Insolvency Law Concepts

Implications for the banker

 Learning outcomes
• By the end of this lecture you should be
able to:
– Describe the concepts on which insolvency
law is based
– Define key terms in insolvency law.
– Outline the priority of creditors in an
insolvency situation.
– Recognise areas where banks can improve
the return obtained in insolvency.
 Insolvency in context
Informal chat
Formal facility review COLLECTIVE
Facility re-structure ACTION

CCJ
Insolvency action

PRIVATE
or INDIVIDUAL
Early warning Too late

PRO-ACTIVE
ACTION RE-ACTIVE
 What is insolvency?
• INSOLVENCY ACT DEFINITIONS:

• Inability to pay debts as they fall due (The liquidity or

Cash Flow “test”)

• Liabilities exceed assets (The Balance sheet “test”)

You only need to FAIL one test to

be insolvent
 What is Insolvency Law?
• Legal protection for creditors and
debtors
• A statutory end to debt contracts
• Reflection of society’s wishes to:

- Punish some debtors

- Rehabilitate honest debtors
 The Cork Report 1982
“ It is a basic objective of " …in a modern society
the law to support the the emphasis should be
maintenance of on the rehabilitation of
commercial morality debtors and that a three
and encourage the year period of restriction
fulfilment of financial is sufficient for those
obligations. Insolvency who have failed
must not be an easy financially."
solution for those who
can bear with
equanimity the stigma
of their own failure…"
A Revised Framework for
Cork, 1982, p.53 Insolvency Law, 1985, p.41
 A brief history of insolvency law
Bankruptcy Act 1883

Bankruptcy Act 1914

Debtors’
Gaol Companies Act 1945

Insolvency Act 1986

Enterprise Act 2002

…… 1761……………...…..1883……......1986.……...2002
 Relevant Law
• Insolvency Act 1986 (as amended)
• Insolvency Rules 1986 (SI 1986 No. 1925)

• Amended by…..
– Insolvent Partnerships Order 1994
– Insolvency Act 2000
– Enterprise Act 2002
 Insolvency Regimes for Individuals
• Bankruptcy
– Available assets and income are seized and
liquidated.
– Funds generated are distributed to creditors.
• Individual Voluntary Arrangement (IVA)
– Selected assets and income are offered.
– Funds generated are distributed to creditors.
• Debt Relief Order (DRO)
– owe less than £15,000
– No Income, No Assets (NINA)
 Key Concepts
• Licensing of Insolvency Practitioners (IPs)

• Proof

• Creditor Priority

• Treatment of Creditors

• Antecedent transactions

NB: Rules are the same for individuals and corporate.

 “Proving” as a creditor
• All claims in an insolvency must be provable.
• Invoices / receipts / documentation must be
complete.
• NO DOCUMENTATION = NO DEBT
• “Proof” is sent to the Insolvency Practitioner
handling the insolvency.
• The IP judges whether the claim is valid.
Priority of Creditors

Secured Creditors

Insolvency Fees

Preferentials

Ordinary Creditors

Interest

Deferred
Creditors
 Types of Creditor
• Secured – charged property
• Preferential – Unpaid Wages and
Holiday pay up to a maximum of £800
per employee
• Ordinary – unsecured plus debts where
guarantee / third party security is held
• Deferred – Family members
Rules for Creditors
Secured Creditors • Set Off
Insolvency Fees
• Pari-Passu
Preferentials

Ordinary Creditors
• Collective
Interest action
Deferred
Creditors
• Cascade
 Creditor rules
• Set Off
– Only net amounts owed can be claimed – bank must set
– off credit & debit balances
• Pari-Passu
– Each creditor in a class is treated equally with other
creditors in that class
• Collective action
– No unsecured creditor can take individual action for
debt recovery
• Cascade
– Higher ranking creditors must be paid in full BEFORE
lower ranks get anything
CHARGED OTHER
ASSETS ASSETS
 CHARGED OTHER
ASSETS ASSETS

FIXED CHARGE
REALISATIONS IP
FEES

PREFERENTIALS

UNSECURED
Opportunities for Banks

Secured Creditors • Security

Insolvency Fees
• Wages lending
Preferentials

Ordinary Creditors • Interest

Interest included
Deferred
Creditors
 Antecedent transactions
• Preferences
– S.340 Insolvency Act 1986
– Any transaction which places a creditor or guarantor in a
better position relative to all other creditors
– Usually involves paying one creditor before others

• Transactions at an Undervalue
– S.339 Insolvency Act 1986
– A transaction where the value received is considerably less
than the true value
– This includes gifts

• Reduces assets available to the body of creditors

 Preferences: Conditions
• The transaction must have occurred within 6
months of the start of insolvency
– This is extended to 2 years where the preferred
party is an “associate”
– An associate is a spouse, close relative or
business partner of the debtor
• There must have been a desire to prefer
(presumed where an associate is involved)
• The debtor was insolvent at the time of the
transaction
 Preferences: The Bank (1)
• A bank should be put on alert when:
• A debtor who was previously struggling to
repay their borrowing unexpectedly repays
their borrowing AND
• This is accompanied by the debtor requesting
the release of personal security (e.g. land or
a guarantee)
• The bank must never return the security
document
 Preferences: The Bank (2)
• Where a bank takes additional security from a
debtor but does not provide any additional
lending, is this a preference in favour of the
bank?
• Re: M.C. Bacon Ltd (1989)
• The answer is no as long as the bank has
insisted on the security in order for the debtor
to keep the existing lending facility
• The debtor would be choosing the lesser of
two evils so there is no desire to prefer
 Transactions at an Undervalue -
Conditions
• The transaction must have occurred
within 5 years of the start of insolvency
• Insolvency at the time of the transaction
need only be proved if the transaction
took place more than 2 years ago
• Insolvency is presumed where the
transaction involves an associate
 Transactions at an Undervalue:
The Bank
• Where a bank takes additional security from a debtor
but does not provide any additional lending, is the
security a transaction at an undervalue?
• Re: M.C. Bacon Ltd (1989)
• The answer is no as the bank provides adequate
consideration when it permits the debtor to keep their
borrowing facility
• The bank does have to be careful if it should take an
asset as security that has been acquired at an
undervalue by the debtor