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.
- One of the main rescue procedures 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 or insolvency office holders. 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.
- A director led process also introduced in 2020 which leaves the directors in situ to trade the company (or the members to trade a limited liability partnership) with an insolvency practitioner acting in the role of "monitor" overseeing the company’s affairs. The monitor supervises the moratorium and must be, and remain of, the view that a rescue of the company will be possible. The directors therefore remain in control of the company and the aim is to allow companies time to formulate a turnaround plan with a breathing space from creditor action.
- Companies are eligible to use the moratorium if the directors state that the company is, or is likely to become, unable to pay its debts and the monitor is of the view that it is likely a moratorium would result in the rescue of the company as a going concern. Companies already subject to an insolvency procedure, and those that have been in a moratorium, CVA or administration in the previous 12 months are excluded from using the process. Certain companies, including insurance companies and banks, are automatically excluded.
- There are two ways a company may enter moratorium:
- by the directors filing relevant documents at court (the out-of-court process); or
- by the directors making an application to court (the in-court process).
The in-court process is only required where there is an outstanding winding up petition or the company is incorporated overseas.
- The initial period for the moratorium will be 20 business days but this is capable of being extended or terminated early. An initial 20 business day extension is available without creditor/Court consent, so many moratoria may last 40 business days. Further extensions are available with the consent of creditors or the permission of the court.
- During the moratorium period:
- the day to day running of the business of the debtor company remains with the directors but under the supervision of a monitor (an insolvency practitioner) and with the monitor’s consent required before the directors can undertake certain transactions;
- creditors and lenders will not be able to take enforcement action against the debtor company (including enforcement of security) for pre moratorium debts; and
- landlords cannot exercise rights of forfeiture.
- The company must continue to pay certain of its debts during the moratorium. These include amounts due for new supplies made during the moratorium, rent in respect of a period during the moratorium, wages and salary, and amounts due under financial contracts, including loan agreements. These amounts must continue to be paid or the moratorium will have to end. As amounts due to lenders during the moratorium are among those which must be paid lenders have a large measure of control over the moratorium and it is expected that moratoria will generally be instigated with lender support/consent.
- Certain debts, largely those incurred during the moratorium, have priority status in an insolvency process which follows within 12 weeks of the end of the moratorium.
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.
- A CVA can be challenged within a 28-day period by dissenting creditors on the basis that it is unfairly prejudicial or that there has been a material irregularity.
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.
- On 1 October 2021, the Accountant in Bankruptcy launched the "PTD Protocol" which sets out non-statutory changes to the Protected Trust Deed operational processes.
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.
- Individuals, partnerships (and some other types of businesses) can invoke a "moratorium on diligence".
- The moratorium lasts for a period of 6 weeks during which the debtor is protected from creditor enforcement. This 6 week period has been extended to 6 months until 31 March 2022 as a result of the COVID-19 pandemic.
- An application for a moratorium is made to the Accountant in Bankruptcy either directly by the individual (or the eligible entities) or via a Money Advisor.
- If a moratorium is granted then it will appear on the Register of Insolvencies and on the Debt Arrangement Scheme (DAS) register – a register which is publicly accessible.
- 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.
Enforcement of a standard security
- TThe process for enforcing a standard security is set out in statute. It must be strictly adhered to so as to prevent or limit the possibility of a challenge being raised. The holder of a standard security may exercise the rights contained within the security document or statute as appropriate where the debtor is in default. Such rights may be: to sell the secured property; to carry out necessary repairs; to enter into possession and recover rents; if in possession, to let; or to apply for a decree of foreclosure.
- The procedure to follow for the enforcement of a standard security will differ depending on whether the secured property is used to any extent for residential purposes or not.
- The secured creditor may only enter into possession and sell the secured property in the case of a financial breach where a calling up notice is issued.
EU Directive Implementation
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, with an option to extend that deadline by one year. 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 left the EU on 31 January 2020 and therefore it is not required to implement the Directive. However, the UK made several changes to its insolvency law in the course of 2020 many of which mirror key provisions in the Directive. For example, directors faced with financial distress can now weigh up the new restructuring plan, or the existing ‘tried and tested’ scheme of arrangement.
The restructuring plan also introduced a cross-class cram-down tool to the UK: the ability for a restructuring plan to bind one or more dissenting classes of creditors or shareholders.
Recognition of foreign involvency processes
Many restructuring matters will involve more than one jurisdiction. For example, a company registered in Scotland and being wound up under the Insolvency Act 1986 may have branches, subsidiaries or real estate assets located in overseas jurisdictions. When dealing with such cross-border matters, two key issues which often arise for insolvency practitioners are recognition and assistance.
There are various legislative tools within the UK which facilitate cross-border recognition, for example:
- The UNCITRAL Model Law on cross-border insolvency was enacted in the UK by the Cross Border Insolvency Regulations 2006. This is a set of model terms for UN Member States that provide a process for foreign office holders to apply to court for recognition and assistance;
- Section 426 of the Insolvency Act 1986 provides that a court in a country designated by the Secretary of State (including the Channel Islands, the Isle of Man and most commonwealth countries) can apply to the UK courts for assistance in insolvency proceedings. In providing such assistance, the UK court has a wide discretion and can apply local insolvency law or the relevant foreign insolvency law. The types of assistance the UK court might give under section 426 include an injunctive or administration order; and
- The EU Regulation on Insolvency Proceedings (Recast Insolvency Regulation) applies to proceedings opened in the UK on or after 26 June 2017 and before 11pm on 31 December 2020 (the end of the Brexit transition period). Whilst the Recast Insolvency Regulation will not be relevant to new UK insolvency proceedings, it is relevant to older UK proceedings and to proceedings in EU Member States. Where the Recast Insolvency Regulation does apply, it requires that certain collective insolvency proceedings occurring in one EU Member State are recognised in all other EU Member States and that each EU Member State automatically recognises the powers and authority of an insolvency practitioner appointed in another EU Member State.
Where there is no legislative tool available to allow recognition of insolvency proceedings or assistance of insolvency office holders, common law countries may still provide assistance based on common law rules.
Insolvency changes in response to COVID-19
For more information on changes to insolvency law in Scotland as a result of the COVID-19 pandemic please see our Guide to changes in insolvency law in response to COVID-19.
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.