What Is An Insolvency Avoidance Scheme?

An insolvency avoidance scheme is a way of attempting to avoid insolvent liquidation. Such schemes are typically designed to enable a director to evade the investigation that comes with going into liquidation when insolvent.

How Does An Insolvency Avoidance Scheme Work?

The theory behind an insolvency avoidance scheme is that if a director of an owner managed business sells their shareholding they can then resign as director and a new owner can appoint their own director(s) to take over.

The rationale appears to rely upon creating distance for a director from the point of sale when the company will then usually cease trading, to the time when the company closes, perhaps by being dissolved or in some cases still going into liquidation.

The oddity of such a scheme is that its effect can be achieved in much the same way by a director resigning and appointing a new director without ever selling their shareholding. However, if that were to arise then the promoter of the insolvency avoidance scheme might not have as much to sell to generate income from their scheme and the original owner would still be connected to the company.

Typically the promoters of such schemes will market them as a sale of the business for say £1 but at the same time the business owner selling their shares will need to go through the process of registering the share transfer to the new owner and to do that often will lead to them incurring legal costs. The promoter may arrange this for the director selling their shares with that process generating fees potentially directly or indirectly for the promoter.

Problem With Avoidance Schemes

The problem with such schemes (not perhaps unlike the position with tax avoidance schemes) is they simply do not work. A director of an owner managed company can dispose of their shares but they cannot dispose of their misconduct. Any attempt to do so is conceivably misguided and flawed from conception.

Having said that the basic principle is there is nothing to stop the shareholders of an insolvent (or solvent) company from selling their shares so long as they do so in accordance with the Articles of Association and any applicable shareholder agreement.

Way In Which Insolvency Avoidance Schemes Have Been Marketed

The marketing of insolvency avoidance schemes has been infected by a marketing machine that appears to cloud the integrity of such schemes. Some of these schemes have been closed down in the public interest.

Marketing which has been consistent with some of the following themes has arisen, each of which is irregular and potentially misleading:

• Dump the debt
• Keep the assets
• Avoid Insolvency Practitioners
• Avoid liquidation

Dump The Debt

An insolvency avoidance scheme (which could be considered to be a form of liquidation evasion scheme) based on the sale of the director’s shareholding and appointment of new director(s) does not dump any debts. 

Ignoring the unethical proposition of debt dumping, such concepts completely overlook that a limited company is a separate legal person from the directors. The debts of the limited company remain with the limited company and are not (absent a personal guarantee) the liability of the director personally. 

A change of business owner and director leaves the debts with the limited company; it does not dispose of the debts. 

Keeping The Company’s Assets

The suggestion of some schemes has been to say the former owners can keep the assets. 

A company that is insolvent simply cannot release the assets to directors. The Creditor Duty requires the assets of the company to be available for the benefit of creditors. 

It is a breach of director duty to engage in a scheme that appears to permit assets to be transferred out of an insolvent company, making it more insolvent, so that the former director or owner can take them. It is a complete non-starter.

Avoiding The Use Of An Insolvency Practitioner

An Insolvency Practitioner is a qualified, regulated individual who has to comply with the Code of Ethics and must have professional indemnity insurance. 

Avoiding seeking advice from an Insolvency Practitioner by using a scheme which may involve the use of unregulated and unqualified persons to engage in such practices is perhaps something notable to consider. 

Why would this be perhaps preferred to an Insolvency Practitioner?

Avoiding A Liquidation

Avoidance of liquidation has been a marketing tool of such schemes. However, liquidation is the orderly winding up of a company. It is generally the recognised and preferred route for winding up an insolvent company.

Insolvency avoidance schemes do not and cannot enable a director of an insolvent company to avoid liquidation. The company may well still go into liquidation only at a later date. All directors who have been directors of the company in the three years before going into voluntary liquidation will have their conduct reported on by the liquidator to the Insolvency Service. 

A director who envisages the deployment of an insolvency avoidance scheme will enable them to escape the inevitable scrutiny liquidation inevitably brings may overlook a key observation ie. that it will serve to highlight the potential need for their conduct to be investigated all the more because they have sought to bypass the normally recognised and accepted procedure.

To put the matter in context consider what happened and happens with many tax avoidance schemes involving director disguised remuneration. When the tax scheme is disclosed (as is usually required) on a director’s personal tax return surprise surprise – HMRC will often with some considerable expedition open a tax enquiry. It serves to highlight the need for investigation rather than dispose of the need for investigation. 

We would observe that insolvency avoidance schemes do not appear to work and simply seem to be hopeless. However, whilst they exist, they appear to have some notable disadvantages for directors who make use of them as highlighted above.

Furthermore, a feature perhaps capable of being overlooked is the loss of control that comes when the former director is replaced and this could be significant. 

He or she will thereafter lose control of what happens to the company records to the new director(s) which might have been of assistance to them if they had to justify transactions during their period of trading. They will lose some control of the appointment of a liquidator but crucially they will lose control of the narrative as to what happened when the business was trading because they will no longer be first to the table to explain matters to any potential future investigators and this may put them at a disadvantage.

Liquidate A Company