In simple terms if you have an insolvent company this means it does not have sufficient assets to pay it’s debts. For most companies the only solution is closure and liquidation. Delay in closure creates legal and financial risks for directors.
If the inability to pay debts is genuinely just a short term issue, your business may not be legally insolvent.
The legal tests for insolvency means making an honest assessment of whether you are genuinely likely to be able to improve your company financial position so as to be fair to creditors, taking into account current trading and medium and long term debts as well.
If your business is insolvent, you need to take action which reflects this. Continuing to trade when insolvent, juggling debts or favouring some creditors over others is unlawful and will create risks of personal liability for directors. If you’re unsure of your situation, consider using our insolvency test. Or speak with one of our insolvency practitioners.
Can directors just stop trading if Company is Insolvent?
Many small company directors ask us whether once they reach the conclusion the company is insolvent they can just cease trading and do nothing more. This is an understandable question because it costs money to appoint liquidators.
Some directors do simply stop trading and effectively wait for a creditor to start compulsory liquidation proceedings. A creditor needs to be owed £750.00 or more to be able to force your company into liquidation by the use of a winding up petition.
Waiting for a creditor to liquidate your company is rarely, if ever, advisable. Ceasing trading alone doesn’t fully comply with the duty of directors to put creditors first on company insolvency as ceasing trading does not mean you stop accruing liabilities such as employee wages.
The best option in almost all cases is to contact an Insolvency Practitioner and get advice on the available options. Voluntary liquidation is the most common solution.
What if I’m not sure Whether my Business is Insolvent or Not?
Many businesses experience cash flow problems but if your business has ongoing problems paying creditors. If you are delaying paying some suppliers and/or have falling revenues, you will probably realise yourself that the business is insolvent or very close to it. If you are behind in paying HMRC this is a major warning sign of being insolvent.
There is no single, definitive legal or accounting test for insolvency. In many cases, the answer is obvious but complications can arise where a business may be able to pay very short term debts but realistically cannot pay loans, rent, taxes or other debts which are payable in the next 3-6 months.
There are 2 tests which will generally assist detailed below. If in doubt as to whether your business may be insolvent, the best thing to do is get professional advice early to protect yourself.
(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 looks at the amount of working capital or liquid assets 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 .
Insolvent Company – what next?
The insolvency process for companies will often depend on who takes the initiative. The company may commence a creditors voluntary liquidation or consider going into administration. If the company directors do not act, creditors may commence a compulsory liquidation process.
By closing the company via a process such as liquidation, all of the debt can be eradicated and the company closed.
If your business is insolvent you will need to stop trading. Continuing to trade after you know or ought to know your business is insolvent is, in legal terms, wrongful trading and means you may face personal liability for company debts.
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. 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.
What are Insolvency Proceedings?
Insolvency Proceedings is the collective term for legal mechanisms whether winding up, liquidation, company administration, receivership and, for individuals, bankruptcy.
What are the Main Insolvency Laws?
The majority of laws that cover company insolvency are statutory. Generally speaking once a company is insolvent and a liquidator appointed it will be the liquidator that will consider how the Insolvency laws apply to the way the company was run in the period before insolvency. For directors, this means being aware that a liquidator is required to investigate whether the directors have acted correctly.The key UK insolvency laws are:
- The Insolvency Act 1986
- The Insolvency Rules 1986
- The Company Directors Disqualification Act 1986
- The Employment Rights Act 1996 Part XII, the Insolvency Regulation (EC) 1346/2000.