LCN Corporate Simplification Guide Part 10 – Dealing with insolvent companies

This article forms part of our guide to corporate simplification and legal entity reduction projects. Links to the other parts of the guide are at the end of this article.

It is not unusual that the companies to be removed as part of a corporate simplification project include ones with negative net assets. This article outlines an approach for dealing with the legal issues involved in relation to UK companies.

For the purposes of this article it is assumed that the group as a whole will ensure that all third party creditors will be satisfied in full, and that insolvent liquidation is not an option.

As with any exercise of this nature, the first step is due diligence – designed to identify and preserve material assets, and to identify and address material liabilities. This is addressed in more detail in the following article on managing the due diligence process.

Once the factual position of any given company has been established, the objective is usually to get the company into the position where it has no assets other than cash or intra-group receivables, and no liabilities other than intra-group creditors. The intra-group debtors and creditors can then be netted off (or settled in cash to the extent possible), leaving only an intra-group creditor. This can then be waived, allowing the company to be struck off.

This often involves dealing with the following issues:

  • Transferring non-cash assets
  • Dealing with third party creditors and counterparties
  • Dealing with intra-group creditors

These are addressed in turn below.

Transferring non-cash assets

The company you want to remove may hold non-cash assets – such as loan receivables, fixed assets, intellectual property, or a trade. By definition, the company will have no distributable reserves. This means that any transfer of assets must take place at market value, and not at book value (if lower). This is because a transfer at less than market value to a sister company or to a direct or indirect parent undertaking is likely to constitute an unlawful return of capital and would be void. For more information, see this article on intra-group transfers at market value or book value.

Dealing with third party liabilities (creditors and contract counterparties)

There are three main options for dealing with a third party liability.

  1. Settle the liability – the target company to be removed (or another company in the group) could settle the liability such that it is discharged. If this is done by another group company, then that company will become a creditor of the target company in respect of the amount paid on the target company’s behalf.
  2. Novate the liability to another group company (so that the target company is released from the liability) – this would usually require the consent of the third party, and would often be documented as a novation agreement signed by all three entities. The group company assuming the liability would again become a creditor of the target company in respect of the value of the liability assumed.
  3. Crystallise the liability by appointing a liquidator – this approach may be appropriate in the case of a contingent liability or an onerous long-term agreement such as a lease. An initial assessment would need to be made as to the likely amount of the liability, and the target company would generally need to be capitalized so that the target company’s directors can make the necessary declaration of solvency to start the liquidation process. Once appointed, the liquidator can then invite the creditor to claim in the liquidation, and has the right to disclaim onerous assets. More information on this is given in these articles on dealing with contingent liabilities and disclaiming onerous assets.

Dealing with intra-group creditors

Assuming that the target company is left in the position of having no assets and no liabilities other than an intra-group creditor, then the corresponding debt is generally waived so as to allow an application to be made for the target company to be struck off.

Leaving aside any tax complications, there are two potential issues here.

Firstly, if the creditor is not a direct or indirect parent company of the target company to be removed, there is a question as to whether the waiver will amount to an unlawful deemed distribution by the creditor. This is because the creditor could be said to be giving away value, for the benefit of its shareholder. (The issue is similar to the considerations as to the price at which non-cash assets can be transferred intra-group, as outlined above.) However, given that the debtor (the target company to be removed) is insolvent, it is arguable that the debt has no actual value anyway, and therefore the waiver is simply formalizing the reality of the position.

Secondly, in some cases the balance sheet of the intra-group creditor may be such that a direct waiver would cause problems by creating a position of negative assets or negative reserves, or both. If that is the case, then the benefit of the debt may be assigned to another company (such as the ultimate parent) before it is waived and written off. If the debt is assigned to a direct or indirect parent company of the debtor, then this would also remove the risk that the waiver could amount to an unlawful return of capital.

Read the other parts of this guide to corporate simplification projects:

Part 1 – What is corporate simplification?

Part 2 – Typical triggers and drivers

Part 3 – Quantifying the likely cost savings

Part 4 – Typical project blockages

Part 5 – The ‘corporate memory’ issue, and how to deal with it

Part 6 – Managing the due diligence process

Part 7 – Preserving assets

Part 8 – Using decision trees

Part 9 – Strike off or MVL?

Part 10 – Dealing with insolvent companies

Part 11 – Creating reserves using the solvency statement procedure

Part 12 – Transferring assets at book value or market value

Part 13 – Using cross-border mergers to remove companies

Part 14 – Removing companies with contingent liabilities

Part 15 – Disclaiming onerous leases

Part 16 – To recycle or not?

Part 17 – Restoring a company to the register

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