Are We Insolvent?

You may think that being under cashflow pressure isn't the same as being insolvent. This is not true! Inability to pay debts on time is a definition of insolvency – see below.

It is vitally important to understand that, if the business is insolvent, this results in a shift in the partner’s duty of care from acting for the business to ensuring the creditor’s position is maximised.

Use this page to establish if the business or the individual partners are insolvent.

So how do you know if the business is insolvent? How can you tell if an individual partner is insolvent even if the business appears sound? By now you will have studied the warning signs pages and learned that apparently insignificant issues can lead to business failure when combined.

This page will tell you whether the business is insolvent or not.

There are three methods to determine insolvency

1. The Cashflow Test.
   
   1.1. Simply - can the business pay its debts when they fall due for payment? For example if you are not paying the deductions from employees for NIC and Income Tax across to the Inland Revenue on the 19th of the month after the month they were deducted, then the business could be insolvent.
   
   1.2. If your trade creditors sell to you on say 30 days terms and you regularly pay on 90+ days, then the partnership could be insolvent.
   
   1.3. If you believe that the partnership or an individual partner has insufficient cash to pay its/their liabilities on time then they must take advice/action.
   
   1.4. Remember an insolvent partner can lead to the insolvency of the partnership. See DOMINO EFFECT for full details.
   
   
2. The Balance Sheet Test
   
   2.1. Simply - do you owe more than you own as a business or are the business’s assets exceeded by its liabilities?
   
   2.2. Do you or another partner owe more than you own personally? If yes, to either, then the partnership could be insolvent.
   
   2.3. It is important to point out that this test should include contingent or future liabilities. (If you need advice on these issues click here).
   
   2.4. Many people tell us that on a balance sheet test the business is not insolvent therefore they do not need to act. However under the cashflow test above the business may, of course, still be insolvent.
   
   2.5. In our experience an apparently solvent balance sheet may include items that are overstated, such as stock and work in progress, or debtors that are not really collectable. After deducting these items many balance sheets become insolvent.
   
   2.6. So be prudent - you are legally required to present accounts to show a true and fair picture of the business.
   
   
3. Legal Action Test
   
   3.1. If a creditor has obtained a County Court Judgment against either the partnership or an individual partner, this may demonstrate the business’s or the individual partner’s insolvency and the creditor may petition to wind up the partnership, or issue bankruptcy proceedings against the partner of the partnership.
   
   3.2. If a creditor has obtained a statutory demand for greater than £750 and it remains unpaid for more than 21 days, then the creditor may petition to wind up the partnership. (See bankruptcy and partnership winding up).

If you believe that any of the above tests are positive for your business, it is vital that you take action to address the insolvent position. However, don’t panic, look carefully at all pertinent issues and consider the rest of this website.

Remember, if a partner or the business is insolvent you must act to maximise creditor’s interests.

If there is no reasonable prospect of the following happening:

1. New or additional capital or finance being introduced to the business to return the balance sheet to a solvent position or to remove the cashflow pressures;
   
   
2. A sale or acquisition of the business assets;
   
   
3. A partnership voluntary arrangement, simultaneous individual voluntary arrangements, individual voluntary arrangements or partnership administration;
   
   then the partners may face personal bankruptcy or compulsory winding up of the partnership.