What Happens if a Company Cannot Pay Its Debts? UK Insolvency Guide for Directors

It is usually a Tuesday. The VAT return is sitting open on a screen, the payroll run is two days away, and a director realises the maths does not work this month. That is the moment most of our calls begin. The mistake we see most often in the next 48 hours is treating the realisation as a cash-flow problem when, legally, it has already become an insolvency event.

Once a UK company cannot pay its debts as they fall due, or its liabilities exceed its assets, your duties as a director shift from shareholders to creditors. Continuing to trade past that point without taking advice is what creates personal liability. This guide names the moment, sets out the four scenarios you might actually be in, and tells you what to do before the next payment run.

Company Cannot Pay Debts at a Glance

When a UK limited company cannot pay its debts as they fall due, it is technically insolvent under section 123 of the Insolvency Act 1986. From that point director duties shift from shareholders to creditors under the BTI v Sequana principle, and continuing to trade without taking active steps to minimise creditor loss puts the directors personally at risk under section 214 (wrongful trading). The realistic options are a Time to Pay arrangement, an informal creditor negotiation, a CVA, administration, or a creditors’ voluntary liquidation.

Quick Answer: When a Company Cannot Pay Its Debts

If your company cannot pay its debts as they fall due, it is cash-flow insolvent under section 123(1)(e) of the Insolvency Act 1986. From that moment, your duty as a director shifts to protecting creditor interests.

You must stop incurring credit you cannot pay back, get written advice from a licensed insolvency practitioner, and choose between rescue, sale, or a formal procedure within days, not weeks.

When “Cannot Pay” Becomes an Insolvency Event

“Cannot pay” is not one situation. It is four, and the legal consequences are different for each. The contrarian point most directors miss: balance-sheet insolvency, not cash-flow insolvency, is what most often triggers wrongful-trading liability later, because it is the test that survives even when you are still scraping payments together.

Main Director Risk When the Company Cannot Pay

The main risk is wrongful trading under section 214 of the Insolvency Act 1986. If you keep trading after the point where you knew, or should have known, there was no reasonable prospect of avoiding insolvent liquidation, a court can order you to contribute personally to the shortfall. The risk is sharper when your decision-making is undocumented.

What to Do Next If the Company Cannot Pay

Hold a minuted board meeting within seven days that records the cash position, the liabilities, and the advice taken. Stop selective payments to favoured creditors. Get written insolvency-practitioner advice before the next supplier or bank payment goes out. Then choose your route: rescue, restructure, sell, or close.

What “Cannot Pay” Actually Means in UK Law

UK insolvency law does not treat “we cannot pay this month” as a single legal status. Under section 123 of the Insolvency Act 1986, a company is deemed unable to pay its debts in two distinct ways. The distinction matters because each test triggers different director duties and different creditor remedies.

Cash-Flow Insolvency Test (s.123(1) IA 1986)

Section 123(1)(e) is the headline test most directors recognise. Your company is cash-flow insolvent if it cannot pay its debts as they fall due. A statutory demand for more than £750 left unpaid for 21 days is enough to prove it. So is an unsatisfied judgment.

The test is mechanical. It does not care whether the underlying business is viable. If you missed last month’s PAYE because the receivable from your largest customer landed late, you were technically cash-flow insolvent at that moment, even if everything cleared two weeks later.

Balance-Sheet Insolvency Test (s.123(2) IA 1986)

Section 123(2) is the test most directors do not appreciate until afterwards. Your company is balance-sheet insolvent when its liabilities, including contingent and prospective liabilities, exceed its assets. You can be balance-sheet insolvent and still meeting payments. You can pass the cash-flow test on any given Tuesday and still be balance-sheet insolvent every day of the year.

This is the test that bites later. When an administrator or liquidator looks back at when the duty to creditors first arose, they often anchor on balance-sheet insolvency, especially where directors took on more credit while deficits were widening. We see this in almost every wrongful-trading review we run.

Difference Between Temporary Cash Gap and Insolvency

A temporary cash gap is when funds are landing, just not in the right week. The receivable is contracted, the buyer is solvent, and the gap is bridgeable through forbearance, an overdraft headroom call, or a director loan. It is not insolvency, but it can become insolvency quickly if forbearance is refused.

The dividing line is honest evidence. If you can show, on paper, that the cash will arrive within a defined window and you have written agreement from creditors to wait, you are managing a gap. If you cannot, you are insolvent and need to act on that footing. Our triage on how to save a struggling business covers the bridging steps when the gap is genuinely short term.

How to Tell Which Scenario the Company Cannot Pay Falls Into

You cannot decide what to do next until you know which of the four scenarios you are in. The diagnosis is forensic, not optimistic. The three documents below are what an insolvency practitioner will look at first, and they are the documents we ask for on every initial call.

13-Week Cash-Flow Forecast as the Trigger Document

A 13-week cash-flow forecast, week by week, with realistic collection dates and committed outgoings, is the document that decides scenario (a) versus (b). If the forecast shows a positive closing cash balance every week with reasonable haircuts on receipts, you are managing a gap. If any week dips below zero, you are cash-flow insolvent in that week.

Build the forecast yourself, in a spreadsheet you can defend later. Do not let optimism creep in. If your largest customer has paid late three months running, model them at 30 days late, not 0.

Statement of Assets and Liabilities as the Balance-Sheet Test

For the balance-sheet test, prepare a statement of assets and liabilities at realisable, not book, values. Plant and machinery at auction value, not depreciated cost. Stock at trade-sale prices. Debtors net of an honest provision. Then list every liability, including contingent ones: dilapidations, personal guarantees called, HMRC penalties accruing, redundancy if you closed the doors today.

If liabilities exceed assets on this honest basis, you are balance-sheet insolvent. This is the moment most directors discover they crossed the line months earlier. See our framework on the insolvency test for worked examples.

Creditor Pressure as the External Trigger

Creditor pressure is the third diagnostic. A statutory demand, a winding-up petition advertised in the Gazette, or a single creditor refusing further forbearance is an external signal that the cash-flow test will be deemed proven if challenged.

If you are at this point, the question is no longer whether you are insolvent but how creditors will be paid. Our guide on dealing with creditor pressure covers the immediate triage.

What Options Are Available When the Company Cannot Pay

Your options collapse into three categories once you have diagnosed the scenario honestly. Each category protects creditors differently and exposes you to different residual risks. The comparison below is the version we walk directors through on a first call.

Informal Agreement or Repayment Plan

If you have a temporary cash gap or one large creditor causing the pressure, an informal arrangement may hold. Time to Pay with HMRC is the most common. Bilateral forbearance with a landlord or trade creditor works where the relationship has history. The catch: informal agreements offer no protection from the next creditor who refuses to play along.

Rescue or Restructuring Procedure

If the underlying business is viable but the debt load is not, a formal rescue procedure binds creditors and gives you a window to trade through. A Company Voluntary Arrangement (CVA) restructures debt by 75% creditor vote.

Administration imposes a moratorium and gives an administrator the steering wheel. The Restructuring Plan under Part 26A of the Companies Act 2006 can cram down dissenting classes. Detail on each procedure sits in our guide to rescuing a business from insolvency.

Sale, Closure or Insolvency Procedure

Where the business is not viable, the route is sale or orderly closure. A pre-pack administration sells the business as a going concern at administrator-controlled valuation. A Creditors’ Voluntary Liquidation (CVL) closes the company at the directors’ initiative. Compulsory liquidation, by contrast, is forced on you by a winding-up petition and removes you from the steering wheel entirely.

Option	Best for	Director control	Creditor protection
Time to Pay (HMRC)	Tax-only cash gap, otherwise solvent	Full	None against other creditors
CVA	Viable trading, unsustainable debt	Retained, supervised	Binds 75% by value
Restructuring Plan	Complex creditor classes, secured debt	Retained, court-supervised	Cross-class cram down
Administration	Rescue or going-concern sale needed	Lost to administrator	Statutory moratorium
Pre-Pack Administration	Going-concern sale, speed needed	Lost to administrator	SIP 16 disclosure to creditors
CVL	Not viable, orderly closure wanted	Lost to liquidator	Pari passu distribution
Strike-off	No debts, no trading, no assets	Full until strike-off	Creditors can object

What Risks Should Directors Watch When the Company Cannot Pay

The personal-liability risks below are not theoretical. Each one has its own statutory basis, its own evidence trail, and its own track record in the Insolvency Service investigation files. The risks compound. Directors who walk into one usually walk into two or three.

Risk	Statutory basis	What it means in practice
Wrongful trading	s.214 Insolvency Act 1986	Personal contribution to creditor losses if you traded past the no-reasonable-prospect point
Fraudulent trading	s.213 Insolvency Act 1986	Personal liability and possible criminal sanction for trading with intent to defraud creditors
Preferences	s.239 Insolvency Act 1986	Court can reverse payments to a creditor (often a connected party) made in the 6 months before insolvency
Transactions at undervalue	s.238 Insolvency Act 1986	Court can reverse asset transfers below market value made in the 2 years before insolvency
Personal guarantees	Contract law	Bank, landlord, or supplier can pursue your personal assets directly
Director loan account overdraft	Companies Act 2006 / IA 1986	Liquidator will demand repayment of overdrawn DLA in full
Director disqualification	CDDA 1986	Up to 15 years’ ban from directorship for unfit conduct
Misfeasance	s.212 Insolvency Act 1986	Personal liability for breach of fiduciary duty to creditors

What Directors Should Do When the Company Cannot Pay

Call a Solvency Review Board Meeting Within 7 Days and Minute the Cash Position

Convene a board meeting with one item on the agenda: solvency. Minute the current cash position, the 13-week forecast, the statement of assets and liabilities, and the advice taken. The minute is the document that defends you later. We have seen well-run boards survive an investigation almost entirely on the strength of contemporaneous minutes.

Stop Selective and Connected-Party Payments Immediately

From the realisation moment, every payment must be defensible to a future liquidator. Paying the bank because you fear the overdraft being pulled, while letting HMRC slide, is a preference under section 239. Paying yourself or a related party in priority to trade creditors is the textbook claim a liquidator will run. Stop both immediately.

Get Written Insolvency-Practitioner Advice Before the Next Creditor Pays Out

Verbal reassurance from your accountant is not enough. Get advice in writing from a licensed insolvency practitioner regulated by one of the recognised professional bodies, dated and on letterhead. The advice itself, even if you choose not to take the recommended route, is evidence you took your duty to creditors seriously. Our director investigations guide covers what investigators look for.

Mistakes Directors Make When the Company Cannot Pay

Paying the Bank or Landlord Before HMRC Out of “Goodwill”

The instinct is human: keep the bank sweet, keep the landlord on side. The legal effect is a preference. Once you are insolvent or about to become so, every creditor you pay is a creditor you put ahead of HMRC and the wider unsecured pool. A liquidator will unwind it.

Selling Assets to a Connected Party at Book Value

Transferring the van fleet to a phoenix company at written-down book value, weeks before the insolvency, is one of the most common transactions at undervalue we see. It almost always reverses. If you need to sell assets to a connected party, you need an independent valuation and you need it on file before, not after, the transfer.

Trading On Because “Next Month Will Be Better”

The single most expensive mistake. Each month traded after the no-reasonable-prospect point widens the creditor deficit you may be ordered to contribute to personally. Hope is not a defence to a wrongful-trading claim. Documented evidence of why the prospect was reasonable, week by week, is. If you do not have that evidence, you are exposed.

Related Guides for When the Company Cannot Pay

• How to save a struggling business: operational triage when the gap is genuinely short term.
• Rescue your business from insolvency: formal procedure routing across CVA, Administration, Restructuring Plan.
• Dealing with creditor pressure: what to do when a single creditor is forcing the pace.
• Cease trading: the holding-pattern frame once you have stopped trading but not yet entered a procedure.
• Company Voluntary Arrangement: detailed CVA mechanics, voting thresholds, and supervisor role.

Frequently Asked Questions When a Company Cannot Pay Its Debts