News, Advice and Discussions on British Law

Despite the UK’s economic fortunes improving somewhat of late, hundreds of businesses are still falling into insolvency every month.

According to credit firm Experian’s Insolvency Index, a total of 1,491 firms became insolvent in May 2010.

Under UK business law, insolvency is defined in the Insolvency Act 1986 Section 123:

123. Definition of inability to pay debts (i.e. insolvent)

A company is deemed unable to pay its debts – [...]

(e) If it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due. (Known as cash flow insolvency.)

1. A company is also deemed unable to pay its debts if it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities. (Known as balance sheet insolvency.)

Liquidation
If your business becomes insolvent it may be put into liquidation. This is where the assets and property of the business are redistributed to satisfy all claims of your creditors.

The liquidation process can be instigated by the directors and shareholders of the insolvent business but the process will only be legally effective if there is a convening of a meeting of creditors where they can appoint a liquidator of their choice – known as creditors voluntary liquidation (CVL).

Alternatively, a creditor can petition the court for a winding-up order which can place the insolvent business into a compulsory liquidation.

Generally, the priority of claims on the insolvent company’s assets will be determined in the following order:

1. Firstly, the costs of the liquidation are met out of the company’s remaining assets
2. Secondly, the preferential creditors under applicable law are paid
3. Thirdly, in many legal systems, the claims of the holders of a floating charge will be paid; other claims may also fit into this layer
4. Fourthly, if there is anything left, the unsecured creditors are paid out proportionally in accordance with their claims. In many jurisdictions, a portion of the assets which would otherwise be caught by a floating charge are reserved for the unsecured creditors.
5. In the very rare instances where the unsecured creditors are repaid in full, any surplus assets are distributed between the members in accordance with their entitlements.

There are two insolvency procedures available to companies; these are Administration or a Company Voluntary Arrangement.

Administration
Administration is a procedure designed to avoid, or at least delay, liquidation. Businesses in Administration appoint an Administrator, who must be a licensed Insolvency Practitioner, to manage the company’s affairs and protect the interests of creditors while restructuring the company so that it can continue as a going concern.

One particular type of Administration is pre pack administration. This is where the Administrator immediately completes a pre-arranged sale of the business, often to its directors or owners, to enable a best price to be achieved and thus maximise the price of assets for the business’ creditors.

Company Voluntary Arrangement (CVA)
A CVA is a legal agreement between an insolvent business and its creditors where a fixed amount lower than the outstanding actual debt is paid to creditors. These payments are usually made on a monthly basis and remaining debts are written-off at the end of the agreed terms. The CVA is managed by a Supervisor who must be a licensed Insolvency Practitioner. If the CVA fails, the insolvent business is usually put into liquidation.

To lay the foundations for a successful business it is important to give due thought and consideration to the legal decisions you make when starting a business. Read further for legal advice on all the business law issues that arise when setting up a new business.

Establishing a structure for your business
Sole trader, partnership or limited company?
Under business law, one of the first things you need to do when establishing your own company is to decide the on the structure of the business.

There are essentially 3 structures to choose from and each has its own advantages and disadvantages.
They are:

• sole trader
• a partnership with one or more people
• a limited company

Sole Trader
This is the simplest form of business model. There are no legal formalities required to set yourself up in business as your own boss. The downside is that you also carry the can if things go wrong. You are personally liable for all the debts of the business, and creditors could look to your house, car, savings etc. to settle any money owed to them. You do not have to produce audited accounts, but you will need to keep records for the taxman. If you do set up in business on your own in this way you should advise your tax office, as you will now be taxed as a self-employed person.

In Partnership
If you set up your business with one or more people, then you will be in partnership, whether or not you actually get anything down on paper – even if the partners are other members of your family. Your partnership will be governed by the Partnership Act 1896 but generally this is not what you want or need. Anybody working together in partnership (including families) should get a Partnership Deed drawn up by a solicitor, which covers how the partnership will work on a day-to-day basis, how it can develop and how it can be ended. Generally each of the partners is personally responsible for all the businesses liabilities, whether they knew about them or not. Therefore choose your partners carefully. Partners remain self-employed and only need to prepare accounts for tax purposes (although we’d recommend you prepare them properly anyway).

Limited Company
This is the most formal way to run a business, but it has the added advantage of limiting your liability to the amount of share capital you have invested in the business. Note that banks and others will therefore ask you for personal guarantees for loans etc. The disadvantages are that there is a cost involved in setting up a company – you can buy one off-the-shelf for as little as £125 and that you have to comply with Companies Act legislation – accounts, records and returns at Companies House. As a Director you are no longer self-employed, but employed by the company, so you are likely to have to deal with National Insurance and PAYE Income Tax matters.

Registering your company name
Business names no longer need to be registered with any Government Department. They are now governed by the Business Names Act 1985. You’ll find an excellent guide to the Act on the Companies House website. You will need to display your trading name in accordance with the Act at your place of business, and on stationery and invoices etc.

Basically, when starting a business, you need to check, as best you can, that the name you choose to trade under is not the same or similar to any other business, particularly in your locality. If it is then you may find yourself being sued for “passing-off” i.e. trading on the back of someone else’s reputation, or even in breach of a trademark

If you set up a limited company then you will only be able to register a name which is not already on the register. You can search the Companies House Register online here.

Trading Laws
If you are going to be supplying goods and services to the public then you are going to need to know about certain bits of consumer legislation – such as the Sale of Goods Act (they must correspond with their description, be of satisfactory quality and be fit for the purpose) and the Trade Descriptions Act.

Terms of Trading
If you are going to be dealing with the public and other businesses then you need to get your Terms of Business sorted out. These deal with your contractual relationship with your customers and suppliers. They should cover such items as estimates for work, payment terms, transfer of title to goods, failure to perform contractual duties etc. The terms on which you trade should be as beneficial as possible to you (without putting your client or supplier off), and are unique to you and your business. It is worth getting them professionally drafted by a commercial solicitor.