'Winding Up' Petitions Provide Alternative Collection Approach
From the May 2000 edition of Managing Exports
International credit professionals with an unsecured exposure in England have some protection against nonpaying debtors. They can file a winding up petition. John William Craig of Brachers Solicitors explained how the process works at the recent Credit 2000 conference in London: When a petition is filed, the creditor is essentially invoking a class remedy-that is, the creditor is not only acting for itself but technically for all others in the same class (usually, the unsecured creditors).
Winding Up as a Collection Tool
Craig says that the courts do not intend for winding up petitions to be used as collection tools. However, he says, "if a company pays the debt, the court is happy to dismiss the petition on such terms as to costs as the parties may agree." In practice, the petition ends up being used as a collection tool at times, although that is not the court's intent. These petitions must allege that the company is unable to pay its debts. Therefore, these petitions can only be used under certain circumstances.
Tests for Insolvency
The primary grounds for a winding up petition must be that a company is unable to pay its debts. The courts spell out two primary tests of this inability:
- The cash flow of commercial insolvency test. A company is insolvent when it is unable to pay its debts as and when they fall due. Under this test whether the company has vast wealth in assets that are tied up and cannot be realized does not matter. If it cannot pay its way, asks Craig, why should the creditors wait while the company attempts to liquidate some of its assets? Craig says that there is a general assumption of insolvency once it is shown that the company has not paid an undisputed bona fide debt whether this is a judgment debt or a trade creditors' petition debt.
- The balance sheet test. Craig describes this test as one where the fact that the company's assets are insufficient to discharge its liabilities can be shown. This can be arduous for creditors to prove. "There is usually an averment of balance sheet insolvency," says Craig, "but no specific pleading except perhaps where the accounts have been qualified under what was standard statement of accounting practice number two." He describes practice number two as when the auditors felt the company failed the balance sheet test and qualified the accounts. However, he says that one does not see many qualified sets of accounts.
When Is a Company Unable to Pay Its Debts?
The Insolvency Act of 1986 spelled out the conditions under which a firm would be deemed unable to pay its debts. They are:
- If it neglects to pay a statutory demand creditor whose debt exceeds £750 within three weeks of service of the demand. This provision applies primarily to statutory demand creditors;
- If execution or other process or the judgment is returned unsatisfied wholly or in part;
- If it is proved to the satisfaction of the court that the company is unable to pay its debts as and when they fall due. This is usually reserved for ordinary trade creditors who do not get a judgment or take any proceedings but go in cold; or
- If it is proved to the satisfaction of the court that the company's assets are less than the amount of its liabilities after taking into account its contingent and prospective liabilities. This is the balance sheet test.
How the Process Works
Craig says that after the petition has been filed, it must be served, and the creditor must wait seven working days before an advertisement can appear in the London Gazette. This gives the debtor an opportunity to resolve the matter should it wish to do so. If it doesn't, serious actions ensue.
Craig indicates that the company's bankers will usually freeze its bank account once the advertisement appears. Once this happens, coming to terms with its creditors will be more difficult for the company. With the bank account frozen, the company does not have access to its funds. The company needs to get a validating order, also known as a Section 127 Order, to have the account unfrozen. To do that, it may have to prove solvency, which, as discussed earlier, can also be difficult.
If the creditor has any real hope of working the matter out, it will keep the advertisement out of the newspaper until the last possible moment. Craig says that is ten to 15 days prior to the hearing date. The reason for this is that the advertisement must appear at least seven working days prior to the hearing. He advises that if the matter is not settled by that point, "the only way to concentrate the debtor's mind is to advertise." At the hearing, the company will either pay or a winding up order will be made, assuming the creditors have followed all the applicable rules.
The Company Pays Before the Ad Is Placed
Sometimes creditors get lucky, and the filing of the petition actually succeeds in getting the debtor to pay. In those cases, the creditor should receive not only the amount it is owed but also costs. When this happens, Craig says, an application can be made to the chief clerk of the court for leave to withdraw the petition without a formal hearing. It is usually granted as long as there is more paid supporting creditors.
Reading this, some may wonder if there is any value in Advertise. Under circumstances the creditor is well advised to place the advertisement. Craig says that if the debtor is paying everybody else or paying off its overdraft lines, the best way to stop this practice is to advertise. In actuality, some debtors will attempt to pay off their bank to get the directors out from any personal guarantees. Under these circumstances, the creditor is urged to place the advertisement at the first legal opportunity-after the seventh day.
Have All Your Ducks in a Row
Before undertaking the filing of a petition, the creditor must make sure that everything is as it should be and that the debt is clean. This not only means that the amounts involved should be correct, but also that there are no outstanding legitimate disputes. The solicitor handling the case for you will be quite clear on this matter for a very obvious reason. If the debt is not clean and the creditor was not advised of the issues, warns Craig, the solicitor dealing with the matter may be caught with a personal order for indemnity costs if the petition is stuck out as an abuse. Thus, most solicitors will insist on correctness.
The court fee for filing the petition is £150. Additionally, a £500 official receiver's deposit is required. The deposit is returned if the petition is paid out and dismissed. However, "the Official Receiver takes it toward his fees in the event that an Order is made although it does form part of the petitioner's costs, which are a first charge on the company's assets, subject to the costs of administration and realization," explains Craig. Thus, this process is not to be undertaken lightly as the creditor does bear some of the costs. International credit professionals who have trouble with their English debtors might want to consider a winding up petition should the collection issues become serious enough or the creditor believes others are being paid while they are not. Craig can be reached from the United States at 011-1622-690691.