VocabuLaw

Insolvency

What is it and what does it mean?

Description of the legal term Insolvency:

Insolvency in the British legal system refers to a situation where an individual or a company is unable to pay their debts as they fall due. This status implicates both legal and financial challenges and triggers a series of legal processes tailored to resolve the situation in a manner that is equitable for creditors and, where possible, seeks to rescue the financial entity in distress.

At the heart of the insolvency regime in the UK is the Insolvency Act 1986, which provides the legal framework for dealing with financial failure and sets out the rights of creditors and the duties of the debtor. There are distinct processes for dealing with insolvency, depending on whether the insolvent party is an individual or a corporation. For individuals, the main insolvency procedures are bankruptcy and individual voluntary arrangements (IVAs). For companies, the procedures include liquidation, company voluntary arrangements (CVAs), and administration.

Liquidation, also known as winding-up, is the process by which a company’s assets are sold and the proceeds distributed to creditors. If the company is solvent, its shareholders may voluntarily choose to liquidate, whereas if the company is insolvent, creditors can petition the court for a compulsory liquidation.

Company voluntary arrangements and administrations are designed as insolvency resolution procedures that can allow a business to restructure its debts and potentially continue to operate. An administration, in particular, serves to provide a company with protection from its creditors while a plan is formulated to pay off debts or sell parts of the business.

Bankruptcy is a legal declaration of an individual’s inability to pay their debts, leading to the appointment of a trustee in bankruptcy who takes control of the debtor’s assets for the benefit of the creditors.

One of the essential principles of insolvency law is pari passu, which means that, in the distribution of a company’s assets, unsecured creditors are to be paid proportionately to the size of their claims, after secured creditors have been paid.

The UK insolvency framework is designed to provide transparency and fairness in the treatment of debtors and creditors, ensuring that the rights of each party are considered and balanced. Ethics and integrity are integral to the insolvency profession, and insolvency practitioners must be duly qualified and adhere to professional standards and regulations.

Legal context in which the term Insolvency may be used:

The collapse of British construction giant Carillion in January 2018 stands as a stark example of corporate insolvency. With liabilities nearing £7 billion, Carillion entered compulsory liquidation after rescue talks with its lenders and the UK government failed. This situation left thousands of employees jobless and disrupted the supply chain of subcontractors and smaller businesses integral to its projects. Carillion’s insolvency had significant ramifications, resulting in parliamentary inquiries and discussions about corporate governance, auditing practices, and the effectiveness of the regulatory framework for large private-sector service providers to the public sector.

Another poignant example is the administration of the British travel company Thomas Cook in September 2019. After failing to secure additional funding during its financial difficulties, Thomas Cook ceased trading, triggering the largest peacetime repatriation effort to bring back around 150,000 stranded British customers from abroad. The insolvency of Thomas Cook highlighted the vulnerability of the travel industry to shifts in market conditions and consumer habits, as well as the importance of insolvency laws that can swiftly address the fallout of a business failure on such a large scale, ensuring that affected parties are dealt with justly.

The term insolvency is central to the British legal ecosystem when addressing financial failures. The laws and procedures related to this state of financial distress aim to manage the orderly redistribution or reallocation of an entity’s assets, protect the interests of all parties involved, and ultimately contribute to market stability and faith in the economic system. Such laws also function as a deterrent and governance tool, prompting directors and management to make prudent financial decisions. The efficacy of insolvency laws is critical for maintaining trust in the British economy and legal system.

This website is for informational purposes only and may contain inaccuracies. It should not be used as a substitute for professional legal advice.