Section 110 Insolvency Act 1986 reconstruction

Strategic diversification of the activities of a business is not a new concept. Indeed, it can be necessary for a business’s survival in an ever-evolving market and be used to encourage growth potential. For those who look to maximise brand reach, considerations as to the formal separation of different business activities operated under a single “umbrella” entity may not necessarily be a priority, especially when the going seems good. 

However, businesses continue to operate in challenging conditions. Companies operating distinct businesses may wish to take the opportunity now to assess whether it would be commercially advantageous to create a more logical group structure.  

In certain circumstances, it can be advantageous to separate different business streams from one another by way of a demerger whereby one or more business streams are transferred to specific entities within the same corporate group.  A reconstruction which separates or ring-fences one or more parts of its activities from another can be an effective Restructuring tool.

This article looks at a demerger under section 110 of the Insolvency Act 1986 (“section 110 reconstruction”) by private limited companies and limited liability partnerships in the context of a solvent liquidation. 

Why demerge?

Typical commercial reasons for undertaking a demerger include:

1. separating underperforming elements of a business;
2. preparing for a sale of part of the business;
3. separating property assets from a trading business;
4. separating businesses that do not have a common strategy;
5. separating businesses which operate in different markets;
6. unlocking shareholder value in particular business lines;
7. facilitating different shareholder objectives/resolving disputes between them; and
8. separating part of a business that is subject to regulatory or industry requirements, which may obstruct the functionality of the remainder of the business.

What is a section 110 reconstruction?

A simplified section 110 reconstruction of a private limited company typically involves the elements set out below. 

Incorporation of new companies

1. A new company (“HeadCo”) is incorporated and a share exchange in which the shareholders of the company proposing to undertake the reconstruction (“ParentCo”) exchange on a share for share basis their shares in ParentCo for shares in HeadCo.
2. Two or more additional new companies are incorporated (together “NewCos”).

Reconstruction stage

3. Following steps one and two above, HeadCo is liquidated, and the liquidator transfers its assets (which may include shares in any underlying companies) to the relevant NewCos. A section 110 reconstruction can just involve the liquidation of the original parent company (ParentCo).  However, liquidating a newly incorporated company (HeadCo) minimises the risk of a third-party creditor interfering with the progress of the reconstruction, which it is usually employed.
4. In return for the transfer of the assets that the liquidator distributes to each of the NewCos, the NewCos each issue shares to the shareholders of the liquidated company (HeadCo) in satisfaction of their rights on the winding-up. HeadCo is then dissolved, leaving the NewCos, each holding certain of its assets.

Benefits of section 110 reconstruction

A section 110 reconstruction can be particularly useful in circumstances where the entity proposing to undertake a restructure:

1. has insufficient distributable reserves to make a distribution (see paragraph number 6 (Distributions of Assets) of the paragraph below entitled “Potentially useful, but still remember”);
2. cannot undertake a capital reconstruction;
3. cannot satisfy the requirement of being trading for the purpose of taking advantage of the tax reliefs available to other more commonly used methods of demerger; or
4. wishes to take advantage of the tax reliefs available on a section 110 reconstruction. Advance tax clearance can be obtained.

Section 110 reconstruction considerations

A section 110 reconstruction may be used in isolation (see above at “What is a section 110 reconstruction”) or as part of a larger restructuring exercise or prelude to a sale.  However, it is important to bear the few initial considerations set out below.

1. Tax and accounting advice: advice should always be sought on tax and accountancy; including the availability of the tax reliefs applicable on a Section 110 Reconstruction and whether this method of demerger is appropriate in the particular circumstances.
2. Eligibility requirements: the entity to be liquidated (referred to as “HeadCo in the example provided above) must be a company registered under section 1(1) of the Companies Act 2006 (which includes companies registered under its predecessor legislation) or a limited liability partnership. The transferee(s) (referred to as “NewCos” above) must be a company or a limited liability partnership.
3. Shareholders’ support: HeadCo should have the support of a large majority of its members to make the section 110 reconstruction commercially viable.
4. Liquidator’s indemnity: a liquidator is likely to require an indemnity from the shareholders of HeadCo and, in certain cases, from the shareholders of the NewCos for the liquidator and the entity in liquidation (HeadCo in the example above) against any liabilities that arise during the liquidation. Such indemnity is also likely to include provisions enabling the liquidator to receive fees and expenses incurred during the appointment.
5. Directors to swear a declaration of solvency: the directors of the HeadCo, which are likely to be the same as those of ParentCo, must swear a statutory declaration of solvency before the shareholders of HeadCo resolve in favour of HeadCo’s winding-up.
6. Distributions of assets: if there are to be any distributions of assets as part of the section 110 reconstruction (other than the dividends in specie that will be made by the liquidator under the scheme itself), it will be necessary for the entity making such distribution to have the necessary authority in its constitutional documents to declare dividends in specie of assets and sufficient distributable reserves; and
7. Timing: There are certain time limits, which are applicable to a section 110 reconstruction.