Insolvency, Receivership and Charges

Most companies that fail do not simply disappear. Their creditors try to get paid, and the law gives them tools to do it: a creditor with security can appoint a receiver, the company can strike a deal with its creditors, or it can be wound up. The law of charges decides who gets paid first.

Examiners return to this chapter every year, in short questions on the tests of insolvency, the circumstances for receivership, the differences between a fixed and a floating charge, and the qualifications of an insolvency practitioner.

This topic covers the meaning and types of insolvency, the four tests of insolvency, the survival options for a company in difficulty, receivership (appointment, powers, duties, liability, accounts and distribution), schemes of arrangement, compromise and netting, insolvency practitioners, the tax rules on restructuring, and fixed and floating charges with the negative pledge clause.

Insolvency: meaning, types and tests

Meaning and types

Insolvency occurs where a person or company is unable to pay its debts. The syllabus recognises two types: corporate insolvency and personal insolvency. May 2024 Section A asked for the two types, and the answer was corporate and personal insolvency. Where a company or limited liability partnership fails, it is the company or the limited liability partnership (LLP), and not its members, that becomes insolvent.

Insolvency may lead to the company’s end through liquidation, where its assets are distributed to meet creditors’ claims.

In May 2015 the examiners described an insolvent person as one who cannot meet his financial obligations to creditors when they fall due, so that his liabilities exceed his assets.

They gave the consequences of personal insolvency as:

• exposure to a bankruptcy petition by creditors
• exposure to being sued by creditors to recover their money
• transfer of the bankrupt’s assets to the trustee in bankruptcy when the petition ends
• embarrassment and harassment by creditors

In November 2020 they distinguished insolvency from bankruptcy: insolvency relates to a company, and bankruptcy to a natural person.

The consequence for a company is that it may lead to winding up, where its assets are distributed to its creditors.

The four tests for corporate insolvency

The Companies and Allied Matters Act recognises these tests:

1. Failure to pay on demand. The company is unable to pay a debt, as the Corporate Affairs Commission (CAC) regulations may determine, within three weeks after a demand for payment. The earlier examiner’s answers put the debt at more than ₦2,000.
2. Unsatisfied judgment. There is a wholly or partially satisfied court process issued in respect of a judgment debt. State it in the words of the Act.
3. The court’s finding. The court determines, after taking into account any contingent or prospective liability of the company, that the company is unable to pay its debts.
4. Balance sheet test. The company’s liabilities exceed its assets.

These tests were asked in November 2016 (three tests), May 2018 (three tests), May 2019 (for both a company and an LLP, 6 marks), November 2020 and May 2024 (three tests, 6 marks). The May 2017 multiple-choice question asked which item is not a test, and the answer was “outstanding debts owed to the company in excess of one billion naira”. Failure to file annual returns is also not a test (November 2014).

The survival options

The formal options for a company in financial difficulty are receivership, schemes of arrangement, netting, compromise, or winding up. Winding up is in the previous topic. The others follow below.

Receivership

What it is

Receivership is an alternative to liquidation. It is the right of a secured creditor to appoint a receiver to manage the company’s assets that are the subject of the creditor’s security. The receiver sells the assets, or collects the income arising from them, to satisfy the debt.

Appointment by the court and out of court

• By the court. The court may appoint a receiver, or a receiver and manager, of the property or undertaking of a company if the principal money or interest is in arrears, or the security or property is in jeopardy. A receiver so appointed is an officer of the court (section 552), and he must follow the court’s directions.
• Out of court. A receiver or manager may be appointed under the instrument of indebtedness, the debenture. He is the agent of the person on whose behalf he is appointed. If he is appointed manager of the whole or part of the property, he stands in a fiduciary relationship to the company and must observe utmost good faith in all transactions with it or on its behalf (section 553).
• No receiver for a naked debenture. A receiver or manager may not be appointed to enforce debentures that are not secured by a charge (section 205).

Notice and effect

• The receiver must give notice of his appointment to the CAC within 14 days, with the terms and remuneration. He must also send notice to the company at once.
• Every invoice, order for goods or business letter must state that a receiver has been appointed.
• The powers of the directors and shareholders to deal with the assets over which the receiver is appointed cease and are vested in the receiver. If he is also manager, he has power to carry on the business, although the directors remain in office and the shareholders are unaffected.
• The receiver must not be confused with the official receiver, a court official who protects the company’s assets between the winding-up petition and the winding-up order.

When a company is placed in receivership

Depending on the terms of the agreement between the company and its debenture holder, a company may be placed in receivership where:

1. the principal sum borrowed or the interest is in arrears;
2. the security or property is in jeopardy, that is, events have occurred or are about to occur which make it unreasonable, in the debenture holder’s interest, for the company to retain power to dispose of its assets;
3. the company fails to fulfil any of its obligations under the debentures or the debenture trust deed;
4. any circumstance occurs which, under the terms of the debenture, entitles the holder to realise his security;
5. the company is being wound up;
6. any creditor issues a process of execution against any of its assets;
7. the company ceases to carry on business; or
8. creditors holding more than one-half of the total owing on a class of outstanding debentures apply to the court for receivership.

May 2016 asked for these circumstances, and the examiners listed the same eight.

Receiver and receiver and manager

Powers (Eleventh Schedule)

These powers are deemed to be included in the debenture unless inconsistent with it, and the parties may expressly exclude them. They include the power to:

• take possession of, collect and get in the company’s property, with proceedings as needed;
• sell or dispose of the property by public auction or private contract;
• raise or borrow money and grant security over the property;
• appoint a solicitor, accountant or other professional to help him;
• bring or defend legal proceedings in the company’s name, and refer questions to arbitration;
• insure the business and property, and use the company’s seal;
• execute documents, and draw, accept, make and endorse bills and promissory notes in the company’s name;
• appoint agents and employ and dismiss employees;
• carry on the business, establish subsidiaries and transfer the business or property to them;
• grant or accept leases, surrender tenancies, and make arrangements and compromises;
• call up uncalled capital and claim in the insolvency of any person who owes the company money;
• present or defend a winding-up petition, and change the registered office; and
• do all other things incidental to these powers.

The syllabus adds that a receiver of the whole undertaking may borrow money, that the lenders may supply the funds, that a receiver has no obligation to keep the employees but must pay the wages for services rendered to the company in priority to other debts if he lets them go, and that receivership does not of itself affect the company’s contracts.

The company’s power to deal with the contracts of the charged undertaking ends from his appointment, and he may carry on with or terminate them.

Agency and duties

• At common law a receiver appointed by the mortgagee was the agent of the mortgagor. The rule in Medforth v Blake softened this by imposing a duty of care in equity. CAMA has no room for the old rule: the receiver is the agent of the debenture holder or mortgagee who appointed him, and the Act imposes specific duties in the interest of the company.
• His primary duty is to take possession of and protect the property, receive the rents and profits, discharge outgoings and manage the property for a beneficial realisation of the security.
• A receiver and manager stands in a fiduciary relationship to the company and owes utmost good faith in transactions with it.
• He must act in what he believes to be the best interest of the company as a whole, to preserve its assets, further its business and promote its purposes, as a faithful, diligent, careful and ordinarily skilful manager would. He may have regard to the interests of employees and members.
• Nothing in the articles, a resolution or a contract can relieve him of these duties or of liability for breach.
• He is personally liable on any contract he enters into, and may be indemnified only if he made it in the proper performance of his functions or with the express or implied authority of the appointor, subject to the rights of prior encumbrances.

Accounts

A receiver or manager appointed under a debenture secured by a floating charge over the whole or substantially the whole of the property must send an abstract of receipts and payments to the CAC, the debenture trustees, the company and every known debenture holder within two months after each 12 months from his appointment, and within two months after he ceases to act.

Where he is appointed under an instrument in other cases, the abstract is due within one month after each six months. A receiver who defaults is guilty of an offence and liable to a fine of ₦25 for every day of default.

Realising the security and distributing the money

• A receiver appointed under an instrument may sell the assets by auction or private treaty, but not fraudulently at an undervalue. He must show the duty of care when selling and is liable for negligent losses.
• Section 656 empowers a secured creditor to realise or deal with his security during the winding up of an insolvent company.
• A court-appointed receiver sells only with the directions, order or approval of the court.
• Unless the instrument or the court orders otherwise, money in the receiver’s hands is applied to: (a) the cost of realising the security; (b) the receiver’s expenses and remuneration; (c) the costs and expenses of trustees under any debenture trust deed; (d) the cost of any action by the debenture holder; (e) preferential debts out of the property subject to a floating charge, in priority to the debenture holders; and (f) the debenture debt and interest.
• Where there are many persons interested in the company’s assets, a court-appointed receiver should apply to the court for directions (section 552(2)), as the November 2021 solution stated.

Proceedings

The company’s legal personality remains, so the receiver sues and defends in the company’s name. He needs neither the leave of the court nor the concurrence of the shareholders.

Schemes of arrangement, compromise and netting

Arrangement (sections 710 to 717)

An arrangement means any change in the rights or liabilities of members, debenture holders or creditors, or any class of them, or in the regulation of the company, other than a change made under another provision of CAMA or by the unanimous agreement of everyone affected (section 710).

A special resolution may put the company into a members’ voluntary winding up and authorise the liquidator to sell the whole or part of the undertaking to another body corporate.

Compromise

Where a compromise is proposed between a company and its creditors, the court may order a meeting of the creditors, a class of creditors or the members. If a majority representing not less than three quarters in value support it, the compromise may be referred to the Securities and Exchange Commission (SEC), which appoints an inspector to investigate and report.

If the court is satisfied that it is fair, it sanctions it, and it then binds all the creditors or the class, or the members. A certified copy of the order is delivered to the CAC for registration and annexed to every copy of the memorandum issued afterwards.

Once sanctioned, the scheme binds all creditors, even secured ones who did not vote for it, and the directors remain in control and the shareholders’ powers are unaffected.

Netting (section 718)

Netting occurs on:

• (a) termination, liquidation or acceleration of a payment or delivery obligation under qualified financial contracts under a netting arrangement
• (b) calculation of a close-out, market, liquidation or replacement value of each obligation
• (c) conversion of those values into a single currency
• (d) determination of the net balance, by set-off or otherwise

Insolvency practitioners

CAMA 2020 listed the categories of insolvency practitioner, but the Business Facilitation (Miscellaneous Provisions) Act 2023 deleted that provision (section 868). The CAC is expected to issue guidelines from time to time. The November 2023 examiners listed five practitioners: a liquidator, a provisional liquidator or official receiver, an administrator, a receiver/manager and a nominee.

Qualifications (section 705)

1. a degree in law, accountancy or another relevant discipline from a recognised university or polytechnic;
2. at least five years’ post-qualification experience in insolvency matters;
3. authorisation by BRIPAN (Business Recovery and Insolvency Practitioners Association of Nigeria) or membership of another professional body recognised by the CAC; and
4. an authorisation of the CAC or other qualifications the CAC prescribes.

Under section 706, the CAC may recognise a professional body whose rules provide that its members are permitted to act, are fit and proper persons, and meet the education, training and experience requirements.

Tax on business restructuring

The Nigeria Tax Act (Chapter 9) deals with restructuring, and its focus is on mergers. When two or more trades or businesses merge, a new trade is not deemed to have started, so the cessation rules do not apply to the business that ended in the merger. If a business is sold or transferred and so ceases, the cessation rules in Part V of Chapter Two apply.

The parties must notify the tax authority of any restructuring before starting it (section 189).

Fixed and floating charges

The background

At common law a trading company has an implied power to borrow for its objects, unless its constitution or a statute prohibits it, and to secure the loan by a mortgage or charge over its property, including uncalled capital. CAMA gives the power in statute. Creditors rarely accept a naked debenture, so the company usually charges its assets.

A secured debenture is secured by a fixed charge, a floating charge, or both.

Fixed charge

• A fixed charge is a charge over specific property that fastens to the property when the charge is created. The identity of the property does not change, though it may be extended. The property or class of assets must be sufficiently described in the instrument.
• It is usually over land, buildings, plant and other fixed assets, and not over shifting assets such as stock in trade. But the syllabus says the true test is whether the debtor’s freedom to manage the assets in the ordinary course of business is restricted, not the nature of the asset. Book debts and after-acquired property can be subject to a fixed charge.
• It takes the form of a mortgage, legal or equitable. A fixed charge expressed in a deed is a legal mortgage. An equitable mortgage arises, for example, from deposit of title deeds.
• For a series of debentures, a trust deed appoints trustees and vests the charge in them.
• It binds the property in the hands of third parties, and the company cannot dispose of the property without the chargee’s consent.
• Advantage: a particular asset is available on default, and it has priority over later floating charges. Disadvantage: the chargee is confined to the assets charged, even if they fall in value or fall short of the debt.
• Priority. Section 204: a fixed charge has priority over a floating charge on the same property, unless the floating charge forbade later prior charges and the later chargee had notice. Section 207(4), as amended in 2023: the holder of a fixed charge has priority over other debts of the company, including preferential debts.

Floating charge

A floating charge is an equitable charge on all or any of the company’s property, whose constituent items constantly change. In Illingworth v Houldsworth it was described as ambulatory and shifting, hovering over the property until some event makes it settle and fasten on it.

The Supreme Court adopted this in Intercontractors Nigeria Ltd v UAC: it floats until the event stated in the debenture deed makes it settle, remain fixed and crystallise into a fixed charge. In Evans v Rival Granite Quarries it was called a present security over all the assets in it, but not a specific security.

The statutory definition (section 203(1))

A floating charge is an equitable charge over the whole or a specified part of the company’s undertaking and assets, including cash and uncalled capital, present and future, but so that it does not stop the company dealing with those assets until:

1. the security becomes enforceable and the holder, under a power in the debenture or deed, appoints a receiver or manager or enters into possession;
2. the court appoints a receiver or manager on the holder’s application; or
3. the company goes into liquidation.

Three features

1. a charge on a class of assets, present and future;
2. a class of assets that in the ordinary course of business would change from time to time; and
3. an understanding that until the charge attaches on crystallisation, the company may deal with the assets in the ordinary course of business.

Advantages of a floating charge to the company

These appear in the exam as “two advantages” (November 2017 and November 2022). The syllabus gives five:

1. It is a valuable way for a going concern to raise money on the security of its assets while keeping the power to deal with them in the ordinary course of business.
2. It is the most convenient security where the company has little fixed assets but a large stock in trade. A fixed charge would need the chargee’s consent to sell each item.
3. It lets stock be turned over in the ordinary course, and the charge attaches to whatever the stock is converted into and to new stock acquired.
4. It gives the chargee a measure of control and protection against unsecured creditors on crystallisation, because the company reports regularly if in difficulty.
5. It is an incentive to creditors to give larger credit to an expanding business. The company may create a later fixed charge over the same assets unless the floating charge provides otherwise.

Legal consequences

• The charge covers all present and future assets in it, and anyone acquiring them takes them subject to it. But it gives an immediate charge that attaches to no asset until crystallisation.
• While it floats, the chargee cannot exercise proprietary or possessory rights, and cannot get an injunction against the company dealing with the assets in the ordinary course of business, where the security is not in jeopardy.
• The company can sell property and give a good title to the buyer, who takes free of the charge. The sale money becomes subject to the charge.
• The company may grant a fixed charge over property in the floating charge in the ordinary course of business. The fixed charge has priority over it, unless a negative pledge clause prohibits it.

The negative pledge clause

This is a covenant not to grant any later security ranking ahead of or equally with the existing charge, without the debenture holder’s consent. It protects the floating charge by limiting the company’s dealing powers. Under section 204, though, it protects the chargee against a later fixed chargee only if that chargee had actual notice of the prohibition when the charge was granted to him.

Fixed and floating charges compared

Receivers and floating charges

The court may appoint a receiver, or in the case of a floating charge a receiver or manager, where the charge has become enforceable.

Even if it has not, the court may appoint one if it is convinced that the debenture holder’s security is in jeopardy, because events have occurred or are about to occur making it unreasonable for the company to keep its power to dispose of its assets.

Working through the rules

Which test of insolvency?

Which charge, and when does it crystallise?

Receiver’s distribution in figures

A receiver sells property subject to a floating charge for ₦100m. Costs of realising are ₦5m, receiver’s remuneration ₦5m, preferential debts ₦15m, and the debenture debt with interest is ₦100m. The money goes: ₦5m (costs), ₦5m (remuneration), ₦15m (preferential debts), leaving ₦75m for the debenture holder, who is short by ₦25m. If the debt were secured by a fixed charge, the holder would have priority over preferential debts under section 207(4).

Receiver’s abstracts

A receiver is appointed under a floating charge on 1 January 2025. The first abstract covers 12 months, to 31 December 2025, and is due within two months, by 28 February 2026. If he is appointed under an instrument in another case, the abstract is due within one month after each six months, so the first covers to 30 June and is due by 31 July.

Worked problems

Problem 1: Jaugernault Plc and the bank

1. The nature. It is a charge, and because it is over specific property that the company cannot deal with in the ordinary course, it is a fixed charge.
2. Mortgage or pledge. A mortgage transfers an interest in property as security, subject to cessation on redemption. A pledge involves handing over possession of goods. Here the house is transferred under a deed, so it is a mortgage.
3. The type. It is a legal mortgage, because it is expressed to be a deed.

Problem 2: appointing a receiver

1. The circumstances. Arrears of interest and a creditor’s process of execution are among the circumstances in which a company may be placed in receivership.
2. The appointment. The holder may appoint a receiver or manager under the debenture, who will be his agent. The charge crystallises. The receiver notifies the CAC within 14 days.
3. The powers. A receiver may take possession, collect debts and sell the charged assets. If he is made manager, he may also carry on the business and borrow.
4. Distribution. The proceeds pay the costs of realisation, the receiver’s expenses, trustees’ costs, preferential debts out of the floating charge property, and then the debenture debt.

Problem 3: the later mortgage

1. The rule. A fixed charge has priority over a floating charge on the same property, unless the floating charge forbade later charges and the later chargee had actual notice of the prohibition when his charge was granted (section 204).
2. The application. Bank B did not have actual notice, so the negative pledge does not bind it.
3. Advice. Bank B has priority over the factory. Bank A should make sure that later chargees are told of the clause.

Questions that have been asked on this topic, and how to answer them

Common mistakes in the exam

• Saying a debt owed to the company is a test of insolvency. Only the company’s own inability to pay counts.
• Mixing the three-week period with other periods.
• Saying a receiver is the agent of the company. He is the agent of the debenture holder, unless appointed by the court, when he is an officer of the court.
• Confusing the receiver with the official receiver.
• Saying a receiver without a manager’s appointment may run the business. He may not.
• Saying a floating charge attaches to assets when created. It attaches on crystallisation.
• Saying a floating charge ranks ahead of a fixed charge. The fixed charge ranks first, and also ahead of preferential debts.
• Describing a deed over a specific building as a pledge. It is a legal mortgage.
• Forgetting the “actual notice” requirement for a negative pledge.

Quick revision

• Insolvency tests: three-week demand; judgment debt; court’s finding with contingent liabilities; liabilities exceed assets.
• Options: receivership, arrangement, compromise (three quarters in value), netting, winding up.
• Receiver: agent of the debenture holder (officer of the court if appointed by the court). Notice to CAC in 14 days. Receiver and manager runs the business. Personally liable on contracts. No receiver for a naked debenture.
• Fixed charge: specific property, no disposal without consent, ranks first (ss.204, 207(4)). Floating charge: changing assets, crystallises on receiver, possession or liquidation (s.203). Negative pledge needs actual notice.
• Insolvency practitioners: degree in law or accountancy, five years’ experience, BRIPAN or recognised body, CAC authorisation (s.705).

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Section A style: multiple choice

Section B style: written questions

Model answers

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