When a privately-held company has no funds legally available to pay a mandatory redemption, do the preferred holders become creditors of the company?

 Insolvency for any company is a stressful period. When a private limited company enters into an insolvency situation, the directors are not only responsible to the creditors of the company. They are also responsible to the shareholders. When there are no funds to pay the preferred shareholders when their shares are redeemed, they become creditors of the company.

What are preference shares?

There are two different types of limited company shareholders – preference shareholders and ordinary shareholders. Ordinary shareholders who have invested in a limited company are issued with what are called ‘common stock’ shares. However, those that are issued with preference shares get what is called ‘preferred stock’. In general, it is only larger limited companies that issue preference shares and usually to outside investors.

Whilst both types of shareholders own a portion of the company and receive a dividend, the shareholders’ rights and privileges are different. Surprisingly, preference shareholders are not allowed to vote at shareholder meetings. This means that when it comes to key decisions, such as entering into insolvency procedure, they have no say in what happens but they do become creditors of the company.

Differences between preference shareholders and ordinary shareholders

Investing in a company as a preferred shareholder is less risky than being an ordinary shareholder as the dividend is fixed and is not linked to the company’s performance. So, if the company is experiencing a downturn in business, the preferred shareholders will still receive their dividend. That said, should the company become successful, their dividend will not increase.

Although preference shareholders receive a fixed dividend, there is no guarantee they will actually receive it regularly. If the company is having financial difficulties, other shareholders may vote against dividends being paid out. However, in all cases of dividends being paid, preferred shareholders must be paid before ordinary shareholders. This is the same if a company is insolvent and enters liquidation.

With preference shares, a company may issue redeemable shares. These types of shares enable shareholders to return their shares to the company, i.e. redeem their initial investment. This is a favoured option if a company plans to buy back the shares at some point in the future.

In normal circumstances, shareholders are not able to demand a return on their investment unless their company enters liquidation, in which case they become creditors of the company. The same applies to the company; they are not entitled to force shareholders to sell their shares back to the company.

What is the difference between insolvency and bankruptcy? How do these affect creditors and shareholders of a company?

Insolvency and bankruptcy – it’s confusing to know which applies to your business. Whilst the two are similar, they are also very different and don’t mean the same thing. Insolvency is when a company or an individual can’t pay their debts on time. Bankruptcy is the legal process that follows when an individual has been declared bankrupt.

A creditor can petition for insolvency and bankruptcy proceedings if the company owes them more than £750, and the debtor does not dispute the fact they owe the debt. In some cases, insolvency may end up in bankruptcy if the two parties are unable to come to an agreement regarding the debt owed.

What is insolvency?

Insolvency is where a business is unable to pay their debts to creditors on time. There are two types of insolvency:

• Cash flow insolvency – although the company’s assets are more than their liabilities, or debts, they do not have sufficient cash flow, or liquid capital, to pay the priority debts. Basically, they don’t have the cash as all their liquidity is tied up in assets. Most cash flow insolvencies can be resolved through a voluntary agreement with creditors whereby a lower regular payment is accepted until the company’s financial situation changes.
• Balance sheet insolvency – this is the reverse of cash flow insolvency in that the company’s debts are greater than the total value of its assets. That said, it doesn’t mean that all is lost. There are a variety of options for companies and creditors that don’t necessarily lead to liquidating the company or declaring bankruptcy.

What is bankruptcy?

Bankruptcy isn’t the financial situation, as in the case of insolvency. It is the legal procedure following being declared insolvent. Bankruptcy only applies to individuals, not partnerships or companies, although there are misconceptions about the use of the term bankruptcy, and it is often used in the wrong context. However, US companies can file for bankruptcy once declared insolvent, which is probably where the confusion comes from.

Insolvency and bankruptcy – the differences

Insolvency is the financial state of an individual, a sole trader, a partnership or a limited company. It is not the legal procedures or the options that can be agreed to in order to pay back a company’s debts.

Only an individual or sole trader can declare bankruptcy. Partnerships and limited companies can enter a debt management plan, go into administration or liquidate the company. If an individual owes more than £5,000 to any creditor or creditors, they can declare bankruptcy themselves, known as a debtor’s petition, or a creditor can petition the courts to declare the individual bankrupt, which is called a creditor’s petition. In the case of a debtor’s petition, the individual is liable for the court costs. If it’s a creditor’s petition, the creditor is liable for the court costs.

The impact of insolvency and bankruptcy on a company’s shareholders and creditors

When a company is declared insolvent, be it voluntary or compulsory, secured and unsecured, creditors are entitled to pursue recovery of the debt through the court or via the insolvency practitioner appointed to handle the insolvency process.

Whether it is proposing a company voluntary arrangement (CVA), putting the company into administration, or liquidating the company, the insolvency practitioner will liaise with creditors throughout the process. This includes putting forward any voluntary arrangements, organising and attending creditors’ meetings, distributing realised funds from the sale of the company’s assets according to a set hierarchy, and winding up the company with Companies House.

Not all creditors will receive a dividend to repay their outstanding debt. If there aren’t sufficient funds released from the sale of assets, unsecured creditors and shareholders may lose out.

In the case of a individual’s or sole trader’s bankruptcy, creditors are no longer entitled to chase for recovery of the outstanding debt and must cease all court action. The insolvency practitioner appointed to service the bankruptcy process handles all communication with the creditors, including all payments. Once the bankruptcy period has ended, usually after a year and known as discharge, any debts that are still outstanding are wiped off except for court fines and loans from the Student Loans Company. Creditors are no longer allowed to contact an individual to recover any outstanding debt after discharge.

If there is a shareholder’s agreement, it offers a level protection should the company become insolvent. It will also protect the shareholder against directors of the company trading unlawfully, which are serious allegations.

When a company becomes insolvent, it must stop trading in order to put the creditors’ interest first. A shareholder’s agreement, which overrides the company’s Articles of Association in insolvency cases, often stops a stand-off between shareholders and directors, particularly over the handling of debts and any conflicts, and enables a resolution to be implemented. The agreement will also help minority shareholders who, in different circumstances and without an agreement, would have little to no influence on important insolvency matters.

Is it possible not to pay back your debts by hiding your money from creditors?

 Not paying back your debts is not an advisable course of action. However, if you decide to go down this route, it’s best to know where you stand and what your legal rights are. Most of the time, your debts will be chased down by a debt collection agency but sometimes, it is the creditor that will pressure you into business debt payback.

 

What are debt collection agencies and creditors allowed to do when chasing a business debt?

It’s a worrying time dealing with business debt; creditors and debt collection agencies will put pressure on you for business debt payback. At the moment in the UK, there isn’t a regulatory body that governs debt collection agencies that chase business debt. There are certain guidelines that most agencies follow when dealing with debt collection cases.

 

Firstly, if the creditor has not contacted you regarding a business debt, and no action has been taken to recover the debt, the debt is called ‘statute barred’. Essentially, this means that time has run out for the creditor to collect the debt, despite the debt still being legally owed to the creditor. It is considered unfair if a debt collection agency or a creditor misleads a debtor into thinking that they are allowed to still recover the debt.

 

If you have told the debt collection agency or the creditor that you are not paying the debt but they continue to press for payment, it may be considered as harassment. This goes against Section 40(1) or the Administration of Justice Act 1970.

If you are being chased for business debt payback by more than one debt collection agency working on behalf of one creditor, this is considered bad practice.

 

When you query a debt with the debt collection agency or creditor, they should not continue to chase for business debt payback whilst the dispute is being investigated and resolved. The debt collection agency or creditor must detail the outstanding debt. In the eyes of the law, it is up to the creditor to prove the debtor owes them money, and why. It is not up to the debtor to prove they don’t owe the debt. Read more....

Can creditors come after my business for personal debts?

If you’re experiencing debt problems on an individual basis, and you have your own business, you may have been threatened by creditors that they can target your business for personal debts. In some circumstances, creditors can make a claim against your business to recover their debt. However, if you have a limited company, it is less likely to happen. That said, if you have signed a personal guarantee as a director, you are personally liable for that debt.

Types of personal debt

In early 2020, it was revealed that more than half of UK adults had personal debt up to £100,000. Indeed, 63% have entered the decade with some level of personal debt, excluding mortgages. Much of the debt includes overdrafts, loans, credit card and store card debts.

The most common form of personal debt is credit card debt. Creditfix’s survey showed that the average level of debt on personal credit cards is £3,000; men tend to owe £300 more than women. Additionally, most people don’t pay off the balance in full every month, with 22% of people paying just the minimum payment, or less.

Personal and business debt for sole traders and partnerships

Whether your debt is personal or business-related, when you are a sole trader, i.e. self-employed, you are liable for all your debts. In the eyes of the law, you and the business are one legal entity; your business is not separate from you. This means that any business or personal debts you incur will have to be paid by you.

Creditors are within their rights to take action not only against your business, but also against you personally. This will put your personal assets, such as your family home, and your business assets at risk.

As with sole traders, a partnership of two or more people is also considered one legal entity. That means that all partners are jointly liable for any debts. Creditors are entitled to take action against any of the partners to collect the debt, or all at the same time. In addition to this, if one partner pays more than their share, according to the partnership agreement, that partner is allowed to recover the extra money they’ve paid from the other partner, including taking court action. However, there are exceptions to this situation. Read more...

When a limited company in the UK goes bankrupt … Do the creditors receive any money or do they lose out?

It’s a worrying time for creditors when a limited company goes bankrupt or enters an insolvency process. The biggest concern, particularly for the smaller unsecured creditors, is whether they will ever receive the outstanding debt owed to them. There is a predetermined order in which creditors are paid during the bankruptcy or insolvency process, according to the Insolvency Act 1986, which often means that unsecured lenders may very well lose out. 

When a limited company becomes insolvent and enters into a bankruptcy or insolvency procedure, a top insolvency company in the UK is instructed to handle the process. It is the instructed licensed insolvency practitioner from that company that liaises with the insolvent business’s creditors and arranges for them to be paid.