Corporate insolvency law governs what happens when a company cannot pay its debts. The Insolvency Act 1986 (IA 1986) provides the legal framework for various procedures to deal with insolvent companies, balancing the interests of creditors, employees, and the company itself.
A company is insolvent if it satisfies either of two tests:
[2013] UKSC 28
A company with long-dated liabilities argued it was not balance sheet insolvent as future assets might cover future liabilities.
The balance sheet test requires considering whether the company has reached "the point of no return" where it cannot meet future liabilities as they fall due.
Balance sheet insolvency is not purely mathematical - it requires assessment of whether future liabilities can realistically be met.
A company is deemed unable to pay its debts if a creditor owed £750 or more serves a statutory demand and it remains unpaid for 21 days (s.123(1)(a) IA 1986).
Remember: a company can be insolvent under one test but solvent under the other. Cash flow problems can exist even with positive net assets.
Administration is a procedure designed to rescue a company as a going concern, or if that is not possible, to achieve a better result for creditors than would be achieved in a liquidation.
A QFCH holds a floating charge over the whole or substantially the whole of the company's property. QFCHs have special rights including the ability to appoint an administrator out of court and to veto other appointments.
When a company enters administration, an automatic moratorium comes into effect under paragraph 43 of Schedule B1:
The moratorium gives the administrator "breathing space" to assess the company's position and formulate proposals for achieving the statutory purpose.
Liquidation is the process by which a company's existence is brought to an end. The company's assets are realised, its debts paid (so far as possible), and any surplus distributed to shareholders.
| Feature | MVL | CVL | Compulsory |
|---|---|---|---|
| Company Status | Solvent | Insolvent | Usually insolvent |
| Who Initiates | Shareholders | Shareholders | Court (on petition) |
| Declaration of Solvency | Required (s.89) | Not required | Not applicable |
| Who Appoints Liquidator | Shareholders | Creditors (final say) | Court/Official Receiver |
| Resolution Required | Special (75%) | Special (75%) | None (court order) |
| Creditor Involvement | Minimal | Significant | Significant |
For MVL, directors must make a statutory declaration that they have made a full inquiry into the company's affairs and believe the company will be able to pay its debts in full within 12 months. This must be made within 5 weeks before the resolution.
Making a false declaration of solvency without reasonable grounds is a criminal offence. If debts cannot be paid within 12 months, the liquidation converts to a CVL under s.95.
[1973] AC 360
A quasi-partnership company with three members. One was removed as director, excluding him from management despite his shareholding.
The court can wind up a company on just and equitable grounds where equitable considerations (mutual trust, participation rights) are breached, even without specific wrongdoing.
In quasi-partnership companies, the court looks beyond strict legal rights to underlying equitable expectations between members.
Wrongful trading makes directors personally liable if they allowed the company to continue trading when they knew or ought to have known there was no reasonable prospect of avoiding insolvent liquidation.
Directors are judged by the HIGHER of: (a) the general knowledge, skill and experience reasonably expected of someone in that role, AND (b) the actual knowledge, skill and experience that director has. A director cannot hide behind incompetence.
Under s.214(3), a director is not liable if they took every step with a view to minimising potential loss to creditors that they ought to have taken:
[1989] 5 BCC 569
Directors continued trading for 18 months after accounts showed the company was insolvent, hoping trade would improve.
Directors liable for wrongful trading. The "moment of truth" was when they should have concluded insolvent liquidation was unavoidable - continuing to trade beyond this point breached s.214.
The test is when directors KNEW or OUGHT to have concluded there was no reasonable prospect of avoiding insolvent liquidation.
Fraudulent trading applies where business is carried on with intent to defraud creditors or for any fraudulent purpose. It requires actual dishonesty - much harder to prove than wrongful trading.
| Feature | Wrongful Trading (s.214) | Fraudulent Trading (s.213) |
|---|---|---|
| Mental Element | Knew or ought to have known | Intent to defraud (dishonesty) |
| Who Can Be Liable | Directors only | Any person knowingly party |
| Standard of Proof | Civil (balance of probabilities) | Higher (closer to criminal) |
| Criminal Liability | No | Yes (s.993 CA 2006) |
| When Available | Only in insolvent liquidation | Liquidation (civil remedy) |
| Defence | Took steps to minimise loss | No dishonest intent |
[1933] Ch 786
Directors continued trading and incurring debts when the company was insolvent. The question was whether this amounted to fraud.
Fraudulent trading requires actual DISHONESTY - "real moral blame". Mere mismanagement, incompetence, or unreasonable optimism is not sufficient.
The high threshold of "intent to defraud" distinguishes fraudulent trading (s.213) from wrongful trading (s.214).
A liquidator or administrator can apply to set aside transactions where the company made a gift or entered into a transaction for significantly less than the value received.
"Connected persons" include directors, shadow directors, their associates (family members, partners), and companies under common control (s.249 IA 1986).
The court will not make an order if the transaction was: (1) entered into in good faith for the purpose of carrying on the company's business, AND (2) at the time there were reasonable grounds for believing it would benefit the company.
A preference occurs when a company puts a creditor in a better position than they would have been in on insolvent liquidation, and the company was influenced by a DESIRE to achieve that result.
[1990] BCC 78
An insolvent company granted a debenture to its bank after the bank threatened to withdraw its overdraft facility.
The debenture was NOT a preference. The company acted solely due to commercial pressure from the bank, not from any desire to prefer the bank over other creditors.
A preference requires the company to be "positively influenced" by a DESIRE to prefer. Commercial pressure negates this desire.
If a creditor threatens legal action or withdrawal of facilities and the company pays to continue trading, this is commercial pressure, not preference. The company acted to survive, not to prefer.
Floating charges created at a "relevant time" are invalid EXCEPT to the extent of new value (money paid, goods/services supplied) provided at or after the charge creation.
If a bank lends new money at the same time as taking a floating charge, the charge is valid to the extent of that new money, even if the company was insolvent.
| Claim Type | Connected Person | Unconnected Person | Additional Requirements |
|---|---|---|---|
| Transaction at Undervalue (s.238) | 2 years | 2 years | Insolvency presumed (connected) or must prove (unconnected) |
| Preference (s.239) | 2 years | 6 months | Desire to prefer presumed (connected) or must prove (unconnected) |
| Floating Charge (s.245) | 2 years | 12 months | No insolvency needed (connected) or must prove insolvency (unconnected) |
When a company is wound up, its assets are distributed according to a strict statutory order of priority:
A portion of floating charge realisations must be set aside for unsecured creditors: 50% of first £10,000, plus 20% of remainder, capped at £800,000.
Unsecured creditors share equally (pro rata) in available assets. If insufficient funds to pay all creditors in full, each receives the same percentage of their debt.
When a company approaches insolvency, directors' duties shift. Section 172(3) CA 2006 now codifies the common law rule that directors must consider creditor interests.
[1988] BCLC 250
A director caused an insolvent subsidiary to transfer funds to the parent company (also in difficulty) to reduce the parent's overdraft, prejudicing subsidiary creditors.
The director was liable to account to the subsidiary. When a company is insolvent, directors must have regard to CREDITORS' interests and cannot prefer group companies.
Directors' duties shift towards creditors when the company is insolvent or of doubtful solvency.
Directors of insolvent companies face multiple risks: wrongful trading (s.214), fraudulent trading (s.213), misfeasance (s.212), transactions at undervalue, preferences, and disqualification under CDDA 1986 (2-15 years ban).
Directors should seek professional advice as soon as financial difficulties arise. Early action may avoid personal liability and improve outcomes for all stakeholders.