Insolvency means that an individual or a company cannot pay the money they owe.
However, in the UK the term more commonly refers to companies, whilst bankruptcy is used to denote personal insolvency.
This article will explore how corporate insolvency can affect a business, and what you can do about it.
Business Definition
There are two basic definitions of insolvency from a business setting. They are as follows:
Balance Sheet Insolvency
Balance sheet insolvency means you have negative net assets.
With assets (including cash) listed in column A of a spreadsheet, and liabilities in column B, you can quickly ascertain whether you have enough liquidity, at any given point in time, to pay what you owe. If you do not, you are technically insolvent.
Cash Flow Insolvency
The cash flow test is even simpler. Does your business have enough cash flow to pay your bills? If you don’t, you have failed the cash flow insolvency test.
What Should You Do if You’re Business is Insolvent?
Our chief bit of advice, if you either suspect or are certain that the business is insolvent, is to ask an expert. Speak with our friendly team right now via live chat or telephone, and find out what your options are. Failing that, speak to your accountant or other financial advisor at the earliest opportunity.
You should be careful not to pay anyone, including yourself.
It’s also worth documenting any actions you do take to ensure that your can demonstrate you acted responsibly.
What the Implications of Insolvency for Company Directors?
As a company director, insolvency comes with a very clear shift in responsibility.
Once you become aware of your company’s situation, you are no longer legally mandated to serve your shareholders. Rather, you must consider the interests of the creditors as a whole. If you carry on past the point where there is no reasonable prospect of avoiding insolvent liquidation or administration, a liquidator or administrator can bring a civil wrongful trading claim seeking a contribution to the company’s assets. It is not a criminal charge.
As to what the situation means for your company, this will depend on the facts. Ultimately there are two outcomes for an insolvent company:
- Business restructuring and/or turnaround
- Liquidation and the end of the limited company
Working with an Insolvency Practitioner
Whether your company emerges from insolvency via a turnaround process or closes down, an insolvency practitioner will be required.
Insolvency practitioners in the UK are required to undergo a specialist training and obtain a license from a regulatory body in order to practice.
The industry is carefully monitored and regulated.
It’s important to realise that, while a company director can choose an IP, the IP’s duty is to provide the best return for creditors.
He will also be required to conduct what is called a ‘directors’ investigation’ whereby the actions of directors in the period preceding insolvency is examined for potential misfeasance.
United Kingdom Insolvency Law
The key pieces of legislation pertaining to insolvency in the UK are as follows:
- Insolvency Act 1986
- The Insolvency (England and Wales) Rules 2016
- Company Directors Disqualification Act 1986
- Employment Rights Act 1996 Part XII
According to these laws, insolvent company’s have access to four main processes:
- Company Voluntary Arrangement – A structured repayment plan with creditors
- Administration – Usually an attempt to rescue the business as a going concern the administration involves restructuring while under the protection of a statutory moratorium
- Administrative receivership – now largely a legacy procedure. A lender could once appoint a receiver to take control of the business under a floating charge, but the Enterprise Act 2002 removed that right for floating charges created on or after 15 September 2003, apart from limited statutory exceptions. A modern qualifying floating-charge holder appoints an administrator instead. See our guide to administrative receivership
- Liquidation – the formal closure of an insolvent company, in which its assets are realised and the proceeds distributed to creditors in the statutory order of priority