Is my company insolvent? Take this insolvency test
We're under a lot of pressure, but is our company insolvent?
So how do you know if your business is insolvent? You may have studied the warning signs pages and learned that apparently insignificant issues can lead to business failure when combined.
A company is deemed to be insolvent if it is unable to pay its debts as and when they are due, or the value of its liabilities is larger than the total value of its assets i.e. it has a negative balance sheet. However, having a negative balance sheet does not necessarily mean that the company will go into an insolvency process.
In order to establish if your company is insolvent you need to apply the 3 tests for insolvency that will determine if your company is viable in the future. Look at the tests for insolvency below which will tell you whether the company is insolvent or not.
There are three key tests for insolvency of a UK company or LLP:
The Cashflow Test For Insolvency
Simply - can the company pay its debts when they fall due?
For example, if your company is not paying the deductions from employees for NIC and Income Tax across to HMRC on the 19th of the month following the month they were deducted, then the company could be insolvent. This has of course now changed as a result of RTI in that PAYE is paid across to HMRC in real time. However, the company may have built up arrears in the past.
If trade creditors sell to the company on say 30 days terms and the company regularly pays on 90+ days, then this could mean the company is insolvent. However, if the creditors are happy with this arrangement then you could argue that the terms have changed and you are paying them in the "reasonably near future" but be honest with yourself!
A director has a legal requirement to understand this issue. If you believe that the company has insufficient cash to pay its liabilities on time you must take action. Note: if the company is insolvent, you as the directors must act to MAXIMISE CREDITORS INTERESTS
The Balance Sheet Test
A balance sheet test is a legal exercise to establish whether your company is in an insolvent state.
A court will determine what value to attribute to the prospective and contingent liabilities of a company. This includes deferred payments or potential litigation decisions against a company, so a precise arrangement can be made.
If the court expects the company to meet all of its liabilities in reasonable time, it will not be deemed to be balance sheet insolvent. However, if it cannot fulfil its liabilities, insolvency proceedings must begin.
The burden of proof for these proceedings is on the party asserting insolvency. So, if creditors are trying to prove insolvency to initiate a winding-up petition, they must prove the balance sheet to be insolvent. That said a court is unlikely to wind up a company just because it is balance sheet insolvent. It will wind it up if it can't pay the petitioner. Inability to pay demonstrates cashflow insolvency anyway. The definition of balance sheet insolvency was determined in the case of (BNY Corporate Trustee Services Ltd & Ors v Neuberger  UKSC 28)
(If you need advice on these issues email us at firstname.lastname@example.org)
Many directors tell us that on a balance sheet test the company is not insolvent therefore they do not need to act. However, under the cashflow test above the company may still be insolvent. So you must act properly if it is. Remember, if the company is insolvent, you as the directors must act to MAXIMISE CREDITORS INTERESTS. Failure to do so could lead to personal liability for the directors. Call now if you have questions - 08009700539 or 020 7887 2667.
The Legal Action Test
The 'legal action' test is to determine whether a company has any demands for payment that have been upheld or are likely to be upheld by a court via a hearing or an order. These legal actions point to the company's inability to meet its liabilities.
If a creditor has obtained a County Court Judgment, this may demonstrate the company's insolvency and the creditor might petition to wind up the company. (See compulsory liquidation).
If you believe that any of the above tests are positive for your business, it is vital that you and the board of directors take action to address the insolvent position. However, don't panic. Look carefully at all pertinent issues and consider the useful information on the rest of this website.
If the company is insolvent, you must act to MAXIMISE CREDITORS INTERESTS. Failure to do so could lead to personal liability for the company's debts.
Call now if you have questions - 0800 9700539
Worried about poor cashflow? Feel you have got into a bit of a mess? Covid-19?, How to pay wages on pay day? For reassuring advice on a range of issues download our free Ultimate Guide For Worried Directors today. Or just call us on 0800 9700539
Please note that the guide includes updates due to Covid-19 For instance there have been some changes to insolvency legislation that limits creditors actions. A new 20 day moratorium for distressed businesses has also been introduced.