What is Company Insolvency?

Understanding the implications of insolvency^[1]Trusted Source – .GOV- Options When a Company is Insolvent can help you make informed decisions and minimise negative impacts.

For directors, the failure of a business means the end of your company and potential legal repercussions if you haven’t handled the company’s financial affairs appropriately.

For creditors, it will mean waiting in line while an insolvency practitioner sells company assets to try and recoup as much as possible of what is owed.

For employees, it means job loss and financial insecurity, and it can also affect suppliers or any business with economic ties to the company.

For shareholders, the value of their shares in the company is likely to decrease, and in some cases, you may lose your entire investment if the company is liquidated.

This guide aims to provide a comprehensive overview of what insolvency is, the different types of insolvency, and the insolvency process.

We will also explore the roles and responsibilities of an insolvency practitioner, the warning signs of insolvency, and what you can do to manage insolvency effectively.

By the end, you will have a clear understanding of the impact of insolvency and the options available to you.

What is Insolvency?

Insolvency is a legal term used to describe the financial state of a company that is unable to pay their debts as they become due. Essentially, it means that the entity in question has more debts than assets or income, and as a result, they cannot meet their financial obligations to creditors.

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.

There are two official tests for insolvency: failing either one means you are insolvent.

What Does Insolvency Mean?

A diagnosis of insolvency comes with immediate and significant implications for the business and its stakeholders.

1. Directors Responsibilities Change – In insolvency, a directors primary responsibility shifts away from shareholders and towards creditors. Every action must demonstrate this is understood.
2. You should cease trading – A company that is insolvency must cease trading, or risk accusations or ‘wrongful trading’ further down the line.
3. You should seeking professional advice: It is important for company directors and shareholders to seek professional advice from an insolvency practitioner or other qualified advisor as soon as possible. This can help to assess the severity of the insolvency and identify potential options for addressing the situation.
4. You may need to enter a formal insolvency process: In some cases, a formal insolvency process, such as administration or voluntary arrangement, may be necessary to protect the company from legal action and provide a framework for restructuring or winding down the business.

Ultimately, the key to managing insolvency for a company is to take proactive steps to address the situation as soon as possible. This may involve seeking professional advice, engaging with creditors, and exploring all available options for restructuring or winding down the business.

Help if Your Company is Insolvent

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Signs your Company May be Insolvent

While these signs are not exhaustive or definitive, they are signs of a company that may be likely to face insolvency. The signs include:

1. Cash flow problems: If a company is consistently struggling to pay bills or has difficulty meeting its financial obligations as they become due, it may be a sign of insolvency.
2. Mounting debts: If a company has a significant amount of debt that it is unable to pay off, it may be a symptom of a more serious problem.
3. Overdue taxes: If a company has overdue taxes or has failed to file tax returns, it may be a sign that the company is is reaching a tipping point.
4. Difficulty securing credit: If a company is unable to secure credit or has been turned down for loans or credit lines, it may be a sign that the company is running into financial hot water.
5. Late payment of suppliers: If a company consistently pays suppliers late, this is a red flad for impending insolvency.
6. Declining sales: If a company’s sales are declining or the company is losing customers, directors should keep a weather eye out for insolvency.
7. High staff turnover: If a company is experiencing high staff turnover, it may be a sign that the business is struggling or that there is uncertainty about the future.

What Happens When a Company Becomes Insolvent?

The insolvency process is a legal framework designed to deal with companies who are unable to pay their debts as they become due. The process aims to protect the interests of creditors while providing a framework for the restructuring or winding down of the business.

The exact processes will differ, depending on the course of action suggested by the insolvency practitioner you’re working with. Here is a generalised overview of the process:

1. Initial Assessment: The first step in the insolvency process is for you to seek professional advice from a licensed insolvency practitioner such as ourselves. Via a free consultation, we can assess your financial situation and determine what your options are.
2. Formal Insolvency Process: If your company is insolvent, the question is can it be rescued or is closing it down is the best option. Your IP will recommend a formal insolvency process based on this diagnosis. Closure will mean liquidation, whereas rescue may mean a voluntary arrangement or company administration.
3. Working with an Insolvency Practitioner (IP): The IP’s role is to manage the affairs of the company and ensure that the interests of creditors are protected.
4. Asset Valuation: If the company is being liquidated, the IP will carry out an inventory of the assets of the business and assess their value. They will also investigate any claims made by creditors.
5. Creditors Meeting: A meeting will be held with the creditors to provide an update on the process and seek approval for any proposed restructuring or winding down plans.
6. Restructuring or Winding Down: Depending on the circumstances, the company may be able to restructure its debts, renegotiate contracts, or sell assets to repay creditors. If this is not possible, the business may need to be wound down, and assets may be sold to repay creditors.
7. Final Distribution: Once the restructuring or winding down process is complete, the administrator or supervisor will distribute any remaining assets to the creditors.

The Insolvency Practitioner

An Insolvency Practitioner (IP) is a licensed professional who specializes in providing advice and services related to insolvency and corporate recovery.

To become an IP, an individual must meet certain qualifications and hold a license from a recognized professional body, such as the Institute of Chartered Accountants in England and Wales or the Insolvency Practitioners Association.

The role of an IP in an insolvency process can vary depending on the specific circumstances of the case. Some of the key responsibilities of an IP may include:

1. Initial Assessment: The IP will assess the financial situation of the business or individual to determine whether they are insolvent and to identify potential options for addressing the situation.
2. Managing the Insolvency Processes: The IP will manage the process of restructuring or winding down the business or individual, including taking control of assets, investigating claims by creditors, and communicating with stakeholders.
3. Maximizing Asset Value: The IP will work to maximize the value of the assets of the business or individual to repay creditors, which may involve selling assets or renegotiating contracts.
4. Reporting to Creditors: The IP will provide regular reports to creditors on the progress of the process and seek approval for any proposed restructuring or winding down plans.
5. Final Distribution: Once the process is complete, the IP will distribute any remaining assets to the creditors.

The role of an IP is critical in managing the insolvency process effectively and minimizing the impact on all stakeholders involved. It is important to choose an experienced and qualified IP such as ourselves who can provide the necessary expertise and guidance throughout.

How Insolvency Affects Different Parties

We’ll cover the key consequences of insolvency for the principle parties: creditors, company directors and employees

Consequences for Creditors

The consequences of a company’s insolvency for creditors can vary depending on the type of insolvency proceeding and the case’s specific circumstances. Some general implications for creditors include the following:

1. Loss of debt: In most cases, creditors will not be able to recover the company’s total debt. The amount healed will depend on the company’s assets and the priority of the creditor’s claim.
2. Delay in payment: Insolvency proceedings can be lengthy, and creditors may have to wait a significant amount of time before receiving any payment.
3. Risk of non-payment: In some cases, creditors may only be able to recover their debt if the company’s assets are sufficient to pay all of its creditors.
4. Loss of security: If a company goes into liquidation, any security held by creditors, such as mortgages or charges over assets, may be lost.

Consequences for Directors

The consequences of business insolvency for directors can be severe and can include the following:

1. Personal liability and Impact on personal finances: Directors can be held personally liable for the company’s debts in certain circumstances, such as if they allowed the company to continue trading while it was insolvent.
2. Disqualification: Directors can be disqualified from acting as directors of any company for up to 15 years if they are found to have acted improperly in relation to the company’s insolvency.
3. Investigation and prosecution: Directors may be subject to investigation by regulatory bodies, such as the Insolvency Service, for offences related to the company’s insolvency, such as fraud or misfeasance.
4. Harm to reputation: Insolvency can harm a director’s reputation and future career prospects.

What’s are the Main Insolvency Procedures?

In the UK, several main corporate insolvency proceedings can be used to address a company’s financial difficulties. Their processes differ for each one.

These include:

1. Liquidation (also known as winding up): This is the process of bringing a company’s existence to an end and distributing its assets to creditors. There are two types of liquidation: compulsory liquidation (ordered by the court) and voluntary liquidation (at the company’s or its shareholders’ request).
2. Company voluntary arrangement (CVA): This is a legally binding agreement between a company and its creditors to pay all, or a proportion of, its debts over an agreed period. An insolvency practitioner supervises the process.
3. Administration: This is a process in which an administrator is appointed to manage the company’s affairs, business, and property with the goal of rescuing the company as a going concern or achieving a better outcome for the company’s creditors as a whole than would be likely if the company were immediately wound up.

Can I start Insolvency proceedings myself?

Under UK law, a licensed insolvency practititioner must manage insolvency processes to ensure fair play for creditors.

As a director, you can initiate most insolvency processes yourself, but this should always be decided in conjunction with an IP, since they will have to perform them.

What are the Main Insolvency Laws in the UK?

The majority of laws that cover company insolvency are statutory. Generally speaking, once a company is insolvent and a liquidator is appointed, it will be the liquidator that will consider how the Insolvency laws apply to how the company was run in the period before insolvency.

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.

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References

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.

1. Trusted Source – .GOV- Options When a Company is Insolvent