Insolvency, Liquidation and Winding Up


A. Insolvency

 

One can bring an action to wind up an insolvent company or to bankrupt an individual. Once such an action has been filed, one may want to terminate existing contracts through Events of Default clause included in the contracts.

 

1. Events of Default


Insolvency events of default and termination clauses need to be reviewed carefully when drafting any contract regardless of whether a standard form is used. The trigger event will depend on whether you are acting for the creditworthy party and whether it is an early "trigger" or a late "trigger".

 

If events of default are not drafted carefully, the counterparty wishing to enforce its rights against the insolvent counterparty may not be able to do so as early as they would like or at all. Whilst the solvency of the counterparty may not be in question when the original contract is negotiated, it is prudent to draft the insolvency events of default on the basis that the counterparty may become insolvent during the term of the contract. Consideration should also be given to whether the contract automatically terminates or only terminates on the election of one of the parties. Particular care should be taken when events of default are automatic.


Information Covenants
Depending on the event of default, one party may not be aware that an event of default has occurred in relation to the other party. An information covenant should be included which will require the one party to inform the other party when a particular event or an event of default has occurred. However, as this is only a contractual remedy, it can be of limited practical use.

 

Grace Periods
Grace periods can be included, however it is preferable to have grace periods in respect of particular events of default, for example, those defaults that are capable of being cured (such as payment defaults). 

 

2. Availability of Assets to Creditors

 

Unsecured creditors of an insolvent company are generally entitled to share pari passu (rateably in proportion to the amount of their debts) in the assets of the company. Assets which are subject to an effective fixed or floating charge in favour of a secured creditor are excluded for these purposes.

 

Nemo Dat Rule

 

Assets which are in the possession of the company, but which are owned by a third party, are not available to either secured or unsecured creditors. In particular, a company cannot normally grant a security interest in respect of property which it does not own. (the nemo dat rule).

 

Retention of Title

 

Third party assets include trust property and chattels held by the company as bailee (e.g. the contents of a warehouse) but, for a manufacturing business, the most important category will often be stock, equipment or other goods which have been sold to the company subject to a contractual provision that the seller will retain legal ownership unless and until payment has been received. Such contractual terms take a variety of forms and are collectively referred to as "retention of title", "reservation of title" or "Romalpa" clauses (ROT Clauses).

An effective ROT Clause allows an otherwise unsecured trade creditor (ROT Seller) to repossess the goods which it has supplied (ROT Goods). This is normally preferable to the ROT Seller proving in the liquidation of the company as an unsecured creditor. Insofar as an ROT Seller has retained ownership of goods, it will effectively have priority over both secured and unsecured creditors of the insolvent company.

 

An effective ROT Clause will be recognised by an insolvency office holder; in particular a receiver appointed by a secured creditor or a liquidator or administrator of the company. If an insolvency office holder uses or sells ROT Goods without the consent of the ROT Seller, both he and the company may be liable in tort. This is so even where (as is normally the case) a sale by the office holder is "of such right and title (if any)" as the company may have in goods in its possession. Hence, ROT Goods will normally be expressly excluded from any such sale.

 

In order to confer valuable rights, an ROT Clause needs to:

  • be incorporated into the contract for the sale of goods;
  • be legally effective to retain title; and
  • relate to goods that are still identifiable and are capable of being returned to the ROT Seller.

 

B. Difference between "Administrative Receivers", "Receivers", "Administrators" and "Liquidators"

 

Administrative Receivers are appointed (usually) by a lending bank ("appointor") holding a floating charge (see below) over the business and assets of the company. They have extensive powers to carry on trading and/or sell any asset of the business and act in the interests of the appointor. There is little to prevent Administrative Receivers from breaking contracts or cherry-picking and they have few statutory duties. Almost everything they do is influenced by their desire to make a "Receivers' profit" i.e. will the transaction result in a net increase in cash. Administrative Receivership, however, saves more jobs and businesses (not companies) than any other rescue process.

 

Receivers are receivers appointed either under an express or an implied term providing such a power in a debenture (document acknowledging/creating debt). These receivers have only so much power as is granted in the debenture or under statute and therefore it is essential to consult the debenture to ascertain their powers.

 

Administrators are court-appointed and take over the running of the company, displace the directors and within 3 months must put proposals to the creditors for salvaging whatever can be salvaged from the company or proposing a scheme of arrangement / Company Voluntary Arrangement. Since they are court-appointed they cannot act in a partisan manner. They have extensive powers to manage a business and/or sell assets. During an administration there is a moratorium on litigation and security enforcement against the company and its property.

 

Liquidators are appointed by either the court or the shareholders and/or creditors to wind-up a company's affairs. They rarely sell going concerns.