Liquidating a Business

  123528   Structure: Issues, Legal rules and application Title 1) Business Angels   Issues The Business Angels (“the Company”) is a new business and therefore the shares of the company would not be easily marketable. This limits the ways the funds for the venture can be raised. The Debt could be secured by a Debenture by giving either fixed or floating charge or both on the Company’s assets.

The debt secured on director’s home. This could be a problem if the property is a matrimonial home and is in joint name. Any new business which is trying to raise funds by borrowing money has to consider giving personal guarantee by its director and its implications. Analysis Business Angels is a new company in the niche market of beauty treatment for celebrities with a top quality product. This suggests that the company has more than 50% chance of success in the business and marketability of its shares is low. The success of the company also depends, to a certain extent, on the management team on board.

Keeping all these factors in mind, the investment options which your client could consider are limited. As a starting point, your clients could invest their own money, however this means your clients are exposed to higher personal risk of losing their own money if thing went wrong and business has to fold. This also means that they have to use their investments and life time savings. On the other hand it might be difficult to raise the required amount of capital personally. Another option is to use Venture Capital to raise required funds.

The Venture Capital companies specialise in providing finance for a new company and are willing and able to take higher level of risk. In order to secure the finance it would be necessary to persuade the Venture Capital providers that this business is viable and have every chance of success in the market. The venture capital involves provision of either equity finance or in the form of loan capital for a medium to long term. This option is more attractive because the funding provided is unsecured and so has fewer risks. However, the business will be diluted as the Venture Capitalist would take a percentage of voting rights with the shares in the business which would decrease the amount of control your clients have over the business. It is common for the venture capital companies to insist on a company’s Board of Directors in order to control the way the company is run and have up to date information as to what is happening with their investment.. This method does offer the potential for above average return. 3i is the largest venture capital operation in the U K. The Enterprise Investment Scheme (“EIS”) allows individuals to invest directly in a business.

This scheme allows individuals to offset 20% of their investment against income and Capital Gains Tax. From 6th April, the maximum annual investment will be A£400,000. The E I S are usually very high risk and therefore may or may not be suitable for your client as it depends on whether or not your client is risk averse. There is always a possibility of a business loan from a bank and this is good for long term finance needs. The bank would need security and personal guarantees to be in place before any loan is released. The security is usually taken over the Director’s home which means a charge would be registered at the Land Registry against his property reducing the amount of equity further. This clearly puts his house at risk. Although borrowing money from the Bank does not dilute your clients share holding in the company as the Bank’s do not insist on a seat on the Board but it is an expensive option and you need to have security. If on the other hand, the Company has enough assets including book debts over which the bank is willing to take the charge in return for the funds for the Company then the charge taken by the Bank would be an “All Monies” charge.

This means that the funds are invested by taking a fixed charge and floating charge which covers all monies coming into the business. A fixed charge is a form of security where a specific item of property or an asset of a company is used as security for the investment. If the money invested does not get paid back then the asset over which there is security becomes forfeit. The company is not allowed to deal with the particular asset in question without being allowed to do so by the holder of the fixed charge. Currently the law today allows a company to be able to grant security over all of its assets. A floating charge is a form of security which can be granted by companies to lenders. It enables a company to offer security to a lender using assets which can change on a daily basis. An example of this is stock. Individual items move into and out of the floating charge as they are sold and bought.

The floating charge comes into effect and gets converted into a fixed charge if there is a default in terms of the security. A floating charge is more flexible than a fixed charge but not as effective. Also the lender can appoint a receiver to run the business. If there are two or more floating charges in existence then the charge that was created first takes priority unless there is an express authority set in the first charge giving it a priority or it is on part of the company’s assets and the Court construes that it should have a priority ranking. Generally a fixed charge is created over the land and other immovable property while the stock and book debts are included in a floating charge.

[1] The Enterprise Act 2002 has attempted to restore the balance between the secured and unsecured creditors by heavily restricting the administrative receivership as an enforcement option and abolishing its use completely in most cases where secured lending after the Act becomes effective. The effective date when the Act becomes fully operational is 15 September 2003. Although the Act restricts or prohibits the floating charge holder from appointing an administrative receiver it does not prevent the appointment of fixed charge receiver. However, there is condition attached to such an appointment that they must vacate the office in case where an administrator is appointed. If a creditor holds a security which was in existence before the effective date then such a creditor could still retain their priority status and can appoint administrative receiver if he needs to enforce its security.

Not only that, but the Act also gives right to secured creditors with a qualifying floating charge a new right whereby they are able to appoint an administrator without having to go to court. Some commentators have said that this could be perceived by the banks as loss of control and may consider levying extra charges on company’s borrowing making it more expensive and difficult to obtain.

Current practice is to consider rescuing the company rather than enforcing security. The receiver tries to obtain best price on a sale and takes reasonable care while he is running the business and considers the fundamental issues which affect all creditors. The priority between fixed and floating charges is regulated in the same way as legal and equitable charges. Since fixed charges rank ahead of preferential creditors on a winding up, a creditor taking security will wish to have as much of his debt secured by a fixed charge as possible. This is illustrated in Re CCG International Enterprises Ltd

[2] a bank had a charge over insurance monies due to the company in its favour.

According to the terms of the charge the bank had a first fixed charge on all sums due under the insurance policy. The terms allowed that these sums could be used by the company, at the option of the bank, in setting off any loss or damage arising under the risk covered by the policy. Until then the monies were to be held in an account directed by the bank. It was held that the charge was a valid fixed charge. In the New Bullas Trading Ltd

[3] case, it was held that it was possible to treat book debts and proceeds differently. This created a debenture hybrid as a fixed charge whilst the book debts were uncollected. It was up to both parties to agree when the fixed and floating charge came into play. This gives banks the best of both worlds as therefore an uncollected book debt can be subject to a fixed charge but proceeds become a floating charge.

The question here was when the receivers were appointed, were the uncollected book debts subject to a fixed or floating charge. The judge concluded that there was no need to deal with book debts before collection and this can be subject to fixed charge. Once it is collected, the proceeds required by the business then become a floating charge. On the other hand, in Re Bank of Credit and Commerce International

[4] it was held that a lender could take a charge on a debt in respect of which it is a debtor, however in Re Double S Printers

[5] it was held that the charge in question can only be treated as a fixed charge unless a debenture holder can show that they have control over the debt in their capacity as a chargee. Likewise, in Re Westmaze Limited

[6] it was stated that “even when the parties called the security a fixed charge, it did not preclude the court from finding it merely to be a floating charge”. In 2001, a Privy Council decision in Re Brumark

[7] it was stated that the Court of Appeal decision in Re New Bullas Trading Limited

[8] was wrong. In both cases the charge was placed over book debts.

Lord Millett stated that it is possible to have a fixed charge over specified book debts. If that is correct then these would be removed from those assets that might otherwise be claimed by the preferential creditors and the crunch lies in the control held over the secured asset by the chargee. In Re Brightlife Limited

[9] Hoffman J held that the security in question was a floating charge notwithstanding its description by the parties as a fixed charge. The reason for this decision was the Company, although was not allowed to deal with the debts while these were uncollected, it was free to do so i.e. pay into its ordinary bank account when these are collected and deal with them without any restriction. In the case of Spectrum Plus Limited & Ors v National West Minster Bank Plc[10] the court initially decided that a Siebe Gorman[11] type charge over book debts was a floating charge. Nonetheless, after appeal it was decided that this type of charge over book debts was a fixed charge. This was because in order to categories a charge as a fixed charge instead of a floating charge, the borrower needs to pay the amount of the book debts into a blocked account. In Siebe Gorman the provisions of the debenture made it a fixed charge over the book debts and required the company to pay the proceeds in the bank account which in turn gave right to the bank to prevent the company to withdraw the proceeds. And this is what made the charge a fixed charge. In Spectrum and Siebe Gorman, the account was not blocked. In this case a debenture provided a specific charge over book debts which made the charge a fixed charge. It was necessary for the company to pay the book debts collected into the company’s account they held at the bank and were not free to deal with the debts.

This created a fixed charge over the book debts as per the earlier decision in Siebe Gorman v Barclays bank Ltd[12] Lord Millet in Agnew& anr v Commissioner of Inland Revenue & anr[13] : Lord Millet rejected the points made in New Bullas. He said that ‘the question is not merely one of construction but one of categorisation. The only relevant intention is the intention of the company who should be free to deal with the charged assets to remove them from security without the consent of the holder of the charge. If it is so, then there is no fixed charge.

According to Lord Millet, so long as the bank cannot prevent the company from collecting the debts and having the free use of the proceeds, it was a floating charge. The question is not whether the company is free to collect the uncollected debts, but whether it is free to do so for its own benefit. Implications and Conclusion If the book debts are subject to a fixed charge, the proceeds become payable to the bank. If they are floating charge, they become payable to the employees and tax authorities. They get the preference. Fixed charge is not good for the company’s business.

They will not have any access to funds which will affect their cash flow. Therefore, if your client wishes to take a debenture over company’s assets including book debts then he has to ensure it does not become a floating charge by ensuring he is free to deal with the proceeds of the book debts for the day to day running of the business. The Enterprise act 2002 allows for secured creditors who have a qualifying floating charge the right to appoint an administrator without having to go to court. This can be done by giving two business days notice at the court without having to prove that the company is insolvent, however it must be proved that the security it valid and enforceable When a company goes into liquidation the claims from various types of creditors commence with an incantation of the pari passu principle. There is an inherent tension between the fundamental principle of contract that is freedom to enter in to a contract and expect to get a priority on the one hand and the mandatory pari passu principle on the other.[14] Under the new insolvency regime, the priority of preferential creditors such as the Crown has been abolished but there still seems to be a question of secured creditors. The law as it stands today allows a company to be able to grant security over all of its assets. However if the company imposes restriction on these secured creditors then it is likely that the credit facilities will become more expensive regardless of rescue procedure in place. It may become more difficult to obtain finance, which is less flexible.

This may lead to more personal guarantees and securities from directors of the company being demanded by the secured lenders to reduce their exposure. On the other hand when the company runs into financial difficulties then secured creditors would want to protect their position, which could be detrimental to the unsecured creditors. Title 2) Condor Plc Issues and Analysis Condor Plc (“The Company”) has debts of A£3.2 million. Out of this A£1.2 million is owed to Statutory Preferential creditors and A£500,000 to floating charge holders. In order to establish a personal liability of the directors it is essential to understand the regulations relating to company liquidations. It is assumed that the Liquidators expenses are going to be paid before any other creditors. BUCHLER & ANOR (as joint liquidators of Leyland Daf Ltd) (Respondents) v TALBOT & ANOR (as joint administrative receivers of Leyland Daf Ltd) & ORS (Appellants) & ORS[15] The Insolvency Act 1986 (as amended by Enterprise Act 2002) has great effect on the day to day responsibilities of directors involved in running of a company. Under these provisions the directors may be held personally liable for the debts of the company if they incompetently manage the company’s affairs whilst knowing the company is insolvent. The Directors of the Company are aware of the financial crisis it is experiencing as the company has suffered a slump in their profits in 2004. There is no information with regards to the company’s financial performance to establish whether or not company is Balance Sheet insolvent or has liquidity problems. Section 124 of the Insolvency Act 1986 provides that an application to the court for the winding up of to company shall be by petition presented either by the company, or the directors, or by any creditor The Company has petitioned for its own winding up that has gone into voluntary liquidation.

The directors must have made a statutory declaration that the company is solvent and will be able to pay all its debts in full plus interest within a specified period not exceeding 12 months[16] making it a members’ voluntary winding up. The company has a relatively short trading period as it has only traded for four years. The floating charge is held by three directors and presumably it is a qualifying floating charge (“QFC”). This would effectively give them a right to appoint an administrator to realise their security and get their debt paid by giving only two business days’ notice at the court provided they can prove the security is valid and enforceable. However, as the company has already gone into liquidation this option is no longer open to them. It is not clear which assets are covered by the floating charge. Vanessa Finch[17] evaluates in her article the potential contribution of recent reforms which have been implemented in an effort to further a rescue culture. Under the new insolvency regime the holder of qualifying floating charge would be prohibited from appointing an administrative receiver however, they would be able to appoint an administrator without recourse to the court. This new provision applies to any floating charge which is created on or after the date these new provision came into force. If this is the case then it obviously leaves open for the holders of the floating charges, the directors, created before the new legislation came into force, to appoint an administrative receiver. According to Marion Simmons, Q C[18], if a lender holds a floating charge which came into force before 15 September 2003 then that charge holder retains its right to appoint an administrative receiver.

The charge holder also gains the right to appoint an administrator and is not weighed down by the fact that the new provisions do ring-fence assets to certain extent in favour of unsecured creditors. The question states that the Company suffered a slump in their profits in 2004 which is 2 years ago. It is therefore essential to establish the level of company’s financial performance over the last 18 months. This would be necessary to establish whether or not the directors of the company were or ought to have been aware of the company’s ailing financial position and impending insolvency. If a particular point in time can be identified in the last 18 months when company became insolvent having struggled to pay its debts as they fell due, then it would be necessary to see if the directors have taken any corrective actions for example have they sought any professional advice etc if not from that point onwards it would be held that the directors Traded to the detriment of the creditors or general body of creditors.

This can also be construed as Trading with the Knowledge of Insolvency and that makes the directors liable personally to the debts incurred after that date. If the directors fail to take any action then they may be responsible for Wrongful Trading under the provisions of Insolvency Law. Your client, the liquidator of the company would realise the assets of the company and after paying preferential creditors and fixed and floating charge holders, if any, he would distribute the remaining funds amongst the creditors. In 2005 the Company offered significant discount to their prospective clients. It should be established whether this was the reason for the company’s financial difficulties. Swelling the Assets: Clawing back The liquidator may be able to increase the value of the assets available to the creditors at the start of the insolvency by relying on claims arising from general law unrelated to the insolvency such as debts and other obligations owing to the insolvent and proprietary claims. The liquidator may bring such claims which are only available in a formal insolvency such as an insurer of ,say, Accountants, whose advise led to formal insolvency of the Company as in Caparo Industries Plc v Dickman[19]. It is also possible for the liquidator to establish personal liability of a constructive trustee for assisting in the breach of trust with knowledge where the principal wrongdoers has become insolvent and the trust property has been dissipated. It is possible to challenge transactions prior to the insolvency and those transactions which are intended to defeat creditors.[20] If there are transactions which took place after the petition for winding up was presented then those transactions can be challenged[21]. If the Company has paid off any creditors in a relevant period leading up to the Company’s liquidation then these payments can be clawed back[22]. Similarly, any extortionate credit bargains the Company may have entered into[23] are also challenged. Furthermore, if the directors have paid excessive pension contributions which can be claimed back for the benefit of the creditors[24]. In RE M C Bacon Limited[25] dominant intention to prefer one creditor over the other need not be necessary to establish however a desire to prefer must be shown clearly. The Company in this case gave a charge over its assets to the bank in order to secure existing borrowings. It was held that this transaction cannot be treated as a preference because the bank had threatened to withdraw its support if the security was not forthcoming.

However, in Katz v McNally[26] it was held that payments to directors who were husband and wife, of a company shortly before it went into administration which effectively discharged their loan accounts with the company, were preferences. In Phillips v Brewin Dolphin Bell Lawrie[27] the House of Lords stated that it is important to look at the consideration as a whole in an undervalue transaction instead of on its own. It should be noted that all these provisions under the Act can be backdated and in accordance with the pari passu principle. This is to prevent some creditors getting paid in front of other creditors or stop directors from transferring assets to associates or shelter assets by making excessive contributions to a pension scheme before the insolvency. In addition to this, the provisions of the Act prevail over any property dispositions which may take place during the matrimonial proceedings. Third Party Liability The liquidator may also impose liability to contribute to the assets of the Company on third parties whose action may have contributed to the loss of creditors. For example, the shareholders of the company will only have limited liability up to the amount of unpaid shares which they have already agreed to pay, to contribute towards the assets for the repayment of creditors. The liquidator may use his inquisitorial powers bestowed up on him by the Act to seek disclosure of any insurance policy a director may have to protect against the breach of duty. In addition to this, the liquidator may bring a claim against the directors who are responsible for the management of the company[28] or for slowing the company to continue to trade whilst insolvent when the directors knew or ought to have known that they were trading without any reasonable prospects of paying the creditors. The question states that the directors have valuable real estate property near Chelsea FC and therefore it would be worth pursuing the claim under section 212 against the directors and go after the properties they hold to increase the pool of assets for the creditors. Conclusion The liquidator should collect all the business assets and get them valued and auctioned to ensure maximum price is collected. In addition to this if any of the share capital is not fully paid up then the liquidator can collect the unpaid amount towards the debt of the company. If the directors have financially benefited at the expense of the creditors of the company then it may be possible to make the directors personally liable to make up the losses.

Furthermore, if there are insufficient assets to pay off the creditors then the Court would look at the benefit that has been derived by the directors at the time when the Company was struggling to pay its debts, and make the directors personally liable for the debts incurred. The process is commonly known as ‘Lifting the corporate Veil’ to make the directors personally liable. If that happens then the liquidator would be able to get their hands on the directors’ properties with a view to realise them and collect the proceeds for the benefit of the company’s creditors or alternatively register a second charge on their property in order to stop them from dealing in the property without notifying the liquidator. In any case it is necessary to see how the company’s affairs have been managed over the past 18 months before it went into liquidation. It may be useful to find out how the decision to allow the prospective clients a significant discount for the company’s services was made. If it was unanimous decision at a board meeting and as a direct result company’s finances have suffered then all three of them would be responsible for the company’s insolvency. In order to increase the pool of assets for the Company’s creditors, the liquidator should be looking at any unpaid capital, any assets of the company over which there is no fixed or floating charge registered. The liquidator should check if the floating charge is valid and enforceable. In addition to this he should also check whether any of the creditors have any charge over company’s property. An application to the court to seek an order to make the director’s personally liable for the debt should also be considered. Any attempt to swell the assets invariably runs the risk of failure of a claim in which case assets available in the liquidations would have been diminished even further and therefore it is vitally important that the liquidator seeks the consent from the creditors and keeps them informed of any such actions and developments. Bibliography  

1. Boyle and Bird, Company Law (Jordans, 2004)
2. Annotated Guide to Insolvency Act , published by Thomson Sweet & Maxwell, 7th Edition
3. The Company Law Legislation, CCH New Law, 1999
4. Lawtel web site for case law
5. www.insolvency.gov.uk/consultation

6. Department of Trade and Industry web site, www.dti.gov.org

7. The Association of Business Recovery Professionals, R3

8. www.bixhelp24.com/insolvency
9. www.nabarro.com/legal article by Patricia Godfrey Head of Insolvency and Corporate Recovery
10. www.pkf.co.uk
11. Corporate & Personal Insolvency Law, by Fiona Tolmie second edition published by Cavendish.

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Footnotes

[1] Illingworth v Houldsworth [1904] AC 355 (HL); Re GK TunbridgeLtd [1995] 1 BCLC 34, page 270 Boyle & Bird

[2] [1993] BCC 580 Lawtel case law web site

[3] 1993 BCC 251 Lawtel case law Web site

[4] [1997] 4 All ER 568 CLT notes

[5] [1999] BCC 303 CLT notes

[6] [1999] BCC 441 CLT law notes, Professional training

[7] BCC 303

[8] [1994] BCC 36

[9] (1986) 2 BCC 99,359 [10] 20045 UKHL 41 [11] Siebe Gorman & Co Ltd v Barclays Bank Ltd 2 Llyod’s 142, [1979] 2 [12] Page 333 – 336, Corporate & Personal Insolvency Law,by Fiona Tolmie second edition published by Cavendish. [13] 2001 UKPC28, 2002 1 AC 710 lawtel web site [14] University College London; Centre for Business Research, Cambridge University, Cambridge Law Journal, Volume 60, Part 3, November 2001, RIZ MOKAL, the Author [15] (2004) Lawtel case law web site [16] Insolvency Act 1986, section 89. [17] Re-Invigorating Corporate Rescue published in Business law Journal by Sweet & Maxwell, September 2003 issue page 527 – 557 [18] Business Law Journal, July 2004 page 423 – 236 published by Sweet & Maxwell and Contributories [19] [1990] 1 ALL ER 568 (HL) page 341, Corporate & Personal Insolvency Law,by Fiona Tolmie second edition published by Cavendish. [20] Section 238 and 423 of the Insolvency Act 1986 (“the Act”) [21] section 127 of the Act [22] Section 239 of the Act [23] section 244 of the Act [24] sections 342Ato 342F of the Act [25] [1990] BCC 78 lawtel web site [26] [1998] BCC 784 the Lawtel web site [27] [2001] 1 ALL ER 673 the Lawtel web site [28] section 212 of the Act

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