. However, creditors may sometimes go through the courts to force the company to 'wind up.'

3. Not strictly an insolvency procedure, but still worth mentioning is administrative receivership. Although they are becoming less common, administrative receivers are useful to insolvent firms that hold floating charges dated before 15 September 2003. The administrative receiver, acting for the holder of the charges, looks to realise assets and pay off the debts. He doesn't attempt to rescue or restructuring the insolvent company.

4. Finally, a company voluntary arrangement (CVA), or scheme of arrangement can be used alongside other insolvency procedures, such as administration. CVAs involve arrangements being made between administrators and creditors, based on proposals made by the creditors. However, schemes of arrangement are often more complex and therefore, they must go through the courts.

There are no restrictions on directors of insolvent firms being taken on as directors of new firms unless they have become bankrupt or have been subject to disqualification orders. However, it is important that the name of the firm that has gone into liquidation is not used in a new company, and directors must not be involved with firms with the same name for five years after the company in question has gone into liquidation.

Finally, it is important that people involved with an insolvent business seek advice as soon as possible to minimise damage to the business and to limit the personal impact on the directors.

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