What Is the Corporate Insolvency Test? A UK Director’s Guide Under the Insolvency Act 1986

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“Am I trading while insolvent?” is the question we tell directors they should be asking three months before they actually ask it.

The UK corporate insolvency test under section 123 of the Insolvency Act 1986 has four limbs; two procedural (statutory demand + unsatisfied execution) and two substantive (cash-flow + balance-sheet).

If you fail any one of them you engage the creditor-duty doctrine under section 172(3) of the Companies Act 2006. The Supreme Court’s BTI v Sequana decision in 2022 confirmed the threshold sits at “probable” insolvency, meaningfully earlier than you might instinctively place it.

Below, we explain how each limb of the test works, how you can run the test on your own company in 90 minutes, and what changes the moment one of the limbs fails.

The 13-week cash-flow forecast is our standard diagnostic tool. The contingent-and-prospective liability inclusion under Eurosail is the rule that catches our clients out. And the dated evidence file you build during the test is what underpins both your s.1157 CA 2006 court-relief defence and your s.214(3) IA 1986 wrongful-trading defence later.

Why the Insolvency Test Matters

Section 123 of the Insolvency Act 1986 sets out four limbs of the corporate insolvency test:

1. s.123(1)(a); statutory demand for £750+ unpaid for 21 days
2. s.123(1)(b); unsatisfied execution of judgment debt
3. s.123(1)(e); cash-flow test: cannot pay debts as they fall due
4. s.123(2); balance-sheet test: liabilities exceed assets, including contingent and prospective

The Supreme Court’s decision in BTI 2014 LLC v Sequana SA [2022] UKSC 25 confirmed what West Mercia Safetywear v Dodd [1988] BCLC 250 had first established: directors’ duties shift from members’ interests to creditors’ interests collectively when insolvency becomes “probable.” The threshold is meaningfully earlier than “unavoidable” or “imminent.”

Failing the test does not, by itself, require immediate liquidation. It does, however, trigger a cluster of personal-liability exposures that operate on the director’s own conduct from the point of failure forward:

• s.214 IA 1986 wrongful trading; contribution-order risk for continuing to trade
• s.212 IA 1986 misfeasance; claim for breach of fiduciary duty on specific transactions
• s.239 IA 1986 preferences; reviewable selective payments in the look-back window
• s.6 CDDA 1986 disqualification; 2-15 year director ban for Schedule 1 conduct breaches

Running the insolvency test honestly is the first step in protecting yourself against all four routes.

The Cash-Flow Insolvency Test: Section 123(1)(e)

Section 123(1)(e) IA 1986: a company is unable to pay its debts if “it is proved to the satisfaction of the court that the company is unable to pay its debts as they fall due.”

The “as they fall due” phrase matters. It captures not just current liabilities (debts already overdue) but near-term debts that will fall due in the immediate forecast period. A company with £50,000 cash and £40,000 of debts overdue today but £60,000 of debts due next week is cash-flow insolvent; even though today’s overdue balances are technically affordable.

The 13-week rolling cash-flow forecast is the standard diagnostic tool. Licensed insolvency practitioners require this before recommending any procedure. It captures:

• Opening cash position (today)
• Week-by-week receipts (customer payments + facility drawdowns + equity injections)
• Week-by-week payments (creditors + payroll + tax + lease + finance)
• Closing cash position week-by-week
• Negative closing balance + no available facility headroom = cash-flow insolvency at that point

When we walk a director through this for the first time, a simple Excel template works. The discipline matters more than the format: include everything (especially contingent obligations like quarterly tax payments + annual insurance renewals), be honest about realistic receipt timing (not optimistic), and refresh weekly during the stress period.

The cash-flow test is the more common trigger for SME insolvency. Most companies hit cash-flow insolvency before they hit balance-sheet insolvency.

The Balance-Sheet Insolvency Test: Section 123(2)

Section 123(2) IA 1986: a company is also deemed unable to pay its debts if “it is proved to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account its contingent and prospective liabilities.”

The contingent and prospective inclusion is the key. The test does not look only at the balance sheet as filed; it adds:

• Contingent liabilities; claims that may or may not materialise (warranty claims, ongoing litigation, dilapidation obligations on leases, cross-guarantees, PG indemnities to other companies)
• Prospective liabilities; future obligations that will arise (future-rent under leases that have not yet been disclaimed, future redundancy obligations, regulatory obligations)

The leading case is BNY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc [2013] UKSC 28. The Supreme Court framed the test as the “point of no return”; the balance-sheet position has to be so bad that the company cannot reasonably be expected to meet its liabilities, taking account of contingent and prospective obligations.

For SMEs, the Eurosail test typically engages later than cash-flow insolvency. A company can be cash-flow insolvent (cannot pay this week’s payroll) while still having a positive balance sheet on paper.

But once the contingent + prospective liabilities are added; particularly dilapidation exposure on commercial leases, undischarged guarantees, and warranty obligations; the balance-sheet picture often shifts materially.

Building the contingent + prospective list is part of the diagnostic. Most SMEs underestimate by 20-50% because dilapidations + warranty + cross-guarantee exposures are not on the management accounts.

The Legal Action Limbs of the Insolvency Test

Sections 123(1)(a)-(d) IA 1986 are procedural triggers; they create a presumption of inability to pay without requiring the court to make findings on cash-flow or balance-sheet position.

s.123(1)(a); statutory demand. A creditor with a debt of £750 or more can serve a statutory demand under r.7.3 of the Insolvency Rules 2016. If the company fails to pay or satisfy the demand within 21 days, the company is presumed unable to pay its debts. This is the most common pre-petition trigger for SME insolvency.

s.123(1)(b); unsatisfied execution. Where a judgment creditor has obtained a court order and the execution officer (HCEO under TCEA 2007) returns the writ unsatisfied; meaning they tried to enforce against assets and found nothing; the company is presumed unable to pay.

This typically follows a CCJ + Warrant of Control where the bailiff finds insufficient assets.

s.123(1)(c)-(d); Scottish + Northern Ireland equivalents. The “unsatisfied execution” route adapted to each jurisdiction’s enforcement framework.

These limbs are presumptions, not conclusions. A company can rebut by showing it has the means to pay (cash + facility + realisable assets sufficient to cover the underlying debt). But absent rebuttal, the presumption is sufficient for the creditor to present a winding-up petition under s.122(1)(f) IA 1986.

In practice, the procedural triggers are how most creditors crystallise their position. HMRC issues statutory demands. Commercial landlords pursue CCJ + enforcement. Trade suppliers escalate to statutory demand once cash is tight.

The substantive tests (s.123(1)(e) cash-flow + s.123(2) balance-sheet) become relevant if and when the matter reaches court; but by then the procedural triggers have usually done the work.

The Consequences of Trading While Insolvent

Failing the insolvency test is not, in itself, a wrong. Continuing to trade after the test fails; without taking steps to minimise creditor loss; is.

The four exposure routes:

Wrongful trading under section 214 IA 1986. Where you knew or ought to have concluded that there was no reasonable prospect of avoiding insolvent liquidation, and you continued to trade, the liquidator can apply for a contribution-order against you personally.

Re Produce Marketing Consortium Ltd (No 2) [1989] BCLC 520 sets the quantum framework: your contribution is calculated from the “point of no return” to the date of liquidation.

Recent benchmark: the BHS Group case (2024) produced a £18m collective contribution-order against former directors.

Misfeasance under section 212 IA 1986. Breach of fiduciary duty in any specific transaction during the insolvency period; paying favoured creditors, taking dividends without distributable reserves, transferring assets at undervalue. The liquidator pursues misfeasance claims by summons; no statutory cap on the recovery amount.

Preferences under section 239 IA 1986. Selective payments to creditors in the 6-month arm’s-length lookback (2 years for connected parties) where the recipient ended up in a better position than they would have been in a liquidation. Re MC Bacon Ltd [1990] BCLC 324: the “desire to prefer” test focuses on intent.

Disqualification under section 6 CDDA 1986. Mandatory disqualification proceedings if conduct findings under Schedule 1 CDDA 1986 substantiate unfitness. 2-15 year range; voluntary undertaking under s.1A CDDA 1986 avoids court costs.

These four routes compound. Liquidators routinely plead s.214 + s.212 + s.239 in a single claim; disqualification proceedings follow on the conduct findings.

Running the Insolvency Test Yourself, A Working Method

Here is the working method we run with directors. It takes about 90 minutes for a small SME:

Step 1: Build a 13-week cash-flow forecast. Weekly buckets for the next 13 weeks. Opening cash + receipts + payments = closing cash, week by week. Include facility headroom separately (available overdraft, available factoring, available asset finance).

Step 2: Identify the cash-flow failure point. Which week shows the first negative closing balance + no available facility? That is the cash-flow insolvency point under s.123(1)(e). If the forecast shows no failure in 13 weeks, you are not cash-flow insolvent in the immediate forecast horizon (but check the assumptions before concluding).

Step 3: List contingent + prospective liabilities. Lease dilapidations (recent industry rule of thumb: £20-40 per square foot for office space), warranty obligations on completed work, ongoing litigation exposure, cross-guarantees to sister companies, PG indemnities you’ve given other parties, future-rent under leases beyond the next 12 months.

Step 4: Reconcile balance sheet under s.123(2). Take current balance sheet, add contingent + prospective liabilities, calculate the adjusted position. If liabilities (current + contingent + prospective) exceed assets at realisable value, you are balance-sheet insolvent under Eurosail “point of no return” framing.

Step 5: Document the reasoning. Board minutes recording: financial position reviewed, alternatives considered, professional advice received, decision made, and (post-Sequana) explicit consideration of creditor interests once insolvency is probable. Date the minutes contemporaneously.

The dated evidence file from step 5 is the universal protection; it underpins both s.1157 CA 2006 court relief and s.214(3) IA 1986 wrongful-trading defence. Without it, the liquidator’s narrative goes unchallenged in any subsequent investigation.

Your Next Step on the Insolvency Test

If either substantive test (cash-flow s.123(1)(e) or balance-sheet s.123(2)) fails:

1. Build 13-week cash-flow forecast within 7 days. Excel template sufficient; refresh weekly.
2. List contingent + prospective liabilities. Include everything; dilapidations, PGs, warranties, litigation, cross-guarantees.
3. Audit creditor pressure points. Which creditors have given notice, issued statutory demand, escalated to litigation? Which have you missed payments to?
4. Free IP diagnostic call within 14 days. Industry-wide free under s.388 IA 1986 + IPR 2005. Verify the IP on ICAEW (icaew.com/regulation/find-a-firm) or IPA (insolvency-practitioners.org.uk) register.
5. Document board decisions contemporaneously. Dated minutes recording each major financial-position review, alternatives considered, advice received, action taken.

In our experience, the free IP diagnostic call is the cheapest insurance a director can buy against personal liability. Even if you conclude the company can trade through the difficulty, the dated record of having taken IP advice is the evidence file we see defeat most s.214 wrongful-trading claims later.

If both tests fail and rescue is not viable, the formal options are CVA (Pt I IA 1986), Administration (Sch B1 IA 1986), Restructuring Plan (Pt 26A CA 2006), or CVL (s.84 IA 1986). The “engagement before enforcement” rule still applies: pre-petition options outnumber post-petition options 5 to 2.

FAQs on the Corporate Insolvency Test