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What Is Business Insolvency

Written by Keith Steven Managing Director 6 July 2021

Business Insolvency

What is business insolvency?

A business is defined as insolvent if it can’t pay its debts when they fall due. There are two main types of business insolvency:

  1. Cash flow insolvency – the business cannot pay bills when they fall due. 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.
  2. Balance sheet insolvency – This is when a company’s total liabilities outweigh its total assets.  But it may still be able to pay its liabilities when they are due.  So a company may have a big tax bill coming up, which is not due yet, but if it was then it couldn’t pay it.  A company might also be deemed balance sheet insolvent if contingent liabilities exceed its assets.  A contingent liability is one that has not as yet crystallised or been determined exactly. 

If your business fits into either scenario, you must act fast to ensure you minimise risk for your creditors.  There is also a legal action test of insolvency which is really a follow on from the cashflow test of insolvency.

When might your business face insolvency?

All company directors should be aware of the risks of business insolvency, and its possible consequences.

It can affect the future of your business and personal life, so it’s worth investigating the options open to you even if your company is not in financial distress.

Here, we’ll explore exactly what business insolvency is and explain as much as we can about the proceedings that follow it. That way, you can be prepared for insolvency proceedings, just in case.

Warning Signs Of Business Insolvency

There are also several warning signs to look for, including:

  • Creditors increasing pressure to pay, often with threats of legal action
  • Company overdraft at its limit, suggesting the company is not viable
  • Applications for borrowing refused
  • Directors taking a pay freeze
  • Late payments to HMRC

As a director, it’s important that you are aware of all these signs. They may help you prevent business insolvency, or mitigate the consequences for you personally and for your company.  Read our page on the implications for directors

What Are My Options If I Face Insolvency?

Being insolvent puts your company in danger of closing down. However, there are several options you can take once your company becomes insolvent, including some that allow the company to continue trading.

Remember, as soon as you realise your business is insolvent, you must do all you can to maximise the creditors' interests. If you don’t, you might be made personally liable for your company's debts.

Get Advice From An Expert Or An Insolvency Practitioner

Business insolvency can be a complex and confusing process, so it’s best to seek expert advice straight away. There are plenty of people and organisations you can turn to, including:

  • Citizens Advice Bureau
  • Solicitors
  • Qualified accountant
  • Licensed insolvency practitioner
  • Reputable financial adviser
  • Debt-advice centre

However, it should be borne in mind that only a licensed insolvency practitioner can take the necessary steps to protect the business or its creditors.  They are an officer of the court and they are the only people that can allow debt write off in a business to be formally binding.  Many insolvency practitioners will outline your options for no charge.  Call us on 0800 9700539 if you want to talk to us direct.

Your options are; 

Create an informal arrangement with creditors

It is vital that you contact your creditors as soon as you become aware of your company’s financial distress.

If your company is experiencing temporary financial difficulties, try contacting your creditors to arrange a payment plan. However, this usually only works if there is no immediate threat of formal action by creditors.

These arrangements are not legally-binding. A creditor can withdraw from the agreement at any point, but this is a good temporary solution that allows you to continue trading.

Before you make alternative arrangements, make sure you’re aware of any costs for changing your repayment terms, including how it will affect your interest payments.

Enter into a company voluntary arrangement (CVA)

Similar to the previous option, a CVA is an arrangement made with creditors to deliver money owed over a new time period.

This is a binding arrangement for all, or part of, the company’s unsecured debts and allows you to continue trading during and after the arrangement.

Go into administration

Administration is a bold move for companies experiencing business insolvency. However, it has many benefits; it offers respite from all creditor actions and enables the company to continue, or be sold.

The process is quite simple. You hand over your company to an insolvency practitioner (the administrator), and while they’re in charge your creditors cannot take legal action to recover their debts without the court’s permission.  Although any charge holder has to be notified and may appoint their own administrator if they wish.

The administrator will draw up proposals to try any of the following.

  • Restore company viability
  • Restructure the business
  • Sell the business as a going concern, or realise more from the assets than in a liquidation
  • Realise assets to pay preferential or secured creditors

The administrator will also decide if you can continue trading during proceedings.

Use administrative receivership

Known more commonly as ‘receivership’, the holder of a 'floating charge' - usually a bank - initiates this option.

They appoint a receiver (a private insolvency practitioner) to recover the money owed. The court is not usually part of these proceedings. The receiver will recover enough money to pay:

  • Their costs
  • Preferential creditors
  • The floating charge holder’s debt

This option does nothing for unsecured creditors and it cannot be used if the floating charge occurred after September 2003. As such, there are hardly any of these nowadays.

Liquidate or ‘wind up’ your company

Liquidation or ‘winding up’ a company, essentially means closing it down. The assets are sold, and funds are given to creditors. Often, this will not cover the money owed to all creditors.

Both solvent and insolvent businesses can do this. If your company is solvent, the term given to this is a member’s voluntary liquidation, if it is insolvent it’s known as a creditors voluntary liquidation (CVL) or a compulsory liquidation.

All liquidations are followed by investigations into the company director's conduct. If the investigation finds anything inappropriate, there can be severe consequences.

What if creditors take action against my insolvent company?

Creditors can try to recover debts from companies experiencing business insolvency in several ways. The most common are:

  • Court judgements
  • Statutory demands
  • If the above don’t work, creditors can apply to wind up the company

However, there are ways to prevent this; you can either pay the debt owed, or use the options above to prevent legal action. You can also apply to stop your creditors from applying to wind up your company.

If none of these options work, a winding up order will probably be issued, leading to:

  • Freeze of the company bank accounts
  • The official receiver selling assets and property
  • Employees losing their jobs if the company is not bought as a 'going concern'

What can happen to me as a director?

It's not just the company that has to face consequences of business insolvency, as a director you might too.

If your actions have been unfit or unreasonable, or you have traded wrongfully or fraudulently, you may face these consequences:

  • A fine
  • Director disqualification for up to 15 years
  • Being held personally liable for money owed, from the time you should have acted
  • A prison sentence

It is extremely important, for both your professional and personal life, that you act quickly if you think your business is insolvent. Seek professional advice and find out about your options, so you can create a plan for dealing with business insolvency.

If you are concerned about business insolvency, speak to our experts today. They’ll be able to give you high-quality, actionable advice tailored to your situation.

Categories: Insolvency process, Implications for Directors

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