Both individuals and companies can be described as ‘insolvent’ but, for individuals, bankruptcy is a more commonly used term.

Below, we’ll explore what insolvency means in detail. If you’re unsure of your situation, consider using our insolvency test. Or speak with one of our insolvency practitioners.

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Insolvency Guide

What is Insolvency?

So what does it mean to be insolvent?

Insolvency is a state of financial stress relating to persons or businesses who cannot pay their debts.

Under UK law, insolvency can be defined as when debts outweigh assets or if bills cannot be paid when due.

Those in a state of insolvency are said to be ‘insolvent’

Insolvent companies are responsible to creditors interests primarily, rather than shareholders.

Insolvent individuals may choose to discharge their debts via bankruptcy. Whereas insolvent companies do so via a process such as liquidation or administration.

A creditor (someone you owe money to) only needs to be owed £750+ to be able to force your company into liquidation by the use of a winding up petition if you are insolvent.

The definition of the inability to pay business debts is laid out in the Insolvency Act 1986, Section 123.

– Insolvency can results from shifting market forces, problems with the cash-flow cycle, or increased expenses.
– Insolvency events in the UK must be handled by licensed insolvency practitioners
– Insolvency does not always mean the end of a company, rather debt restructuring can make debts manageable via repayment installments
– When a company cannot be rescued, liquidation is the process to close down an insolvent company with debts

What is Bankruptcy?

Bankruptcy is the legal process by which individuals who have reached the state of insolvency can discharge their debts.

It is a legal mechanism by which insolvent individuals can eradicate some or all of an accrued debt and move on with their lives.

Individuals can choose to file for bankruptcy, or be forced into it by a creditor, assuming the debt is £5000 or more.

This process is purely for personal finances and plays no bearing on the options available to limited companies or partnerships.

Individuals generally remain bankrupt for a period of one year, until they are discharged. This usually happens on the first anniversary of the date the bankruptcy order was made.

An Example of Bankruptcy

Peter accrues a lot of credit card debt and, after losing his job, realises he cannot make his monthly payment to the lender.

With the creditor putting increasing pressure on him to repay, he decides to file for bankruptcy. He does this online, explaining his financial situation and including a detailed list of his assets.

This goes to the Official Receiver who reviews his situation and arranges an interview.

The Receiver then approves the application, taking control of Peter’s assets, including his car, in order to pay the credit card company.

Peter is listed on the Insolvency Register for one year, and the process will affect his credit record for 6 years.

He is released after 12 months, with the debt written off.

Understanding Company Insolvency

Company’s have different options for insolvency based on the fundamental seperation between personal and corporate finances enshrined in the limited company structure.

Although a director may have founded the company, the company debt is entirely seperate from his/her personal finances, assuming no misfeasance has occurred.

By closing the company via a process such as liquidation, all of the debt can be eradicated and the company closed.

Before this, directors should first ascertain the company’s position via the corporate insolvency test.

These tests are used by accountants to check, via two methods, whether a company is officially insolvent. If you fail either, you should speak with an insolvency practitioner immediately

(1) The Balance- Sheet Test

Do your company’s debts outweigh its assets?

That’s the essential question posed by the balance sheet test. Simply list down all of your company’s assets in one column, and the contingent and prospective liabilities in another. If the value of the assets is lower than the liabilities, you are facing balance sheet insolvency (also called technical insolvency)

(2) The Cash-flow Test

Can your company pay its bills on time? That’s the simple question posed by the cash flow insolvency test.

This test accurately maps the amount of working capital or liquid assets you have available at any given time, comparing forecasted sales with payments that are due.

Since cash-flow insolvency is caused by a lack of liquidity, it can often be resolved by negotiation or payment by intallments.

If you’d rather use a simple tool that does both these things, you easily complete that process here .

What Happens When you Declare Insolvency?

Being insolvent doesn’t necessarily mean the end of your company, there are options for business debt restructuring, company rescue and business turnaround. Insolvency practitioners have a strong focus on rehabilitating a business so it can continue, rather than simply liquidating it.

For directors, speaking with an IP will help you understand your options, how to protect yourself from insolvent trading , accusations of wrongful trading and potentially being made personally liable for any company debts.

The goal of any insolvency is to realise the maximum return for the company’s creditors. To this end, the appointed insolvency practitioner’s (IP) have a number of tools and processes at their disposal which we explain later in this article.

If you’re concerned you won’t be able to afford the IP, you should be aware that most liquidations can be paid for from the realisation of corporate assets. Directors may also be eligible for redundancy payments.

Is there an Insolvency Register?

Is there an insolvency register for individuals and companies in the UK.

For individuals there is a government run register here:

For companies, you can check if a company is either being liquidated or is in provisional liquidation here:

Examples of Insolvency

David forms a limited company which does well for several years before the COVID-19 pandemic stops his cash-flow overnight and debts accrue.

Tied into a costly office lease, David’s company has five full time employees who he cannot pay.

After working with his accountant to check that the company is officially insolvent, David contacts an insolvency practitioner who investigates how much money is owed; whether David has signed personal guarantees for finance, and whether the business is likely to return to profitability in the future.

Concluding that the company needs to be closed, the insolvency practitioner places the company into liquidation, and takes over creditor communication.

David asists the IP with the creation of a Statement of Affairs document, detailing the company’s financial affairs, after which his powers as a director cease.

After a year, the liquidation process is complete, the company is removed from the Register at Companies House and ceases to exist.

How Does Insolvency Affect Company Directors?

As the director of a limited company you should understand how insolvency proceedings are going to affect you. Some processes are there to keep the company afloat so that it may live another day.

If the company is liquidated, your company will be closed, and struck off the register at Companies House. Any assets will be liquidated to pay off creditors.

As a director you will be free to become the director of another company and, assuming there’s no wrongful trading or misfeasance, the closure should not impact your personal finances.

What’s the Difference between Bankruptcy and Insolvency?

Bankruptcy only refers to personal debt and so would be incorrect terminology to use for company debt.

Insolvency is the correct term to refer to a limited company which has liabilities exceeding assets, or which cannot pay its bills when they fall due.

What are Insolvency Proceedings?

Insolvency Proceedings are the collective term for all of the official legal mechanisms of the Insolvency Regime, which include winding up, liquidation, company administration, receivership and, for individuals, bankruptcy.

Insolvency Practitioners

Often (but not always) accountants or solicitors, an insolvency practitioner (IP) is someone who is authorised to act on behalf of insolvent companies, or individuals.

It should be emphasised that IP’s are not simply figures who liquidate companies, but who will always seek to rescue the company if that is a viable proposition.

A structured debt management plan, known as a Company Voluntary Arrangement, represents a good chance to find permanent debt relief.

While the task is always to find the best deal possible for any company creditors, it may well be that processes such as administration, or a company voluntary arrangement, offer the best chance of doing so.

Insolvency Law

The key UK insolvency laws are:

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