By Joanne Hue, Last updated: 2023-01-11 (originally published on 2022-01-21)
When a company becomes insolvent or faces financial difficulties, its business and assets will usually be controlled by an insolvency practitioner. It is often central to determine whether a company is insolvent, as consequences under insolvency law flow from that.
The Insolvency Act (IA), 1986 does not define insolvency itself but rather expresses the concept in the phrase “unable to pay its debts”. Under section 123 of the IA 1986, a company is deemed unable to pay its debts, if:
- It fails to comply with a demand for payment, in the prescribed form (a statutory demand) for a debt of over £750;
- It fails to satisfy enforcement of a judgement debt;
- The court is satisfied that the company is unable to pay its debts as they fall due (the cash flow test); or
- The court is satisfied that the liabilities of the company (including contingent and prospective liabilities) exceed the assets of the company (the balance sheet test).
If a company is ‘unable to pay its debts’ under any of the above tests, a creditor may petition for the company to be placed into compulsory liquidation. The same tests apply to determine whether administration proceedings can be commenced.
The IA 1986 provides four procedures for companies in financial difficulties, one of which is Administration.
What is company administration in the UK?
Administration orders were introduced for the first time by the Insolvency Act 1985. They were intended to be an alternative to immediate liquidation and to enable a company to achieve a more advantageous realization of its assets than would be obtained on liquidation. A petition for an administration would block winding-up petitions by other creditors (a moratorium). The problem was their cost and complexity, as the court had to be satisfied that the company was, or was likely to become, unable to pay its debts.
The Enterprise Act 2002 made significant changes to the administration procedure, enabling the appointment of an administrator, even without petitioning the court, thus making access to the procedure easier, faster and fairer. Those holding floating charges over some or all of the company’s property (e.g. a bank) can apply to appoint an administrator, as can the company itself or its directors.
In all cases, the administrator must provide an opinion stating that the statutory purpose of the administration, which is set out as a hierarchy of objectives in the IA 1986, is reasonably likely to be achieved.
What is the objective when a company goes into administration?
The main purpose and primary objective of the company administration is the survival of the company as a going concern. Only if this objective is not reasonably practicable, or does not produce the best result for the creditors, does the second objective apply.
The second objective is to achieve a better result for the creditors as a whole than would be likely if the company were wound up without first being in administration. An example of when the second objective might apply is where the company is in a position to continue trading until the business (or part of it) is sold as a going concern.
Only if the second objective is not reasonably practicable, and it does not unnecessarily harm the interest of the creditors as a whole, does the third objective of realizing the company’s property for the benefit of one or more secured or preferential creditors apply.
What happens when a company goes into administration?
The control of the company is passed to the administrator when the company goes into administration. The administrator must be a licensed insolvency practitioner. The administrator will notify creditors and Companies House of his appointment by writing to them. The notice of his appointment will also be published in the Gazette.
The main purpose of the administrator is to try to stop the company from being liquidated (wound up). If this is not possible then they will try to satisfy the creditors as much as possible from the company’s assets.
Within a period of 8 weeks of their appointment, they have to prepare and write a statement to the company’s creditors, employees and Companies House. Their statement must explain their plan they wish to undertake to repay debts, the current status of the company and their anticipated outcome. They must invite them to approve or amend the plans at a meeting.
What is the benefit of company administration?
One of the main benefits of the company administration is that the company is protected against any legal actions from creditors, including the issuing of a winding up petition by placing the moratorium around the company. This saves the company from any threats by the creditors during the administration period.
In addition to this, no steps may be taken to enforce security over the company’s property except with the consent of the administrator or the permission of the court. No distress may be levied against the company or its property and no right of forfeiture can be exercised by the landlord in relation to premises let to the company.
Who gets paid first when a company goes into administration?
When a company goes into administration, the money realized from the company’s assets is used to pay debts owed to the creditors. The debts are paid according to the priority set out for the creditors. An insolvent company is not in a position to pay full debts, therefore, debts are paid according to the priority. In such cases, some creditors will not be able to recover their full amount. However, the assets of the company will be realized to pay at least part payment of debt and liabilities.
The way an Insolvency practitioner must act to realize a company’s assets to pay debts and meet claims of the creditors is provided by IA 1986 and the Insolvency Rules. The creditors are divided into different classes and the creditors will be paid according to their order of priority. The right of priority claimants to receive payment is prior to anyone below them in the order of ranking.
How is asset distribution priority set in an insolvency?
As mentioned above, the creditors are paid according to their order of priority when the company goes into administration. Once the top ranked creditor is fully repaid then only the claim of the next creditor in the list will be addressed to get paid. It basically means that creditors are paid in a descending order of priority. This process is referred to as a pari passu distribution.
The priorities are set in the following ways:
- Top rank claimants: Those claimants who have a proprietary interest in the company’s assets and those creditors who hold fixed charges on the firm’s assets have a top rank in the order of priority. The creditors holding fixed value over the firm’s assets are entitled to recover their value from the proceeds of the company’s assets.
- Second rank claimants: are those who are owed expenses of the insolvent business estate. Before satisfying any other claims, these claimants are entitled to recover their expenses from the insolvent estate.
- Third rank claimants: are preferential creditors. Once second rank claimants are fully repaid then preferential creditors will be paid from the remaining company’s assets.
Some unsecured debts are also given a preferential treatment like debts such as payments towards state and occupational pension plans, staff wages and salaries for any work that employees had completed in four months prior to the insolvency and up to a maximum of £800 per staff member. Any staff whose contract has been terminated as a part of insolvency may be paid holiday pay if possible.
- Fourth rank claimants: are those who hold floating charges. Once all of the claims against the insolvent estate and the preferential debts have been settled, the remaining assets will be used to pay those having floating charges.
- Fifth rank claimants: are unsecured creditors. Once all other debts have been paid, if any assets are available then unsecured creditors will be paid out of it. Such creditors have no security over any of the assets of the insolvent company and hence, they have low priority. These creditors have to prove that the insolvent company owes debt to them.
- Sixth rank creditors: Where all the above claimants are paid, if anything remains will be divided between the shareholders.
Are directors obliged to act in a certain way when a company goes into administration?
The directors have certain legal obligations to fulfil when the company goes into administration. They have a duty of care that they act in the best interest of the creditors and must try to maximize the return to creditors. To ascertain this, they have to assess the situation, set objectives, collect information and make their decisions in a way which protects the interest of creditors.
How does administration come to an end?
The administration may come to an end in the following ways:
- automatically after one year – where more time is required to achieve the purpose of administration, this period may be extended with the agreement of the creditors or the permission of the court,
- by court order, where the purpose of administration can’t be achieved in the view of an administrator or where his appointment was made by the court, if he thinks the purpose of administration has been achieved;
- where the administrator was appointed out of court, if he thinks the purpose of administration has been achieved.
What happens when administration comes to an end?
When administration of company comes to an end or is concluded, the following ways may be used:
- Where CVA was agreed during the administration, it may continue according to the terms of CVA.
- the company may be dissolved if there are no funds for distribution to unsecured creditors.
- the company may go into liquidation
- the control of the company may be returned to its directors and management.
Who determines the administrator’s fee?
If there is a creditor’s committee, the administrator’s fee is determined by it, else it can be decided by the creditors or the court. There are certain factors which will be taken into consideration while determining the administrator’s fee and such factors like
- time spent by the administrator and his team,
- the complexity of the case,
- the effectiveness with which the administrator carries out his duties,
- the value and nature of the company’s assets and
- any other exceptional circumstances or responsibility handled by the administrator.
What’s the difference between administration and liquidation?
This question is generally asked whether Administration and Liquidation are the same. Both are entered into when the company is unable to pay its debts or the company’s liabilities are in excess of its total value of assets. These both are formal insolvency procedures, however, they are still different both in their objective and application:
When the company is entered into administration, its main objective is survival of the company whereas liquidation is used to realize the company’s assets before winding up the company.
Although both administration and liquidation are fundamentally different in their application and objectives, both are used to protect the company and limit its damage.