“I have a great business with huge potential but I’m unable to pay my creditors and now realise I should consider insolvent restructuring”

Insolvent Business Rescue Procedures Explained

If you have concluded that your company is insolvent, and that you cannot avoid a formal insolvency procedure, this section explains your options for saving your business.

Whichever procedure you choose, you will need help from a turnaround or insolvency practitioner.

Fundamentally insolvency procedures are divided into those where the company survives (Company Voluntary Arrangements) and those where the company ceases to trade (Voluntary Liquidation or Compulsory Liquidation).

When a company is placed into Liquidation, sometimes the business is transferred to a new company that takes over trading. This is called a Phoenix.

There is another procedure (Administration) that acts as a gateway procedure to temporarily remove control of an insolvent company from its directors and transfer control to an insolvency practitioner as Administrator. The Administrator acts as an officer of the company to either save the company via a CVA, to save the business via a Phoenix or to close it down.

The primary concern that underpins formal UK insolvency procedures is the maximising of creditors’ interests. This means minimising their loss if the business continues to trade and maximising any payment to them.

Rescue using insolvency procedures

The procedures therefore can be used to save companies, or at least save businesses, but the primary concern when saving the company is one of future viability, one that is both profitable and has positive cash flow.

It may be that a company has a profitable core business if only it can be restructured and the debt issues are dealt with. Often such restructuring involves redundancies, closing factories and terminating contracts, all of which would normally require cash but become liabilities if not paid and therefore are often put off to avoid triggering insolvency.

It may be that a company has one bad debt due to a client going bust and as a consequence it cannot avoid formal insolvency.

The business and possibly the company in both of these examples can be saved if this is the wish of the directors and owners but the choice of procedure tends to be influenced by whoever is giving advice. Turnaround Practitioners tend to prefer Company Voluntary Arrangements because the company survives while Insolvency practitioners tend to prefer Phoenixes because they are not required to give consideration about the viability of the future business.

This section will help you understand the procedures and which one may suit you.

Call us for help with choosing the insolvency procedure that is right for your business

K2’s Business Doctors are all turnaround practitioners who have the requisite insolvency knowledge to assist you choose the right procedure

“I’ve heard I can save my company by setting up a CVA. Tell me more”

Company Voluntary Arrangement – CVA

A CVA (Company Voluntary Arrangement) is a powerful tool for dealing with the liabilities of a company by way of deferring payments as part of a new payment plan that is binding on all unsecured creditors so as to allow an insolvent company to continue to trade. In addition to a deferring payments, the plan can also compromise (write off) some or even most of the liabilities.

Approval of CVA

Approval of a CVA follows voting on CVA proposals by unsecured creditors. Approval must be given by at least seventy five percent of the unsecured creditors voting in favour of the CVA proposals. If directors or shareholders are voting because they have provided loans or deferred salary claims then a second vote is held which requires fifty percent of the non-connected party creditors to vote for the proposals.

Unsecured creditors are generally trade suppliers, utility suppliers, HM Revenue & Customs in respect of PAYE, VAT and Corporation Tax, Local Authorities, landlords in respect of arrears and lease termination claims, judgement creditors, unsecured lenders and the unsecured portion of employee claims and director loans and accrued salary.

Once approved the payment terms of the CVA are binding upon all unsecured creditors, including those who rejected it. However, approval of a CVA does not require a supplier to continue trading with the company so ongoing support from key suppliers is normally confirmed as part of preparation of the CVA proposals to ensure the future business is viable. It is normal that forecasts in the CVA proposals reflect a change of trading terms as most suppliers will demand pro-forma payments before supplying to a company in a CVA.

Preparation of CVA proposal

A CVA proposal is similar to a business plan with additional disclosure of information. It needs to include the reasons for the insolvency, the current situation, turnaround and restructuring plans, all of which must reassure creditors that the company is viable and will meet the proposed payment plan. A number of supporting schedules like forecasts will normally be included to support the proposals.

CVA proposals are normally prepared as a collaboration between directors and CVA specialist advisers with contributions from directors who know their business and advisers who have done lots of CVAs. Experience of CVAs should involve them having been successfully discharged, not just been approved as so many fail. CVA experience also needs to be current as creditors are becoming ever more demanding with some such as HMRC having criteria that must be met if their support is to be achieved.

Independent review

In addition to preparing CVA proposals, an independent report on the proposals is required to be prepared for creditors by an insolvency practitioner. Too often this report is prepared by the same firm that prepares the proposals which might raise questions about its independence.

For a CVA to be successful you need the following success factors:

“I want to save my business and have been advised to do a pre-pack, is this right for me?”

Pre-Pack

Essentially a Pre-Pack is a Phoenix, ie the same business but a new company.

The term ‘Pre-Pack’ refers to the pre-packaged Administration process. This involves the sale of the business and assets of an old, insolvent company by its Administrator to a new company. The shareholders and directors of the new company are often the same as those of the old, insolvent company, which is put into Administration.

The process is referred to as a Pre-Pack because all the work to prepare the business for sale is done prior to appointment of an Administrator, who executes the sale immediately after appointment.

Preparing for a Pre-Pack can take some time while assets are valued and negotiations with potential buyers take place. Essentially the business is put up for sale but the process may be kept confidential to avoid key stakeholders like clients, suppliers and employees defecting on the grounds that this would destroy value.

Often the only buyers who can make a realistic offer are the existing directors and shareholders who tend to control value through their knowledge of the business and relationships. The ability to control value means that directors and shareholders buy the business and assets for what might be considered as a derisory amount by creditors of the old company.

Pre-Packs in themselves are not a turnaround tool, they are purely a financial restructuring tool. Accordingly a lot of companies fail within a short time after emerging as a phoenix following a Pre-Pack. Pre-Packs don’t address the viability of the underlying business as they don’t change anything, they only remove liabilities.

Pre-Packs are not the easy route that many argue. TUPE is a crucial issue where employee rights are transferred with the business to the new company which if it needs to downsize is left with the cost of redundancies. The transfer also involves termination of finance and other agreements that need to be renegotiated by the new company, although this can be a benefit when old agreements were onerous or contracts are no longer required. Another factor to be considered is HMRC who have the right to demand a security deposit from the new company in respect of future VAT and PAYE obligations. While it is repaid, normally after 2 years, it still needs to be funded.

Insolvency practitioner perspective

While the advantages and disadvantages for directors and shareholders are clarified below, it makes sense to understand why this approach to saving a business has become the preferred process by most insolvency practitioners and the banks and finance providers whose interests they are looking after. The fees tend to be considerable as they involve: fees for preparation; fees for marketing the business and assets; fees for monitoring; fees for appointment as administrator; fees for the subsequent liquidation and fees for the many other professionals who are needed such as lawyers, valuers and agents. Finally Pre-Packs are quick with no residual obligations on the Administrator other than investigating the conduct of directors and dealing with creditors, and they are financially efficient with funds received early from the sale proceeds, and therefore available to pay fees and repay the banks.

Bank perceptive

Banks and finance companies like Pre-Packs since they are normally debenture holders and can therefore control the process through appointment of their own preferred insolvency practitioners. Where there are sufficient funds, banks and finance companies like Pre-Packs as they rank ahead of unsecured creditors and they can charge huge default, collection and recovery fees that were buried in the small print of the original loan/ facility agreement. Pre-Packs also allow the bank managers who deal with distressed companies to remove them from their portfolio of distressed clients.

Personal Guarantees

In spite of the banks preference for Pre-Packs, they can result in a shortfall which can leave directors exposed to paying the difference under a Personal Guarantee. The sale and purchase agreement between the Administrator, as seller, and the buyer allocates consideration between the fixed and floating charge assets. Since the Administrator’s fees are paid ahead of floating charge assets the bank as a fixed and floating charge holder can be left with a shortfall. Since the sale and purchase agreement is normally confidential between the Administrator and buyer, if the sale is to a third party then the first time a director is aware of his/ her Personal Guarantee being called in is when pursued by the bank.

Advantages of a Pre-Pack:

  • Writes off liabilities
  • Terminates unnecessary leases and onerous contracts – disclaim leases
  • Quick and efficient procedure
  • Business continues to trade – seamless transfer
  • Directors can remain in control if they buy the business
  • Saves jobs
  • No monitoring of ongoing business

Disadvantages of a Pre-Pack:

  • Needs funds to purchase business and assets
  • Needs working capital to trade ongoing business
  • May need to provide HMRC with a security deposit
  • TUPE liabilities pass to the buyer
  • Very poor return for unsecured creditors
  • Shareholders write off equity
  • Time consuming to negotiate and set-up new finance agreements for transferring assets on finance
  • Supplier credit tends to be restricted
  • No moratorium to provide protection from enforcement by creditors
  • Administration orders attract a degree of publicity
  • Pre-packs have had a certain amount of bad publicity due to perception of abuse
  • No fundamental change to underlying business

K2 believes that a company considering a Pre-Pack should:

  • Ensure that the Pre-Packed business is viable
  • Ensure that the Pre-Packed business can be funded and that those funding the business will be repaid within a reasonable time period
  • Compare the outcome of the Pre-Pack with a CVA and Liquidation
  • Ensure that you are not being overcharged for the business and assets
  • Cap the insolvency practitioner’s fees
  • Review any Personal Guarantees to Secured Creditors with a Fixed and Floating Charge
  • Ensure the allocation of consideration between their fixed and floating charges is correct – note only the realisation on Fixed Charge assets are paid directly to the Debenture Holder

We recommend that in all cases before a Pre-Pack is arranged a fundamental review of the business is undertaken. This should not in our opinion be carried out by the insolvency practitioner who is arranging the Pre-Pack. The old business has failed and you do not want to lose further money if you are buying it back via a Pre-Pack. It may be that you want only certain part of the business. Also an independent review of the business viability will help ensure you are not being forced to pay too much for the business.

Finally – if you have been advised to do a Pre-Pack, ask yourself “why? who benefits? how will newco be funded?

“My company can’t be saved. How do I close it down?”

Insolvent Liquidation

Closing down a company that is insolvent where the shareholders and directors don’t wish to continue trading, or where the business cannot be saved involves liquidating its assets for the benefit of creditors.

There are two procedures:
1. Voluntary Liquidation – Creditors Voluntary Liquidation
2. Compulsory Winding Up – follows a Winding Up Petition Hearing in the High Court

Both involve the directors handing over control of the company.

Creditors Voluntary Liquidation (CVL)

Creditors Voluntary Liquidation (CVL) involves the directors being proactive by voluntarily ceasing to trade the business and handing over control to a licensed insolvency practitioner who acts as liquidator to ensure the process is administered in a proper, legal manner for the benefit of creditors who appoint him/ her.

The process of appointing a liquidator is straight forward but requires notice to shareholders who must approve the liquidation and also to creditors who must approve the appointment of a liquidator, although he/ she is normally proposed by the directors.

The liquidator following appointment becomes responsible for the company and has a duty to realise its assets normally by selling them, terminate contracts, disclaim leases, agree creditor claims and distribute the proceeds to creditors after deducting his/ her fee. The final duty is to dissolve the company by having it struck off the register of companies at Companies House.

Investigation of Directors’ conduct

The liquidator also has a duty to investigate the conduct of the directors and file a report on their conduct with the Insolvency Service including recommendations about whether or not they should be disqualified as directors. They may also seek to increase their recovery of cash for creditors by pursuing directors for overdrawn director accounts, outstanding loans, inappropriate withdrawal of funds or assets sold at undervalue.

Preparation

Prior to appointing an insolvency practitioner we recommend that you ensure the books and records are up to date. You should ensure that all declared dividends were legal and any Directors Loan Account is correctly stated. Be aware that the Directors Loan Account will be investigated by the liquidator who will seek to recover any overdrawn amount.

If you want to save your business, consider alternative options such as a Company Voluntary Arrangement.

Advantages of CVL:

  • Offers a clean break to directors who hand over responsibility and control to an insolvency practitioner
  • Early and proactive Voluntary Liquidation by directors reduces risk of wrongful trading
  • Quick and efficient procedure

Disadvantages of a CVL:

  • Offers a clean break to directors who hand over responsibility and control to an insolvency practitioner
  • Early and proactive Voluntary Liquidation by directors reduces risk of wrongful trading
  • Quick and efficient procedure

If you want to close down your company and cease to trade, seek the advice of a licensed insolvency practitioner who can help you through the process

Compulsory Liquidation
Compulsory Liquidation follows an Order made in the High Court for Winding Up a company. The process of a Winding Up Petition is dealt with extensively in the Winding Up Petition section of this website but essentially follows a petition presented by a creditor.
The Winding Up Order effectively forces a company to close and transfers control to an Official Receiver who takes over responsibility for the company’s liquidation.
Directors facing a Winding Up Petition generally need an expert to deal with the petition and also to help decide what is best for the company given the scope for personal liability if they continue to trade.
Advantages of Compulsory Liquidation:

  • There are very few advantages for directors and shareholders other than it saves the cost of Voluntary Liquidation

Disadvantages of a Compulsory Liquidation:

  • Disadvantages of Voluntary Liquidation, plus:
  • There is an assumption that the directors have not behaved responsibly as they could have been pro-active and voluntarily liquidated the company prior to Winding Up by the Court.
  • Greater investigation of directors conduct and increased likelihood of disqualification and possible personal liability for wrongful trading
  • If you have an outstanding Winding Up Petition see this section in our website or call K2 immediately, we provide a 24 hours service for those with a winding up petition

“I’ve heard that you can liquidate a company and start it again, that can’t be true….can it?”

Phoenix

There are three types of Phoenix, a Pre-Liquidation Phoenix, a Post-Liquidation Phoenix and a Pre-pack Phoenix.

The term Phoenix refers to a company whose shareholders and directors are the same as those of the old, insolvent company.

Phoenixes are not turnaround tools, they are purely financial restructuring tools. Accordingly a lot of companies fail within a short time after emerging as a phoenix as they don’t address the viability of the underlying business and therefore they don’t change anything, they only remove liabilities.

Phoenixes are not the easy route that many argue. TUPE is a crucial issue where employee rights are transferred with the business to the new company which, if it needs to downsize, is left with the cost of redundancies. The transfer also involves termination of finance and other agreements that need to be renegotiated by the new company, although this can be a benefit when old agreements were onerous or contracts are no longer required. Another factor to be considered is HMRC which has the right to demand a security deposit from the new company in respect of future VAT and PAYE obligations. While it is repaid, normally after 2 years, it still needs to be funded.

Pre-pack Phoenixes are covered elsewhere so the rest of this page purely considers Liquidation Phoenixes.

The major issues with Liquidation Phoenixes relate to director liability, transactions at undervalue and market perception.

They are a particular issue for directors who may want to use the same or similar names as part of their trading the Phoenix company. Changing a name is also difficult to avoid with brand names and the extensive use of multi-media and website names. Such names are referred to a Restricted Names and their continued use post-insolvency is governed by insolvency legislation that applies to their continued use by directors who are likely to want to avoid personal liability. While directors will be advised they cannot use the same name for five years they will be referred to sections 216 and 217 of the Insolvency Act 1986, and the related Insolvency Rules (4.226-4.230) that set out the three exemptions whereby Restricted Names can be used.

Transactions at undervalue involve selling the assets too cheaply. The normal way to deal with this is for the company or liquidator to employ professional valuers and agents to value and sell the assets. The issues are those of temptation and perception. The temptation is for the directors to take a short cut and do the deal without professionals. The perception is that if the directors sell assets to themselves, they do so at a low price. Therefore any business and asset sale to the same directors or connected parties will be looked into during the investigation by the Liquidator or Official Receiver as part of his duty to look at directors’ conduct. Any transaction at undervalue can be subsequently set aside.

Market perception of Phoenixes is another area of concern. Although it may be legal for the same directors and shareholders to walk away from the liabilities of one company and set up a new one, and to continue trading the same business, many regard this as reprehensible and morally wrong. Such stories are popular with local and consumer press who, if not managed carefully, might be tipped off by unhappy creditors or disgruntled employees.

Advantages of a Liquidation Phoenix:

  • Writes off liabilities
  • Terminates unnecessary leases and onerous contracts – disclaim leases
  • Quick and efficient procedure
  • Business continues to trade – but may have to cease trading temporarily
  • Directors can pick up the business at low cost
  • Saves jobs
  • No monitoring of ongoing business
  • Disadvantages of a Liquidation Phoenix:
  • Needs funds to purchase business and assets
  • Needs working capital to trade ongoing business
  • May need to provide HMRC with a security deposit
  • TUPE liabilities pass to newco
  • Very poor return for unsecured creditors
  • Shareholders write off equity
  • Supplier credit tends to be restricted
  • Personal Liability when using a Restricted Name
  • Adverse publicity
  • Perception during investigation of directors’ conduct
  • No fundamental change to underlying business

K2 believes that a company considering a Phoenix should compare the outcomes with a CVA.

If you have been advised to do a Phoenix, ask yourself “why? who benefits? how will newco be funded? and finally who gets stuffed?