Company Insolvency
I’ll explain the definition of insolvency, the tests to check if your company has crossed the threshold, and the potential solutions.
What is Limited Company Insolvency?
Insolvency is the state where a company cannot pay its debts when due. In other words, the company’s liabilities exceed its assets, and it does not have sufficient cash flow to meet its financial obligations.
For directors, the key thing to realise is that the state of insolvency changes your responsibilities; you must shift your focus to creditors and cease trading. From the point of insolvency, your chief responsibility is no longer towards shareholders, but to maximising creditor returns.
You will also need to seek professional advice and enter a formal insolvency process[1]Trusted Source – GOV.UK – Options when a company is insolvent.
>>Read our full article on the warning signs of insolvency
When is a Company Considered to be Insolvent?
A company is considered to be insolvent when it meets one or both of the following criteria:
Cash-Flow Insolvency
A company is considered insolvent under the cash flow test if it is unable to pay its debts as they fall due[2]Trusted Source – GOV.UK – Section 123(1e) of the Insolvency Act 1986.
This means the company does not have enough liquid assets or cash to meet its current obligations, even if its total assets exceed its total liabilities on paper. The cash flow test focuses on a company’s ability to generate sufficient cash to pay its debts in the short term.
Balance-Sheet Insolvency
A company is considered insolvent under the balance sheet test if its total liabilities exceed its total assets[3]Trusted Source – GOV.UK – Section 123(2) of the Insolvency Act 1986.
This means that even if the company were to sell all of its assets, the proceeds would not be enough to cover its outstanding debts.
>>Read our full article on What are the Risks of Trading Whilst Insolvent?
How to Tell if Your Company is Insolvent
In addition to the formal cash flow and balance sheet insolvency tests, there are several warning signs that may indicate your company is heading towards insolvency. These red flags include consistently paying bills late, receiving frequent demands for payment from suppliers, and being unable to obtain credit from banks or other lenders.
Another warning sign is if your company is facing legal action from creditors or if you are using personal funds to keep the business afloat.
If you are experiencing any of these issues, it’s crucial to seek professional advice from an insolvency practitioner like ourselves as soon as possible. The earlier you act, the more options could be available to you.
Insolvency Processes Explained
If your company is insolvent, here are the common processes that might be used to rescue or close it. In all of these, the focus is on maximising creditor returns.
Company Voluntary Arrangement (CVA)
A Company Voluntary Arrangement (CVA) is a procedure that allows a financially troubled company to pay a percentage of its debts over an agreed period of time if the creditors agree to it. The company can continue operating during this period, making it an ideal option for businesses with a realistic chance of recovery.
The remaining debts are written off at the end of the CVA.
Going into Administration
The administration process provides a company with protection from its creditors while a strategy is formulated. It’s usually chosen to either rescue the business as a going concern or achieve a better result for the creditors than would be likely if the company were liquidated.
During administration, an appointed administrator (a licensed insolvency practitioner) takes control of the company. The administrator’s tasks include reviewing the company’s financial situation, considering options for restructuring or selling the business, and executing the chosen strategy.
Liquidation
Liquidation marks the end of a company’s life by ensuring that its assets are distributed to repay creditors in an orderly and fair manner.
There are two main types of liquidation: voluntary, initiated by the company’s directors when they realise the business cannot continue due to its debts; and compulsory, initiated by creditors through a court order.
In both cases, an insolvency practitioner is appointed as a liquidator to oversee the process, which involves ceasing operations, selling assets, and distributing the proceeds to creditors according to legal priorities.
Liquidation is typically the last resort when there is no feasible way to save the company or when debts far exceed the value of assets.
>>Read our full article on Are Liquidation and Insolvency the Same Thing?
Do I Need an Insolvency Practitioner if my Company is Insolvent?
Insolvency practitioners (IPs) are specialised professionals who play a pivotal role in the insolvency process, and a legal requirement to manage an insolvency process in the UK. IPs are authorised and regulated by the Insolvency Service to act on behalf of insolvent individuals, companies, or partnerships.
An IP’s expertise is in managing the complexities of insolvency procedures, ensuring that the process adheres to legal requirements while aiming to achieve the best possible outcome for all parties involved.
What are the Legal Considerations of Insolvency?
Navigating insolvency involves not only understanding financial recovery options but also being aware of the legal implications. It’s crucial for directors and individuals to be informed about these aspects to avoid further complications.
Understanding Wrongful Trading
Wrongful trading occurs when company directors continue to trade while knowing the company has no reasonable prospect of avoiding insolvent liquidation or administration, and they fail to take every step to minimise potential loss to creditors.
In the UK, this is a serious offence under the Insolvency Act 1986. Directors found guilty of wrongful trading can face personal liability for the company’s debts, disqualification from holding directorships, and even criminal charges in severe cases.
The Impact on Employees
Insolvency has profound effects on employees, who may face uncertainty, job loss, and financial distress. In the event of insolvency:
- Employees may be at risk of redundancy as companies restructure or cease operations. The law provides some protections, including redundancy payments and notice periods, but the immediate impact can be significant.
- Outstanding wages, holiday pay, and pension contributions are prioritised among the debts a company owes. However, there may be delays or shortfalls in payments.
What Are the Options for an Insolvent Company?
If your company is insolvent, immediate action is required to address the financial difficulties. As a director, you have several formal and informal options at your disposal, all aimed at either rescuing the business or ensuring an orderly closure.
Here are the primary options:
- Company Voluntary Arrangement (CVA) – A CVA allows you to negotiate a reduced debt repayment plan with creditors over a fixed period, usually 3 to 5 years. An insolvency practitioner drafts the proposal, presents it to creditors, and supervises its implementation upon approval. » MORE Read our full article on CVA
- Administration – This option offers protection from creditors while a plan is developed for either business recovery or asset sale. The insolvency practitioner acts as the administrator and takes control of the company during this period. » MORE Read our full article on administration
- Creditors’ Voluntary Liquidation (CVL) – If there is no realistic prospect of business recovery, a CVL enables the liquidation of company assets to repay creditors. An insolvency practitioner oversees this process as the liquidator. MORE Read our full article on CVL
- Compulsory Liquidation – Initiated usually by creditors, this court-based procedure leads to the liquidation of the company’s assets. An insolvency practitioner is appointed by the court to act as the liquidator. MORE Read our full article on Compulsory Liquidation
- Informal Creditors’ Arrangement – This is an informal agreement between the company and its creditors to restructure debt. While not legally binding, it can offer short-term relief and doesn’t require an insolvency practitioner.
- Time to Pay (TTP) Arrangement – Specifically aimed at tax debts, a TTP allows you to negotiate with HMRC to pay your tax liabilities in instalments over an extended period. This is also an informal arrangement but has significant implications for ongoing tax compliance. MORE Read our full article on time to pay arrangements
- Refinancing Options
To improve liquidity, you may consider refinancing existing loans or seeking new lines of credit. This can be done through bank loans, asset financing, or attracting new investment.
How Company Debt Can Help
If you’re facing financial difficulties or worried about insolvency, it’s crucial to act now. At Company Debt, our team of experienced insolvency practitioners is ready to provide you with the support and guidance you need. Whether you’re exploring options to save your business or seeking advice on personal financial challenges, we’re here to help. Contact us today on 0800 074 6757. for a confidential discussion and take the first step towards resolving your financial concerns.
FAQ’s on Company Insolvency
What happens if I ignore signs of insolvency?
Trading whilst insolvent could lead to personal liability and disqualification as a director. It is illegal to keep operating without addressing insolvency.
How long does the insolvency process take?
It depends on the complexity of the case and the options pursued. Liquidation can take 6-12 months. Administration or voluntary arrangements may take longer if restructuring the company.
Can an insolvent company recover?
Yes, it is possible to turn around an insolvent business through restructuring debt, asset sales, or via administration. But outcomes vary case-by-case.
What is the order in which debts are paid to creditors owed during insolvency?
The order of priority for repaying creditors is: secured, preferential, unsecured, and shareholders. Creditors must be paid in this order.
Can a company continue to trade while insolvent?
In some cases, a company can continue to trade if the directors believe they can restore the company’s solvency and have taken appropriate advice. However, this must be done with caution to avoid wrongful trading, which could have legal repercussions for the directors.
What are the options for a company with temporary liquidity issues but is otherwise viable?
For companies with temporary cash flow problems, options include negotiating extended payment terms with creditors, seeking short-term financing, or invoice factoring. If the business is fundamentally viable, arrangements like a CVA or refinancing assets may provide the necessary breathing space to improve liquidity.
What is the effect of company insolvency on ongoing contracts?
Insolvency can lead to the termination of ongoing contracts, as many agreements include clauses that allow for termination in the event of insolvency. However, during certain insolvency procedures like administration, there may be some protection to prevent contracts from being automatically terminated.
How does insolvency affect the company’s directors’ ability to start another business?
While insolvency does not automatically prevent directors from starting another business, they may face restrictions if found guilty of wrongful or fraudulent trading. Additionally, they cannot use a name associated with the insolvent company for a new business without court permission.
What are the repercussions for a company that exits insolvency?
A company that exits insolvency through a restructuring or a formal arrangement such as a CVA often emerges as a leaner entity with reduced debts. However, its credit standing would typically be impaired for some time, affecting its ability to secure future financing and potentially influencing its trade terms with suppliers and customers.
Can a director be barred from managing other companies if their company becomes insolvent?
Yes, a director can be disqualified from managing or directing a company for up to 15 years if they are found to have engaged in unfit conduct, such as allowing a company to trade while insolvent, not keeping proper accounting records, or not acting in the company’s best interest.
The primary sources for this article are listed below, including the relevant laws and Acts which provide their legal basis.
You can learn more about our standards for producing accurate, unbiased content in our editorial policy here.
- Trusted Source – GOV.UK – Options when a company is insolvent
- Trusted Source – GOV.UK – Section 123(1e) of the Insolvency Act 1986
- Trusted Source – GOV.UK – Section 123(2) of the Insolvency Act 1986
