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Corporate Insolvency

Part of our SQE1 Business Law and Practice guide → View the full SQE1 Business Law and Practice guide

05 May 2026

Master corporate insolvency procedures, creditor priority, wrongful trading, and director disqualification for SQE1 exams.

Corporate Insolvency

Business Law and Practice > Corporate Insolvency

A director keeps trading despite mounting losses, hoping the business will turn around. By the time they act, the company has run up £200k in liabilities it cannot pay. During liquidation, they face a disqualification claim and a section 214 contribution order—personal liability that no director sees coming because they didn't study the priority waterfall or the negligence test for wrongful trading. This guide covers the insolvency procedures, creditor priority rules, and director liability that examiners test relentlessly on SQE1.

What is Corporate Insolvency in SQE1?

Corporate insolvency law deals with what happens when a company cannot pay its debts. It covers how companies can be rescued (administration, CVA), how they can be wound up (liquidation), and how creditors' claims are prioritised. For SQE1, you need to understand the insolvency tests, the different procedures available, creditor priority in liquidation, and the personal liability that can attach to directors.

Key Principles for SQE1

  • Insolvency Test - Cash-Flow (s.123 Insolvency Act 1986): A company is insolvent if it cannot pay its debts as they fall due. This is a practical test of liquidity.

  • Insolvency Test - Balance Sheet: A company is insolvent if its liabilities exceed its assets. This is a statement of financial position test.

  • Administration (Schedule B1 IA 1986): A moratorium on creditor action while the company tries to rescue itself or achieve a better outcome. An administrator is appointed (by court, creditors, or holders of a floating charge). Administration has a holding power but no automatic rescue.

  • CVA - Company Voluntary Arrangement (ss.1-7 IA 1986): A contractual agreement between company and creditors to restructure debts. Requires approval by 75% of creditors by value and 50% by number (though the second threshold can be overridden). The supervisor monitors compliance. CVAs are particularly relevant to Shareholders and Share Capital discussions on creditor rights versus shareholder interests.

  • Compulsory Liquidation (s.122 IA 1986): Creditors or the court can petition for compulsory liquidation if the company is insolvent or unable to pay its debts. A liquidator is appointed by the court.

  • Voluntary Liquidation - MVL (Member's Voluntary Liquidation): The company is solvent; directors make a declaration of solvency; members pass a resolution; a liquidator is appointed by members to wind up.

  • Voluntary Liquidation - CVL (Creditors' Voluntary Liquidation): The company is insolvent; directors convene a creditors' meeting; a liquidator is appointed by creditors (may be different from the one proposed by members).

  • Priority of Claims in Liquidation: Fixed charge holders; costs of insolvency (liquidator's fees); preferential creditors (up to 12 months' unpaid wages, holiday pay, pension contributions—subject to a cap); prescribed part (5% of floating charge proceeds set aside for unsecured creditors); floating charge holders; unsecured creditors; shareholders. Charge priorities are explained in Company Finance and Financial Reporting.

  • Wrongful Trading (s.214 IA 1986): A director is liable to contribute to the company's assets if they continued to trade when they knew (or ought to have known) the company would enter insolvent liquidation. The test is objective negligence, not fraud. A director can raise a defence if they took every step to minimise loss. This connects directly to Directors' Duties and Liabilities.

  • Fraudulent Trading (s.213 IA 1986): A director is liable if they carried on business with intent to defraud creditors or any other person. This requires dishonest intent. It is rarer than wrongful trading because it requires fraud.

  • Director Disqualification (CDDA 1986): An undischarged bankrupt is automatically disqualified. A director can be disqualified for up to 15 years if they are unfit (e.g., breach of duty, wrongful trading, dishonest conduct). Disqualification is mandatory for a director of a company that becomes insolvent if they are found unfit.

Exam tip

The priority waterfall is the single most tested calculation in insolvency. Examiners deliberately place preferential creditors and floating charges in close succession—students who reverse the order lose marks. Learn the sequence as fixed > costs > preferential > prescribed part > floating > unsecured > shareholders and drill it repeatedly.

Quick Comparison: Priority of Claims in Liquidation (The Waterfall)

| Rank | Creditor Type | Notes | |------|---------------|-------| | 1 | Fixed Charge Holders | Recover from the secured asset first; priority by date of creation if multiple fixed charges | | 2 | Costs of Insolvency | Liquidator's fees, administrative costs | | 3 | Preferential Creditors | Employees (unpaid wages up to 12 months), holiday pay, pension contributions (capped); usually £800 per employee for wages | | 4 | Prescribed Part | 5% of floating charge proceeds (up to £600,000) set aside for unsecured creditors | | 5 | Floating Charge Holders | Recover from assets subject to the charge; rank by date of creation if multiple | | 6 | Unsecured Creditors | Trade creditors, bondholders, etc.; pari passu (equal) distribution | | 7 | Shareholders | Rank last; rarely recover anything |

Quick Summary

  • Insolvency tests: cash-flow (cannot pay debts as they fall due) and balance-sheet (liabilities exceed assets)
  • Creditor priority waterfall: fixed charges > costs > preferential > prescribed part > floating charges > unsecured > shareholders
  • Wrongful trading (s.214 IA 1986): director liable if trading continued when insolvency inevitable; defence available if director took steps to minimise loss
  • Fraudulent trading (s.213 IA 1986): director liable if trading with intent to defraud; rarer because it requires dishonest intent, not merely negligence
  • Administration provides a moratorium but is not guaranteed rescue; CVA requires 75% creditor approval by value
  • Prescribed part (5% of floating charge, up to £600,000) carved out for unsecured creditors—often missed in priority calculations

How This Appears in SQE1 Questions

Scenario: XYZ Ltd has £2m liabilities and £1.5m assets. The director continued trading for six months, incurring £200k in new liabilities, hoping the business would improve. It did not. The company is now in liquidation.

You'll encounter scenarios asking you to:

  • Identify which insolvency procedure is available: Is the company suitable for administration, CVA, or liquidation? What are the legal requirements?

  • Calculate the distribution in liquidation: Given assets, charges, and creditors, work through the waterfall. Students often place floating charges ahead of preferential creditors (wrong) or forget the prescribed part entirely. This single error can cost you 5-10 marks on a priority calculation question.

  • Address wrongful trading liability: Did the director continue trading when insolvent? Is there a defence (steps taken to minimise loss)? Note this is negligence-based, not fraud-based.

  • Spot fraudulent trading: Rare but high-profile. Requires dishonest intent, not mere negligence.

  • Advise on director disqualification: What triggers it? What is the timeline? Can it be challenged? The interaction between wrongful trading and disqualification is frequently tested alongside Company Formation and Constitution questions about director powers and appointment.

Common Mistakes Students Make

  • Priority order is wrong: Students place floating charges ahead of preferential creditors. It's the reverse—preferential creditors come before floating charges.

  • Confusing wrongful trading with fraudulent trading: Wrongful trading is objective negligence; fraudulent trading requires dishonest intent. Wrongful trading is far more common. If the question says "breach of duty" or "negligence," think wrongful trading. If it says "intent to defraud," think fraudulent trading.

  • Forgetting the prescribed part: A percentage of floating charge assets must be set aside for unsecured creditors. This is statutory and applies even if creditors don't claim it.

  • Assuming administration always rescues the company: Administration is a rescue procedure, not a rescue guarantee. Many companies in administration end up being liquidated.

  • Missing the CVA threshold: Students think 50% by value is enough. It's not—you need 75% by value (the 50% by number threshold can be overridden by court if necessary but is still part of the formal test).

  • Confusing voluntary and compulsory liquidation: MVL is solvent; CVL is insolvent. The test is solvency, not creditor petition.

Test Yourself

Want to test this now? Try a few SQE1-style questions below before moving on.

Test yourself

Quick check questions based on this article.

Question 1

Scenario

A private company limited by shares has been experiencing cash flow difficulties for the past year. The company has one director, Mr Stevens. The company owes £250,000 to its trade creditors and £100,000 to its bank under an unsecured loan facility. The bank also holds a fixed charge over the company's factory premises, securing a separate loan of £180,000. The company's factory premises are valued at £220,000. The company has £15,000 in its bank account and stock worth approximately £30,000. The bank has demanded repayment of both loan facilities. The company is unable to comply. Mr Stevens has been advised that the company is insolvent and that a formal insolvency process is likely. The company also owes £8,000 in unpaid wages to its three employees and £12,000 in outstanding PAYE and National Insurance contributions. A winding-up petition has been presented by one of the trade creditors and a liquidator has been appointed. Mr Stevens previously obtained a personal loan from the company of £5,000, which remains outstanding. The company's articles of association contain no unusual provisions regarding insolvency. The company has no floating charges registered against its assets. The liquidator is now distributing the company's assets to creditors.

In what order of priority will the following creditors be paid in the liquidation?

Question 2

Scenario

A private company limited by shares is in financial difficulty. The company has two directors, Mr Norris and Ms Oliver. The company's debts total £500,000. Its assets, if sold on a going-concern basis, are valued at approximately £350,000. The directors have been advised that the company is insolvent on a balance-sheet basis. Mr Norris believes that with a restructuring plan and additional investment, the company could return to profitability within twelve months. Ms Oliver is more cautious and wants to explore formal insolvency procedures that would give the company a moratorium from creditor action while a rescue plan is considered. The company's bank holds a qualifying floating charge over the company's assets. The bank has not yet taken any enforcement action. The company has not previously been in administration. One of the company's trade creditors has issued a statutory demand for £25,000, and the 21-day period for compliance expires in ten days. The directors have not yet taken formal insolvency advice but are aware that several options may be available. The company's articles contain no provisions addressing insolvency procedures. The company employs 15 staff and occupies leased premises with two years remaining on the lease.

Which insolvency procedure would best achieve Ms Oliver's objective of obtaining a moratorium while a rescue plan is considered?

Question 3

Scenario

A company owns a small industrial unit which it has occupied as its main operating premises for the past seven years. The company entered administration last month. The freehold of the industrial unit is owned by an unconnected third party, and the company occupies the unit under a 10-year lease granted five years ago. The landlord has demanded that the administrator pay the rent that has been outstanding since before the administration commenced. The administrator has informed the landlord that the company is continuing to trade from the unit and intends to remain there for the time being. The landlord wishes to forfeit the lease and recover possession of the unit. The company's bank holds a fixed charge over the company's book debts and a floating charge over all other assets. The landlord argues that the administrator has no right to remain in the unit without paying the rent arrears. The administrator does not dispute that rent has been unpaid since before administration commenced. The landlord has not previously sought relief from the moratorium from the court. The administrator considers that the unit is essential to any going concern sale of the business.

Which of the following most accurately describes the landlord's ability to forfeit the lease and recover the unit during the administration?

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