Thu 28 Jul 2022

Is corporate insolvency all that different in Scotland?

During the very first wave of the coronavirus pandemic, there was a consensus that insolvencies were likely to rise, with most people expecting the much heralded “tsunami" of insolvencies.  Of course, that "tsunami" is yet to occur and while the pandemic impact has arguably lessened, it has been replaced by global economic pressures and rising inflation.

There are also a swathe of zombie companies which have, until now, limped on due to Government interventions but will eventually need to be put out of their misery.  All this means that the increase in insolvencies remains highly likely at some stage. With that in mind, it is worth considering the major differences between corporate insolvencies in Scotland and England.

1. There is no Official Receiver in Scotland

In England and Wales the Official Receiver, who is a government civil servant, will take corporate insolvency appointments.  That is not the case in Scotland, where in every corporate insolvency a qualified insolvency practitioner must have consented to act as administrator, liquidator or receiver (as appropriate).  This means that there is no liquidator of last resort in Scotland, although it does also mean that there is no Official Receiver to take a percentage of the asset realisations.

2. There is no such thing as an LPA Receiver in Scotland

The appointment of a Law of Property Act Receiver, where a fixed charge security holder appoints someone to take control of the charged asset (usually to sell, or take control of the rents), is a powerful tool.  Alas, it is a powerful tool which is not available in Scotland.  We do not have LPA Receivers in Scotland, nor anything equivalent.  The only receiver recognised in Scotland is an Administrative Receiver under the Insolvency Act 1986.

3. The law on challengeable transactions is different

Just like in England and Wales, the Insolvency Act 1986 provisions mean that transactions that are entered into by a company before a formal insolvency process begins can be challenged in Scotland if they are detrimental to the company's creditors.  However, there are some important differences in the law between both jurisdictions.

Gratuitous alienations / transactions at an undervalue

In Scotland, we use the term "gratuitous alienation" to describe a transfer at an undervalue, where a company has transferred an asset to a third party and not been sufficiently compensated in return. But it's not just the terminology that's different. 

For starters, the challengeable period, during which a transaction entered into by the company can be attacked, is different. In Scotland, the period is 2 years prior to formal insolvency if the transfer was to an unconnected third party, and 5 years if the transfer was to a connected party, such as a director or a group company, or to an associate of a connected party – for example, to the director's spouse.  In England and Wales, the relevant period for both is 2 years, which is considerably different to Scotland.

The available defences are different too.  In Scotland, it does not matter if the company was acting in good faith when it transferred an asset for too little. What matters is the impact on the creditors.   However, if the transferee can show that they paid adequate consideration for the asset, or the company was balance sheet solvent either immediately before the transfer or at any time following the transfer, or that the transfer was a conventional gift or charitable donation which was reasonable to make, then the transfer will stand and will not be successfully challenged. 

Unfair preference

Although the same term of unfair preference is used in both jurisdictions to describe the situation where a company has unfairly preferred one creditor – for example, by paying a debt, or granting a security over old debt – to the detriment of the general body of creditors, the time periods for challenge and available defences are, again, different. 

In Scotland, the relevant period for a potential challenge is 6 months prior to formal insolvency, regardless of whether the preferred creditor was connected to the company.  That contrasts with England and Wales where, although the relevant period for an unconnected creditor is also 6 months, the period for a connected creditor is 2 years. 

And once again, the intention of the company to prefer one creditor over the others is not necessary to be successful in a challenge. This means that the absence of that intention is not a defence. 

Instead, if the creditor can show that the transaction was in the ordinary course of trade or business, or they received payment in cash for a debt which had become payable – unless collusive with the purpose of prejudicing the general body of creditors – or, the parties to the transaction undertook reciprocal obligations – again, unless collusive with the purpose of prejudicing the general body of creditors – then the challenge to the transaction as an unfair preference will not succeed.

Common law challenges

Although the use of the statutory challenges set out above is significantly more widespread, it is possible to challenge gratuitous alienations and unfair preferences at common law.  In practice, that does not happen terribly often, largely due to the more significant evidential burden, but the benefit to the common law challenges is that the time limits set out above do not apply. 

4. The underlying Insolvency Rules are not the same

As anyone dealing with insolvency cases will know, the provisions of the Insolvency Act 1986 only take you so far.  Much of the technical detail comes from the underlying rules.  There are different rules in Scotland - the Insolvency (Scotland) (Company Voluntary Arrangements and Administration) Rules 2018 and the Insolvency (Scotland) (Receivership and Winding Up) Rules 2018.  Although the technical detail of the rules is supposed to mostly mirror the rules which apply in England and Wales, there are still some differences, such as approval of fees, which are something to be alert to. 

Final thoughts

Although the underlying law comes from the same statute - the Insolvency Act 1986 - there are some quite significant differences in insolvency law between Scotland and England and Wales. Given that at some stage, we are almost certainly going to see an uptick of some size in the number of corporate insolvencies, it is very important to keep those key differences in mind.

This article was first published in Legal Brief.

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