Corporate insolvency winding up – balancing supporting and opposing unsecured creditors

On a creditors winding up petition, the Insolvency Act 1986 (IA) states that a “court may dismiss it or adjourn the hearing conditionally or unconditionally or make an interim order or any other order it thinks fit…” It also highlights that the court may consider the wishes of the creditors or contributories and the powers the court may or must exercise to ascertain those wishes. This can be particularly difficult where there are supporting and opposing unsecured creditors. This article explores how the court balances the interests of supporting and opposing unsecured creditors when considering winding up petitions.

Winding up orders – who gets a say in the process?

Usually, when a winding up petition is pursued and it is undisputed, the petitioner is entitled to a compulsory winding up order as of right. However, it is important to remember that this is a representative right for the benefit of the class the petitioner is a member of, and not solely for the petitioner as an individual. This is why it is known as a ‘class remedy’. Therefore, the interests of all those within that class must be considered when determining whether to grant the class remedy. For instance, if a debtor has other unsecured creditors, these creditors may have an interest in whether the debtor is wound up or not. This is because a winding up order will affect their ability to enforce their rights against the debtor.

When the winding up order is made, the creditors are confined to one collective enforcement process i.e., one for the benefit of the whole class, being all of the unsecured creditors. The debtor’s assets are therefore not available on a ‘first come, first served’ basis, but instead, in accordance with a prescribed statutory distribution scheme. This prescribed statutory distribution scheme essentially provides an order by which each different class (including the (non-preferential) unsecured creditor class) can recover from the debtor.

What does the court do if some creditors are in support of a winding up order being made, but others are against it?

Where there are some opposing unsecured creditors, the court will undertake a balancing exercise. The point is that the court will “have regard to the wishes of creditors or contributories as to all matters relating to the winding up of a company”. The balancing exercise is not a mechanical arithmetical exercise, with the side with the majority value always prevailing. There are other factors.

The focus is on unsecured creditors, because secured creditors, are likely to be protected in any event and therefore are unlikely to have much interest in whether the company is wound up or not.

Where the majority by value lies is important, just not decisive. Even if there was a majority of opposing creditors, the court would still need to be satisfied that they have good reasons for refusing to wind up the company.
A majority of creditors in support of a winding up order is not necessarily decisive either – other factors will be relevant, such as the reasons for taking the positions they do.

So, the balancing exercise is circumstantial and will depend on various factors such as the value of the debts of the creditors on each side among the class, and whether they are commercially rational for the class as a whole. The existence of extraneous factors such as personal antipathy or affection for the debtor (whether arising from some connection or not) are likely to deplete any weight given to these voices. Other extraneous factors could arise from the creditor holding other roles, capacities, statuses, or interests. This would indicate that the creditors may not be “… acting in the interests of the class of unsecured creditors” – as he should be – remember, it is a representative right.

Examples of commercially rational reasons

Good reasons

• An opposing creditor opposes a winding up petition so that the class of unsecured creditors can have a better chance of getting paid, if, the debtor’s assets are not collectively ‘seized’ but rather, the debtor is given more time to return to solvency (though this comes with the risk that individual creditors will try to enforce against the debtor’s assets during its attempted turnaround). It may also be argued by an opposing unsecured creditor that liquidation might cause the available assets to be reduced.
• A supporting creditor may have a commercially rational reason for supporting a winding up petition because liquidation is likely ‘to swell the estate of a company or otherwise improve the lot of the unsecured creditors’.

Bad reasons

• To gain a preference over the secured and unsecured creditors. This would be seen as a reason based on extraneous factors, as it is individual to that creditor and could be seen as failing to act in the best interests of the class of unsecured creditors.
• Where a part secured/part unsecured creditor opposes a winding up order, to protect the security they received. The opposition would not be for the benefit of the general body of creditors but for an extraneous purpose, to protect the particular creditor’s proprietary right of security.

Adjournment for CVA (Company Voluntary Agreement) proposals

A creditor may oppose an immediate winding up order, with the petition adjourned/stayed, to enable something else to occur in the interim. This could be for administrative reasons such as to be able to dispose of the company’s stock more advantageously. It could be to enable a CVA proposal to be considered and approved. The CVA would then take precedence, resulting in the winding up petition being made redundant.

The court acknowledges that the IA permits the unsecured creditors to determine whether a CVA proposal should be approved or not. It is the creditor’s decision whether to decide whether to approve a CVA proposal, not the decision of the court.

This is something supporting creditors to a petition should be aware about. In situations where a CVA proposal is likely to be approved, the creditors would be prevented from being able to rely on the powers of the court to perform a balancing exercise.

Where the debtor company is already in voluntary liquidation

A company already in a liquidation because its shareholder voting to put the company into liquidation (voluntary liquidation) can be made subject to a winding up order. In the same way as above, a petitioner in this situation will have a right to a winding up order, despite the company already being in liquidation, but of course be subject to the court applying the balancing exercise, in a similar fashion.

Summary

A creditor’s winding up petition is for the benefit of the general body of unsecured creditors, it is not for the benefit of the petitioning creditor. Where there are other unsecured creditors, the right to a winding up order requires consideration of the interests of the debtor company’s general body of unsecured creditors. The other creditors may support or oppose the petition, and if there are opposing creditors, the court will conduct a balancing exercise. The weight given to supporting/opposing creditors positions, will depend on a variety of factors, including their relative debt size and the reason(s) for their position, whether they are motivated by commercially rational reasons – in the interests of the general body of unsecured creditors as a whole, or by extraneous factors not shared by the general body of unsecured creditors.

For more information on corporate insolvency, please contact Alexander Neale.

This is a condensed version of the original article co-written by commercial property lawyer Tom Marshall, trainee lawyer Cameron Tinkler and barrister Simon Hill from 33 Bedford Row. You can read the full article here.