Navigating the Complexities of Insolvency Process: A Step-by-Step Guide to Protect the Rights of Unsecured Creditors

Introduction

Unsecured creditors often face significant uncertainty and potential financial losses when a company becomes insolvent. The lack of security over assets means they are at a higher risk of not recovering their debts. The financial impact can be severe, affecting cash flow and potentially threatening the creditor's own business operations. Without proper knowledge and action, unsecured creditors may recover little to nothing of what they are owed. At Zabulis Legal, we specialize in insolvency law and offer expert guidance to help unsecured creditors navigate this complex terrain.

Statutory Solvency Tests

Before company files for insolvency, there are usually signs, such as late payments, change in management behaviour, or demands to pay for services in advance, that may signal about problems at the debtor, that creditors should pay attention to. To determine if a company is insolvent in England, an unsecured creditor can consider several key indicators and steps, reflecting the broader principles of UK insolvency law. Here are the primary ways to check for insolvency:

Statutory Insolvency Tests: There are two main tests to determine if a company is insolvent:

• The Cash Flow Test: A company fails this test if it is unable to pay its debts as they fall due.

• The Balance Sheet Test: A company is insolvent under this test if its liabilities exceed its assets.

Therefore, creditors should review the company's latest financial statements for signs of insolvency, such as consistent losses, negative cash flows, and liabilities exceeding assets. A good risk management tool is to obtain a credit report from a reputable credit agency, or ask for trade references, and check if there are any winding up petitions against the company or court judgements that the company has failed to pay.

Corporate Insolvency Types

In England, insolvency can apply to both individuals and companies when they cannot pay their debts as they fall due. The legal framework for dealing with insolvency is primarily provided by the Insolvency Act 1986 and the Insolvency Rules 2016, along with subsequent amendments and legislation. There are several types of insolvency procedures, each designed to deal with different situations for companies:

Company Voluntary Arrangement (CVA): CVA is a binding agreement between a company and its creditors to allow the company to repay some or all of its debts over time, often at a reduced amount, while continuing to trade. CVA is initiated by the directors, a proposal is prepared with the help of insolvency practitioner (IP) acting as nominee. It needs 75% (by debt value) of the creditors approval to pass. If approved, the IP becomes the supervisor of the CVA, overseeing the company's adherence to the agreement.

Administration: This process aims to rescue the company as a going concern. An administrator is appointed by the company, its directors, creditors, or the court to run the company with the goal of repaying creditors as much as possible, either by restructuring, selling the business, or realizing company's assets. Once the company is in administration, there is a moratorium on legal processes against the company, providing breathing space.

Liquidation (or "winding up"): This is the process of closing a company and selling its assets to pay off debts. There are three types of liquidation:

• Compulsory Liquidation: Initiated by a court winding-up order after a creditor, a company or directors file a petition. The Official Receiver is initially appointed as the liquidator, who may then distribute assets or call in an IP to manage the process.

• Creditors' Voluntary Liquidation (CVL): Initiated by the company's directors after a vote by 75% approving shareholders when the company is insolvent and cannot pay its debts.

• Members' Voluntary Liquidation (MVL): Used when a company is solvent, but the directors wish to close it in an orderly manner.

Receivership is an insolvency process where a receiver is appointed by a secured creditor to take control of specific assets of a company. The aim is to recover the debt owed to the secured creditor. Receivership is less common under current insolvency laws but is still applicable in certain circumstances.

Creditor Ranking in Insolvency

In an insolvency scenario, creditors are ranked based on their claims' priority:

1. Secured Creditors: Those with fixed or floating charges over company assets.

2. Preferential Creditors: Employees owed wages and holiday pay, certain taxes.

3. Unsecured Creditors: Suppliers, contractors, and customers without secured claims.

4. Shareholders: Paid last if any assets remain.

The prescribed part is a portion of the company's net property set aside specifically for unsecured creditors in a liquidation. It aims to ensure that unsecured creditors receive some payment, even if they are not fully repaid. The amount set aside is calculated as follows:

• 50% of the first £10,000 of net property, plus

• 20% of the remainder, up to a maximum of £800,000 (£600,000 where floating charge was created before 6 April 2020.

This provision is crucial as it offers unsecured creditors some chance to recover a portion of their debts.

Step by Step Process for Unsecured Creditors

Unsecured creditors must act swiftly and knowledgeably to protect their rights, and can take the following action:

• Engage Expert Legal Assistance: Consult with insolvency law experts to navigate the process effectively.

• Understand Insolvency Tests: Recognize the signs of insolvency through cash flow and balance sheet tests.
  

• File a Proof of Debt - a document submitted by the creditor to the insolvency practitioner, detailing the amount owed, and providing proof. You can obtain the form from the insolvency practitioner, complete it with accurate information, and submit it within the deadline. You have to ensure that their claim is officially recognized in the insolvency proceedings.

• Engage with Insolvency Practitioner (IP) - if you are aware of any matters about the company or directors conduct, you should bring it to the attention of the IP

• Attend Creditors’ Meetings - Creditors' meetings provide a platform to discuss the insolvency process, vote on proposals, and ask questions. Unsecured creditors have the right to vote on proposals such as CVAs or the appointment of insolvency practitioners.
  

• Receive Dividends - After the insolvency practitioner has realized the company’s assets, unsecured creditors may receive dividends based on the prescribed part and the remaining funds, if any.

Action Changes Things

If you are an unsecured creditor facing a corporate insolvency, contact Zabulis Legal for expert advice. Our team can assist you in protecting your interests and ensuring you maximize your recovery. Book a consultation with us today at info@zabulislegal.com or schedule a meeting through our Calendly link. We are here to help you through every step of the insolvency process. At Zabulis Legal, we are dedicated to providing expert legal guidance in insolvency matters. Let us assist you in securing your rights and navigating the challenges of corporate insolvency.