Insolvency: litigating against a company in financial difficulty

The world is becoming an ever-more dangerous place and learning to manage risk is part of the new reality. In the past year your organisation may well have been left high and dry when a party you have traded with has gone bust. What steps can you take to minimise your loss? How does the insolvency of a company affect your rights against it? And how are your rights going to change with the introduction of new laws in 2003?

Practical hints

What should you do if your opponent in litigation might, or has, become insolvent? First of all, check your facts: establish whether the company is formally insolvent and, if so, what type of insolvency procedure it is in. This can usually be done by carrying out a winding up/administration search at the Companies Court by telephone (020 7947 7328), or a company search.

• Even if the proceedings are not automatically stayed, consider carefully whether there are likely to be any recoveries for unsecured creditors. You can then decide whether you are throwing good money after bad.
• It is not necessary to have a judgment in order to be able to claim your share as an unsecured creditor. All creditors will ultimately get a chance to submit details of their claims (known as proving your claim) against the company and the liquidator or scheme nominee, as appropriate, will then decide whether to accept or reject the claim. If the claim is rejected, you will have a right to ask the Court to determine its validity.
• If an insolvent company starts or continues a claim or counterclaim against you, consider whether it would be appropriate to apply for security for your costs. It usually is.
• Where a company goes into liquidation, set-off will automatically apply between any claims that the company has against you and any claims you have against it. Consider how this might affect your position.
• If you believe that a company is in the process of dissipating its assets (or has already done so) in order to prevent creditors from recovering anything, there are a limited number of options. In certain circumstances it is possible to obtain freezing orders to preserve the status quo.
• If you are already a creditor, it may be possible to have a provisional liquidator appointed who will "hold the ring" until a liquidator can be appointed.
• The liquidator, or else an administrator, will investigate transactions the company entered into prior to the date of insolvency. He has wide-ranging powers to set aside those transactions, particularly where they are with "connected" parties. He will look at whether one creditor was treated preferentially to others, or whether the company disposed of assets for less than their true value.
• A liquidator will also consider whether the directors kept on trading the company after the point in time when they should have realised that there was no reasonable prospect that the company could avoid insolvent liquidation. In these circumstances directors can face personal liability – usually this is the only way of piercing the corporate veil.
• Outside the litigation context, it is still worth considering whether you, as a creditor, have proprietary rights over the company's assets. This could be over goods supplied to the company which are subject to retention of title provisions or monies (perhaps a deposit) that may be held on trust for you. If you have a proprietary interest over an asset (whether hard assets or cash) in the hands of the insolvent company, it remains yours as it does not form part of the estate of the company available for the other creditors.
• It is worthwhile establishing a relationship with the administrator, receiver or liquidator at an early stage, and setting out your claims in writing. He who shouts loudest often gets heard.

The future

The buzz word in the world of insolvency is moratorium. Like lots of trends this has come across the Atlantic. It has been taken up eagerly by opinion formers here.

The idea is that companies should find it easier to achieve sanctuary from their creditors and gain time to sort out their affairs in their own way. Two developments in the law mean that 2003 will see power swing towards the company in trouble (which could be your debtor) and away from the creditor (which could mean you).

The Insolvency Act 2000 has crept in quietly, whilst attention has been lavished upon the more fundamental reforms which will arrive when the Enterprise Act comes into force in the middle of 2003. The Insolvency Act 2000 arrived on 1 January 2003. An important feature of that Act is the new company voluntary arrangement (CVA) moratorium for small companies. "Small companies" are defined as companies that meet two of the following three requirements:

• turnover not exceeding £2.8m;
• balance sheet total not exceeding £1.4m; or
• no more than 50 employees.

From 1 January 2003, management of small companies will be able to trigger an initial moratorium of 28 days to enable them to put a rescue plan to creditors. All creditors will be bound by this initial moratorium and it is important to note that floating charge holders (up to now holders of the Ace card when it comes to chasing up debts) will have no right of veto.

This development is important for two reasons. First, you might be the unlucky creditor of a "small company" and you might have to stop in your tracks just when you thought you could slam home some aggressive litigation. Second, this new measure is quite clearly the legislative equivalent of one of those tiny pots of paint we buy from the DIY shop: the Government is going to monitor carefully this small-scale stab at a moratorium and, if things proceed without a hitch, we will have to expect to see it applied on a much grander scale in the not too distant future.

The Enterprise Act, when it comes into force during the course of 2003, will take the pendulum a little further along the same course. Two aspects of the new regime will make it more difficult for you, as a creditor, to pursue a company which owes you money. First, reforms to the administration process will make it easier for the company which owes you money to enter into administration and to cloak itself with the protection of that all-important moratorium, preventing you from taking hostile action to recover your debt. Second, the Enterprise Act will severely restrict the lender's right to play that Ace card: lenders will only be able to appoint an administrative receiver if:

• the floating charge from which they draw their rights was in place before the new statutory provision comes into effect; or
• the financing occurred in the context of a capital markets transaction or some other transaction as (fairly narrowly) defined in the statute.

So insolvency law will be dramatically reformed when the Enterprise Act becomes law, in the middle of 2003. The culture of insolvency is likely to change, with secured creditors' rights to control the insolvency process being curtailed. The overall effect is likely to be fewer administrative receiverships and more administrations which, in theory at least, should lead to the rescuing of more businesses. But if you are a creditor waiting to get to the head of the queue, 2003 might bring disappointment: there might be times when you have to settle for the warm feeling that will come from doing your bit for the rescue culture!

For further details please contact Robert Hickmott at robert.hickmott@cms-cmck.com or tel +44 (0)20 7367 2987 or Duncan Aldred at duncan.aldred@cms-cmck.com or tel +44 (0)20 7367 2709.