A look at corporate, personal and, where relevant, partnership insolvency proceedings in Scotland, with a brief description to explain key features, as part of our Dictionary of Insolvency Terms in EU Member States. In particular, we highlight who controls the procedure and whether it is likely to be accompanied by a moratorium to prevent enforcement.
Scheme of arrangement
- Derives from company as opposed to insolvency legislation and can be used for the solvent reorganisation of a group structure as well as insolvent restructuring.
- Can be proposed by both a company and a limited liability partnership (either by the directors or members or by an administrator or liquidator if the entity is in an insolvency process). The procedure is broadly the same for each.
- The court convenes meetings of members and creditors to consider a proposed compromise that must be approved by a majority in number and at least 75% in value of each class of creditors and members voting on the scheme.
- A scheme may propose only to affect the rights of some or all of the debtor's creditors. As long as the statutory voting thresholds are met, schemes can compromise or write off the claims of secured creditors without their consent.
- Increasingly being used by UK-based and overseas incorporated companies (which need to establish a sufficient connection with the UK jurisdiction in order to implement a scheme of arrangement) in the leveraged buy-out market to write off or exchange debt for equity.
- Schemes do not automatically provide a stay against actions and proceedings. However, in rare cases, the court has granted a stay to enable a scheme to be pursued. In other cases, the scheme may be preceded by a standstill agreement and/or a lock-up agreement where (usually in exchange for a fee) creditors will commit in advance to vote to approve the proposed scheme. Where the protection of a stay is imperative, the company may first enter administration (which brings an automatic stay) and the scheme would then be proposed by the administrators.
- The main rescue procedure available for insolvent companies and limited liability partnerships, designed to provide breathing space so that the debtor can be rescued or reorganised or, failing that, its assets realised for the benefit of its creditors.
- An administrator can be appointed either by court order on application of the debtor’s directors/members or any creditor or administration may be commenced more swiftly without a court hearing in some circumstances by the filing of documents at court by the insolvent debtor itself, its directors/members or a creditor who is a qualifying floating charge holder.
- The debtor’s management is replaced by an administrator who must be an independent, licensed insolvency practitioner. They have full powers to run and manage the company or partnership, including a power to borrow money and grant security over the debtor's assets. Regardless of who appointed them, the administrator owes their duties to the debtor's creditors as a whole.
- On enforcement, the only deduction to be made from fixed charge realisations is the cost of realising the asset. However, legislation provides that the costs and expenses of the insolvency officeholder, sums due to preferential creditors and also a percentage of realisations that are compulsorily ring-fenced for unsecured creditors must be paid in priority to any sums due to a floating charge holder.
- Administration provides for a stay on all action against the debtor (including litigation against the debtor and the enforcement of security) and can be used to facilitate (controversially in some cases) pre-packaged sales of the company’s or partnership’s business. Despite the stay, an administrator has no power to sell assets which are subject to fixed charge security without first obtaining the permission of the charge holder or the court.
- Administration lasts for one year but can be extended initially with creditors’ consent for a further year and afterwards for a period fixed by order of the court. The moratorium on creditor action remains in place for the duration of the process.
Compulsory liquidation /
Compulsory winding up / Winding up by the court
- A terminal insolvency process commenced by court order against a company or limited liability partnership, usually at the instigation of an unpaid creditor.
- It is commenced by petition filed by the entity itself, its directors/members or one or more creditors. The presentation of a petition does not operate as an automatic stay of proceedings against the debtor. However, dispositions made by a debtor after the presentation of a petition will be void if a winding-up order is subsequently made.
- If a winding-up order is made, a licensed insolvency practitioner is appointed to act as liquidator and the powers of the company’s directors/members of a limited liability partnership/partners cease. It is unusual for a company or LLP to trade in liquidation. Instead, the liquidator's role is to realise the debtor's assets and distribute the proceeds to creditors.
- Proceeds are distributed, broadly, first to the secured creditors and then the unsecured creditors receive the remainder according to the principle of pari passu (in proportion to the amount of debt owed to them when compared with the total amount of unsecured debt of the company). Once all distributions have been made, the debtor will be dissolved.
- Compulsory liquidation brings a stay on court proceedings against the debtor, but it does not prevent secured creditors from enforcing their security.
- On enforcement, the only deduction to be made from fixed charge realisations is the cost of realising the asset. However, legislation provides that the costs and expenses of the insolvency officeholder, sums due to preferential creditors and also a percentage of realisations that are compulsorily ring-fenced for unsecured creditors must be paid in priority to any sums due to a floating charge holder. A liquidator owes their duties to the creditors of the company as a whole and must act in the interests of all creditors.
Creditors voluntary liquidation /
Creditors voluntary winding up
- A terminal process commenced by resolution of the company’s shareholders or, for limited liability partnerships, by a decision of its members.
- A licensed insolvency practitioner is appointed to act as liquidator and the powers of directors/ members cease. It is unusual for a company or limited liability partnership to trade in liquidation. Instead, the liquidator’s role is to realise the debtor’s assets and distribute the proceeds to creditors. The liquidator owes their duty to the creditors as a whole.
- Once all distributions have been made, the company or limited liability partnership will be dissolved.
- There is no automatic stay on actions against the company or limited liability partnership but on application the court may grant such a stay either generally or in relation to specific claims. Such court orders are rare and there is usually nothing to prevent secured creditors enforcing their security.
Company voluntary arrangement (CVA)
- Allows a solvent or insolvent company or limited liability partnership to propose a compromise with its creditors which, if accepted by 75% of creditors who participate in the decision whether or not to approve the proposal, is binding on all of the debtor's unsecured creditors (unless 50% or more of unconnected creditors vote against the proposal). It is therefore commonly used to cram-down dissenting creditors.
- A CVA cannot affect the rights of secured or preferential creditors without their consent.
- Unless it is proposed by a debtor that is already in administration or relates to a small company (one of the criteria being that it has fewer than 50 employees), there is no automatic stay of actions against the debtor. However, a small company may obtain an order of the court staying creditors' actions for the period during which the CVA proposals are circulated among creditors and until creditors decide whether to accept or reject a proposal. During that time, no steps may be taken by secured creditors to trigger a default nor to enforce security.
Protected Trust Deeds
- This is a voluntary arrangement that a debtor (being a natural person, general or limited partnership) reaches with their creditors to compromise their debts.
- The arrangement takes the form of a trust deed granted in favour of a Trustee who will be a registered insolvency practitioner. The trust deed effectively creates a voluntary form of sequestration with the same assets being transferred to the Trustee as would vest on sequestration, the Trustee being given the same powers and the Trustee being directed to distribute funds in the same way. The debtor will usually agree to pay a fixed contribution from income in addition.
- There is a statutory process that must be followed (circulars to creditors with an opportunity to object) for the trust deed to acquire “protected status” and thus make the arrangement binding on creditors and protect the debtor from enforcement action. Objections are required from one-third of creditors in value to prevent the trust deed becoming protected.
Debt Payment Programme under the Debt Arrangement Scheme
- A statutory scheme that allows natural persons, general or limited partnerships to manage and repay their debts. It is a debt management tool rather than an insolvency procedure and does not involve any compromise of debt. It is, however, possible to freeze interest, fees and charges on debts and to extend the period over which debts are repaid.
- An application for a Debt Payment Programme is made through an Approved Money Adviser. Creditors have the opportunity to object but objections may be overridden by the Accountant in Bankruptcy as the DAS Administrator if it is determined that it would be fair and reasonable to allow the Debt Payment Programme to proceed.
When a natural person is unable to pay their debts, one or more of their creditors may petition the court for an award of sequestration to be made against him. Alternatively, the debtor may himself apply to the Accountant in Bankruptcy for their own sequestration. The same procedure applies regardless of whether the debtor was in business or not.
- Statute provides that almost all of the debtor’s assets vest automatically in their Trustee in Sequestration. The Trustee continues to manage the debtor’s bankrupt estate even after the debtor has been discharged from sequestration (usually a year after the award of sequestration is made).
- An award of sequestration does not prevent secured creditors from enforcing security.
- The same terms apply to general and limited partnerships.
A receiver may be appointed out of court to a company by a creditor who holds floating charge security over the whole or substantially the whole of the company's assets.
- The directors’ powers cease on their appointment.
- The receiver’s role is to realise the secured assets in order to repay the debt due to the secured creditor. A receiver can sell assets by private sale. The receiver owes their duties primarily to the secured creditor who appointed him.
- Following changes in the law, receivership is now very rare.
Secured creditor in possession of heritable property
- A creditor who holds security over heritable assets of a company, all forms of partnership or a natural person, may call up their security and seek to take possession of the secured asset in order to sell or lease it to repay sums due.
- A court order may be required before the secured creditor may take physical possession.
Anticipated changes in the next two years
The Accountant in Bankruptcy is currently carrying out a review of the debt enforcement (diligence) processes in Scotland.
The EU Directive on Restructuring and Insolvency1 requires Member States to incorporate minimum common standards into their national restructuring and insolvency laws by 17 July 2021. The intention of the Directive is to reduce barriers to the free flow of capital stemming from differences in Member States’ restructuring and insolvency frameworks, and to enhance the rescue culture in the EU.
Notable features required to be included in Member States’ national laws include:
- An effective preventive restructuring framework to enable debtors experiencing financial difficulties to restructure at an early stage, with a view to preventing insolvency and ensuring their viability.
- A stay of up to four months extendable to up to 12 months to support negotiations of a restructuring proposal, which should prevent individual enforcement action and include rules preventing the withholding of performance, termination, acceleration or modification of essential contracts.
- An ability to cram down dissenting classes of creditors.
- Adequate protection for financing needed to allow the business to survive or to preserve the value of the business pending a restructuring, and for new financing necessary to implement a restructuring plan.
- Provision for honest, insolvent entrepreneurs to have access to a procedure that can lead to a full discharge of their debts (subject to limited exceptions) within three years.
The UK is expected to leave the EU before 17 July 2021. Therefore, it is not anticipated that Scotland will be required to implement the Directive. However, the UK may choose to align its national laws with the standards required by the Directive in order to remain competitive in the market. In 2016 and 2018, the government consulted on potential changes to the UK corporate insolvency regime, many of which mirrored key provisions in the Directive. It is currently uncertain which if any of the proposed changes will be progressed.
Contact: Robert Russell and Chris Parker
1 Directive (EU) 2019/1023 of the European Parliament and of the Council of 20 June 2019 on preventive restructuring frameworks, on discharge of debt and disqualifications, and on measures to increase the efficiency of procedures concerning restructuring, insolvency and discharge of debt, and amending Directive (EU) 2017/1132.