Rachel Faulkner and Sophie Elboz consider the procedure for commencing proceedings and the proper use of statutory demands
Assumptions
For the purposes of this article, the following facts will be used to illustrate some of the points to be made:
- the debtor is a limited company, D, which owes £100,000 to company C pursuant to an invoice for services carried out by C; and
- company C has not obtained any judgment or issued any proceedings in relation to the unpaid invoice.
In such circumstances the choices available to C (assuming that it is not aware of any disputes as to whether the monies are owed) are whether to issue a claim form and sue D for recovery of the debt, or to serve a statutory demand with a view to commencing insolvency proceedings to wind-up D.
This article does not look at the procedure for bankrupting an individual. However, the same general principles apply, although there are some differences in procedure. Therefore, where the debtor is an individual or a partnership, the specific Insolvency Rules and the Insolvency Practice Direction to the Civil Procedure Rules (“CPR”) apply. The crucial difference is that a statutory demand must be served on an individual before a bankruptcy petition can be issued whereas this is not always necessary before issuing a petition to wind-up a company.
Statutory demands - basic procedure
Contents of statutory demand
The contents of a statutory demand are prescribed by rules 4.5 and 4.6 of the Insolvency Rules and there is a standard form. Briefly, a statutory demand must contain the following:
- an explanation of the purpose of the demand and a clear indication that if the demand is not complied with, winding-up proceedings may be instituted;
- the time within which the demand must be complied with (usually 21 days);
- an explanation of the methods of compliance which are open to the debtor;
- separate identification of any interest claimed, of which the debtor has not previously been notified, together with any other charges payable, the amount or rate of that interest or charge and the grounds on which the right to claim payment is claimed;
- information as to how an officer or representative of the debtor can communicate with a named individual representing the creditor (including his address and telephone number) with a view to securing or compounding the debt to the creditor’s satisfaction (this can be the creditor’s solicitor);
Additionally, the demand should be signed by the creditor or a person authorised to make the demand on its behalf and dated.
Procedure for service
The statutory demand must be served personally upon the debtor’s registered office.
The winding-up process
Section 122 of the Insolvency Act 1986 sets out the circumstances in which a company may be wound-up by the court, the most common being that it is unable to pay its debts. A company is deemed to be unable to pay its debts where it has neglected to pay up on a statutory demand for three weeks (s.123 (1)(a) of the Insolvency Act 1986). Therefore, if the debt claimed in the statutory demand is not met within three weeks of service, the creditor may issue a winding-up petition, which must be presented to the court together with the appropriate fee, a deposit and a verifying affidavit. Again, the petition and affidavit are in prescribed form. The winding-up petition must then be served personally, on the registered office of the debtor at least 14 days prior to the winding-up hearing. The petition and an affidavit of service must then be filed at court.
The creditor must also place an advertisement in the London Gazette advertising the petition not less than seven business days after service of the petition, and not less than seven business days before the hearing of the petition.
At least five days before the hearing, a copy of the advertisement must also be lodged at court together with a certificate of compliance with the rules relating to service and advertisement. The Insolvency Practice Direction to the CPR provides a word of warning to creditors that the advertisement is not to be “used as a means of putting pressure on the company to pay the petitioner’s debt”. This is because advertisement has serious consequences: once the petition has been advertised it is likely to come to the attention of the debtor’s bankers who will freeze its accounts pending the hearing of the petition unless the debtor applies to the court for an order allowing it to continue to trade. However, to obtain such an order, the debtor will have to demonstrate solvency to the court, amongst other things.
In addition, once the petition has been advertised, it is likely to come to the attention of other creditors and even if the debtor pays the creditor in full the petition cannot be withdrawn without the leave of the court. In practice, this means that if the debtor waits until after the petition has been advertised before paying up, he will not be able to dispose of the petition before the hearing, so any other creditors can threaten to take over the petition if they are not also paid. This could present a big risk for companies who have a policy of delaying before paying trade creditors.
Costs
While serving a statutory demand is relatively inexpensive, commencing winding-up proceedings can prove more costly.
Advantages/Disadvantages of serving a statutory demand compared to issuing proceedings for recovery of the debt
Statutory demand
Advantages
- the threat of insolvency proceedings is likely to put pressure on the debtor and may persuade it to settle the debt quickly if it has funds to do so because of the consequences flowing from the issuing of the petition and advertisement (in particular, the freezing of its bank accounts mentioned above);
- only minimal costs will be incurred if the debtor pays up on receipt of the statutory demand;
- the creditor can change its mind and go down the route of issuing proceedings for recovery of the debt if the statutory demand does not produce payment as a statutory demand is not a formal court document. However, it would probably be pointless to do so, as the debtor is unlikely to have the funds to satisfy any judgment eventually obtained;
- if the debtor has recently sought to divest itself of assets for the purpose of putting them beyond the reach of the creditor, a liquidator may be able to investigate and bring actions to upset these transfers (although the disadvantage is that the liquidator is likely to require funding to do so and if successful, any money recovered will be put into the pot to be shared between all the creditors).
Disadvantages
- the creditor will relinquish control once a liquidator is appointed;
- liquidation is expensive and a liquidator will recover his costs first;
- the debtor’s secured and preferential creditors will take priority over the unsecured creditors in the liquidation;
- the creditor’s debt will rank equally with that of any other unsecured creditors in the liquidation and, if there are insufficient assets to cover the debtor’s liabilities, the creditor may only recover a percentage of the full amount owed to it (a “dividend”).
Issuing proceedings
Advantages
- A letter before action from the creditor’s solicitors may also exert pressure on the debtor to pay, particularly if a pre-action settlement offer is made by the creditor which complies with part 36 of the CPR;
- If the creditor is successful in the proceedings, it will obtain judgment for the debt in full together with interest and costs and may then be able to take enforcement proceedings (such as obtaining a charging order over the debtor’s property) and therefore gain an advantage over other unsecured creditors. However, this is clearly only worthwhile if the debtor has significant assets.
Disadvantages
- A letter before action is unlikely to carry the same threat as a statutory demand as the debtor will have the opportunity to delay matters by serving a defence;
- If the debtor vigorously defends the proceedings, the creditor will be kept out of its money for some time and will have to incur costs, some of which will be irrecoverable, even if the creditor is successful.
Where a statutory demand is unsuitable
A statutory demand will not be a suitable option in any of the following circumstances:
Debt is under £750
This is the minimum amount currently prescribed by the Insolvency Act 1986 for serving a
statutory demand.
Debt is genuinely disputed
It is an abuse of process for a creditor to serve a statutory demand where the debtor genuinely disputes the debt. For example, if D contended that after entering into the contract, C and D agreed that instead of paying £100,000, D would provide services to C, there would be a genuine dispute as to the consideration for the contract and it would be an abuse of process for C to serve a statutory demand in these circumstances. D would be entitled to apply for an injunction restraining C from issuing or advertising the petition and the creditor would be penalised
on costs.
The debtor has a serious and genuine cross-claim exceeding the debt
If the debtor has a serious and genuine cross-claim exceeding the amount of the debt, the court will not make a winding-up order unless the creditor can show that there are special circumstances; Re Bayoil SA (The Times, 12th October 1998) and Re Richbell Information Services Inc (The Times, 21st January 1999).
Therefore, even if D does not dispute that it owes C £100,000 but contends that C owes it £150,000 for services that it had carried out for C, it will be an abuse of the process for C to serve a statutory demand (provided that it believes that D’s cross-claim is genuine and serious) and if C subsequently presents a winding-up petition, the court would be unlikely to make the order sought and C will almost certainly be ordered to pay D’s costs.
Prospective or contingent creditor and no evidence other than non-payment of statutory demand that company is unable to pay its debts
It is an abuse of process for a creditor to present a winding-up petition based on a prospective or contingent debt if the creditor has no evidence other than non-payment of a statutory demand that the company is unable to pay its debts; Securum Finance Limited v Camswell Limited 1994 BCC 434.
In order for a winding-up order to be made, a creditor has to show that the company is unable to pay its debts. The creditor will usually rely on section 123(1)(a) of the Insolvency Act 1986 to satisfy the test of “inability to pay debts”, which provides that a company will be deemed to be unable to pay its debts if a statutory demand has been served and remains unsatisfied for three weeks.
Therefore, if C was a prospective or contingent creditor, for example, if the invoice presented by C to D provided for payment within 28 days and 28 days had not expired since the invoice was presented, C would have to have evidence other than non-payment of the statutory demand to show that D could not pay its debts as they fell due. For example, C would have to show that D’s current liabilities exceeded the value of its assets.
Conclusion
The statutory demand is a useful and relatively cheap mechanism to put pressure on a debtor to settle a debt. However, it should be used with caution, as it is not intended to be a way of collecting debts, but rather a class remedy for all of the debtor’s creditors to receive an appropriate share of any remaining assets where the debtor company is insolvent. Should the debtor fail to settle the debt and it becomes necessary to commence winding-up proceedings, the process becomes more expensive and the creditor will have to share any assets which there are with all the other unsecured creditors, which may result in it recovering only a percentage, if anything, of its debt.
