Both individuals and companies can be described as ‘insolvent’ but, for individuals, bankruptcy is a more commonly used term than insolvency.
Insolvency is when when a company’s debts outweigh assets or if the company cannot pay its bills when due.
In this article we’ll explore what it means, and the implications for your limited company.
If you’re unsure of your situation, consider using our insolvency test.
What Happens When you go into Insolvency?
Once you realise your insolvency, you should speak with a licensed insolvency practitioner such as ourselves immediately. We can explain the process, as well as your rights and responsibilities moving forward.
Being insolvent doesn’t necessarily mean the end of your company, there are options for debt relief, company rescue and turnaround.
For directors, speaking with an IP will help you understand 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 creditors. To this end, the appointed insolvency practitioner’s 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 insolvency practitioner, you should be aware that most liquidations can be paid for from the realisation of corporate assets, or alternatively from redundancy payments.
Test for Insolvency
Known in bookkeeping as the acid test or quick ratio, there are two simple tests to assess whether your company is insolvent.
Of these two insolvency tests, the cash-flow test is probably the most important as you can have all the assets in the world, but if you cannot pay your bills on time you may find yourself forced into liquidation. An angry 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.
(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 insolvency.
(2) The Cash-flow Test
Can your company pay its bills on time?
This test accurately maps the amount of working capital you have available at any given time, comparing forecasted sales with payments that are due.
If you’d rather use a simple tool that does both these things, you easily complete that process here.
What are the Signs of Insolvency?
The classic signs include:
- Paying suppliers late consistently
- Debts building up with HMRC
- Staff leaving due to concerns over job stability
- Directors lackadaisacal about accounts and bookkeeping
- CCJ against your limited company
- Creditors Letters
- Baliff Threats
- Declining profit margins
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 insolvency 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.
Key Points for Directors
- Avoid increasing the company’s debts once you are aware that the company is insolvent.
- You cannot simply pay off personal guarantees through the sale of assets to reduce your personal debts whilst neglecting the creditors as this can cause more complications for you.
- You cannot transfer assets to a newly formed company as there could be potential serious implications to you personally.
- Employees are regarded as preferential creditors and in any event would be covered under the Government scheme if the company does not have funds to pay them.
- HMRC are responsible for more forced liquidations than any other creditor out there, so if your company owes tax – have a chat with us to see how we can best manage the situation.
- Whilst shareholders own the company, the directors run the company and they have responsibilities such as health and safety, ensuring accounts are filed, tax is paid and so on.
- A limited company is also a completely separate entity in its own right and has its own rules and regulations and as a director you act as an officer of the company. This is very important to understand as your responsibilities are to ensure the company’s interests are at the heart when making decisions. This changes when a company becomes insolvent as you must place the creditors’ interests at the heart of your decision making. Failing to do so or making the wrong decision can create serious financial penalties so it’s important to understand what insolvency is.
What’s the Difference Between Insolvency and Bankruptcy?
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.
What is an Insolvency Practitioner and do I need One?
Often (but not always) accountants or solicitors, an IP is someone who is authorised to act on behalf of insolvent companies, or individuals. You can read our full article here on insolvency practitioners.
Rescuing a Company
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.
Are Insolvency Practitioners Regulated?
At the highest level, it’s the Secretary of State who regulates the industry, although on a practical level it is the Insolvency Service. There are also a number of RPB’s (recognised professional bodies) which are authorised to licence their members to act as Insolvency Practitioners. Once licenced, the individual practitioners are regulated by their professional bodies.
Will my Company be Listed on an Insolvency Register if I go into Liquidation?
What the Key Pieces of Insolvency Law?
The key legislation is the Insolvency Act 1986, and the Insolvency Rules 1986. The Company Directors Disqualification Act 1986, the Employment Rights Act 1996 Part XII, the Insolvency Regulation (EC) 1346/2000.
Company Voluntary Arrangement
With the help of an insolvency practitioner, a company may propose a CVA to its creditors who are a formal agreement to repay monies over a period of up to 5 years. It is at the creditor’s discretion for them to agree to this and, assuming they do; the CVA can be a helpful method for a company to continue trading and find its feet.
Administration is a company rescue process which allows larger companies to take advantage of a protective ring fence that prevents legal action from creditors, while an insolvency practitioner restructures the company. An administrator is usually appointed for no longer than a year (although this can be renewed) with the aim to rescue the company, or if this isn’t possible to achieve a better return from creditors than if the company were liquidated. Administration may also be attempted to realise property that can be distributed to secured creditors.
Unlike a CVA or administration, company liquidation as a terminal process which means the company will cease to exist. During a liquidation, the IP is appointed to realise the company’s assets and distribute the proceeds to creditors. There are two forms of liquidation:
When a court order (winding up order) forcibly sends the company into liquidation because it is unable to pay debts.
These are again split into two subtypes known as creditors voluntary liquidation is, and member’s voluntary liquidation is. Both must be commenced by resolution of the shareholders but where is in MVL is usually used by a retiring director who wishes to formally closes company in a tax efficient manner, a CVL is usually used by directors who sense an impending compulsory liquidation and wish to choose a process to give them more control over the outcome.
Avoiding Director’s Disqualification
As soon as a company is insolvent, directors have a legal obligation to act in the best interests of the creditors. Failure to do this can result in a charge of wrongful trading that can have serious consequences, including director’s disqualification. When facing insolvency, the primary responsibility to cease trading immediately, and to stop paying anything out of the business bank account until you have spoken with a qualified professional.
What Happens to a Company after Insolvency?
If your company has reached the state of insolvency, you might expect to receive:
- A CCJ, Statutory Demand or Petition to Wind up Your Company by a Creditor
- Suppliers and Customers will likely terminate contacts or take other protective measures
- Lenders may call in security (i.e. banks or other secured creditors)
- Directors behaviour comes under scrutiny with the possibility of being held personally liable for company debt if there is evidence of wrongful of fraudulent trading
- Bank Accounts May Be Frozen
What is the Difference Between Liquidation and Insolvency?
Insolvency is a financial state of affairs and does not always mean the company ends up in liquidation.
It’s certainly a crunch point and strong decisions have to be made about the way forward. This is where an insolvency practitioner can help you by making recommendations based on experience and your legal situation.
You may be able to restructure your company and avoid liquidation altogether. In some cases, liquidation is simply the sensible choice to end creditor pressure.
There’s no risk in speaking with us, the free insolvency advice and the first meeting with our company insolvency specialists is absolutely without strings attached and we guarantee that you will have your options presented to you by the end the first meeting.
We will also provide you with a free report on your insolvency situation with no obligations.
Send us an email, or alternatively, if you would prefer to get some advice from one of our insolvency consultants over the phone then call us on; 08000 746 757.