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?

At its most basic level, a company is insolvent when it cannot pay its bills. It can also be considered insolvent when its liabilities (debts) outweigh its assets.

For directors, the key thing to realise is that, if your company is insolvent, you must shift their 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.

Clearly, insolvency has a significant impact on everyone involved.

Creditors may lose some or all of the money that they are owed by the company.

Employees may lose their jobs and have difficulty getting their wages and other employment benefits paid.

Directors can be held personally liable for the company’s debts if found to have been negligent or reckless.

>>Read our full article on the warning signs of insolvency

What is Insolvency?

Is Insolvency the Same Thing as Bankruptcy?

No, insolvency is not the same thing as bankruptcy.

Insolvency is the financial state in which a company or person cannot pay their debts. Bankruptcy is a legal process that follows when an individual declares that they cannot meet their financial obligations[2]Trusted Source – GOV.UK – Guide to Bankruptcy.

In the UK, a company can’t go bankrupt; instead, it goes through processes like liquidation or administration.

When is a Company Considered to be Insolvent?

There are two main tests for insolvency:

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.

This means that 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. 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?

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. They are authorised and regulated by the Insolvency Service to act on behalf of insolvent individuals, companies, or partnerships. Their 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.

Their key responsibilities are as follows:

  1. Advice: IPs begin their role by assessing the distressed entity’s financial situation. They then provide advice on the most suitable form of insolvency procedure, taking into consideration the interests of all stakeholders.
  2. Acting as Supervisor in CVAs: In a Company Voluntary Arrangement, the IP assist in drafting the proposal and oversees the creditors’ meeting. If approved, they become the supervisor, managing the agreed payments from the company to its creditors.
  3. Managing Administration: When a company enters administration, the IP becomes the administrator, taking over the management of the company. Their responsibilities include running the company in a way that maximises returns to creditors, possibly through restructuring or facilitating a sale of the business.
  4. Overseeing Liquidation: The IP is appointed as a liquidator in liquidation scenarios. Their tasks involve ceasing company operations, valuing and selling assets, and distributing the proceeds among creditors according to legal priorities.
  5. Advising on Personal Insolvency: IPs also advise individuals on personal insolvency solutions, such as Individual Voluntary Arrangements (IVAs) or bankruptcy.

Personal Insolvency

Insolvency affects businesses, individuals, and sole traders. The implications are significant, potentially affecting one’s credit rating, asset ownership, and future borrowing capabilities.

How Does Insolvency Affect Sole Traders?

Unlike limited companies, sole traders do not have a separate legal entity from their owner, meaning personal assets could be required to settle business debts. Individuals may face similar challenges, with insolvency affecting credit ratings, employment opportunities, and financial stability.

You have three basic options:

  1. Individual Voluntary Arrangement (IVA): An IVA allows you to reach an agreement with your creditors to pay off your debts over a specified period, usually five years. It prevents further legal action and, upon completion, remaining debts are often written off.
  2. Bankruptcy: Declaring bankruptcy is a more drastic step, where assets might be sold to pay off debts. While it can provide a fresh start, the impacts on your credit rating and restrictions on financial and professional activities are considerable and can last several years.
  3. Debt Relief Order (DRO): Available in the UK for those with low income, few assets, and under £20,000 in debt, a DRO freezes debt repayments and interest for 12 months. If your financial situation hasn’t improved by then, the debts may be written off.

Navigating insolvency involves not only understanding financial recovery options but also being aware of the legal implications and responsibilities. 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 concept underscores the importance of seeking professional advice and acting responsibly when insolvency looms. It’s about protecting not just the company’s interests but also those of the creditors, ensuring fair treatment for all parties involved.

The Impact on Employees

Insolvency can have profound effects on employees, who may face uncertainty, job loss, and financial distress. In the event of insolvency:

  • Job Security: 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.
  • Wages and Benefits: Outstanding wages, holiday pay, and pension contributions are prioritised among the debts a company owes. However, there may be delays or shortfalls in payments.
  • Rights Transfer: In cases where a business is sold as a going concern through administration, employee rights may transfer to the new owner under TUPE (Transfer of Undertakings (Protection of Employment) Regulations). This can offer some job continuity but may also involve changes in terms and conditions of employment.

For employees, the key is to stay informed about the insolvency process and understand their rights and entitlements. For employers and directors, it’s essential to handle insolvency proceedings ethically and in accordance with legal obligations, ensuring that employees are treated fairly and with respect during challenging times.

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:

  1. 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
  2. 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
  3. 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
  4. 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
  5. 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.
  6. 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
  7. 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

Trading whilst insolvent could lead to personal liability and disqualification as a director. It is illegal to keep operating without addressing insolvency.

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.

Yes, it is possible to turn around an insolvent business through restructuring debt, asset sales, or via administration. But outcomes vary case-by-case.

The order of priority for repaying creditors is: secured, preferential, unsecured, and shareholders. Creditors must be paid in this order.

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.

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.

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.

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.

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.

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.

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.UK – Options when a company is insolvent
  2. Trusted Source – GOV.UK – Guide to Bankruptcy