A struggling company is in one of two positions. Either it has a trading problem the board can still fix, or it has a solvency problem, and the law has already started to change what the directors may do. The first job is to work out which one you are in. The right steps for one are the wrong steps for the other.
If the company ends in liquidation, the liquidator will look back at exactly this period, because the office-holder is required to report on how the directors ran it. The question is what the directors knew, and when, and what they did about it. This page sets out how to answer that question now, while the answer can still change.
Start with the test the law uses
Under section 123 of the Insolvency Act 1986, a company is unable to pay its debts if it cannot pay them as they fall due, or if its liabilities, counting those that are contingent or not yet due, are more than its assets. Failing either test is enough.
Run both tests on real numbers, not on hope. That means the aged creditor list including HMRC, a week-by-week cash forecast for the next three months, and what the assets would fetch if sold now rather than what the balance sheet says they are worth.
A company that passes both tests but is short of cash has a timing problem. A company that fails either test has a solvency problem, even if it is still trading and still paying wages. Our guide to checking whether a company is insolvent works through both tests.
What changes for you when solvency is in doubt
A director’s duties are owed to the company. While it is solvent, that mostly means acting for the shareholders. Once you know, or ought to know, that the company is insolvent or bordering on insolvency, or that an insolvent liquidation or administration is probable, you must also weigh the interests of the creditors as a whole. The Supreme Court confirmed this in BTI 2014 LLC v Sequana SA [2022] UKSC 25.
That changes ordinary decisions. Paying one supplier ahead of the rest, repaying a director’s loan, or taking credit you cannot see a way to repay are exactly the transactions a liquidator reviews. A payment made to put one creditor in a better position can be reversed as a preference if the company was unable to pay its debts at the time, or became so as a result, and the payment was made in the six months before insolvency, or two years if the creditor is connected to the company. The company must also have been influenced by a desire to put that creditor in a better position. The court presumes that desire only where the creditor is connected to the company.
The sharpest risk is personal. Where a director kept trading after the point at which there was no reasonable prospect of avoiding insolvent liquidation, the court can order a personal contribution under section 214 of the Insolvency Act 1986. Our page on directors’ duties when a company becomes insolvent covers this in full.
The creditor steps that bring the decision forward
Creditors do not wait for the board to finish its analysis. Three steps are common, and each one narrows what the board can still choose:
- A statutory demand. If a demand for more than £750 is not paid, secured or settled within 21 days, the company is treated as unable to pay its debts and the creditor can petition to wind it up. See what a statutory demand against a company means.
- A county court judgment. Unless it is paid in full within one month, it stays on the public register for six years. Lenders and suppliers check that register. See what to do about a CCJ.
- A winding-up petition. Once it is advertised, the bank will usually freeze the company’s account, and from then on the petitioning creditor, not the board, sets the pace. See how a petition affects the bank account.
What the board can still do while the company is solvent
If the tests show a timing problem, the work is commercial. The priority is cash, not profit, and not growth.
- Collect what you are owed. Invoice on delivery and chase from the first day a payment is late. The law lets you charge interest on late business payments at 8% above the Bank of England base rate.
- Cut cost that does not earn. Discretionary spend first, then premises, contracts and subscriptions. Staff costs come last, because redundancy carries its own cost and notice rules.
- Turn surplus stock and idle assets into cash, as long as the sale does not damage the core business. Sell at a proper price. An asset sold cheaply now is one a liquidator may later ask about.
- Talk to the creditors that matter before they act. A supplier or lender told early, with a credible date, has a reason to wait. One who hears nothing has a reason to issue a demand. For tax, HMRC can agree a Time to Pay arrangement if it is satisfied the plan is affordable.
- Borrow only to bridge a real gap. Invoice finance or a new facility can carry a company through a timing problem. Borrowing to cover losses the business cannot recover makes the eventual deficit larger, and a personal guarantee moves that risk onto you.
The longer turnaround guides are turning round a failing business and how to save a failing business. If cash is the specific problem, start with diagnosing a cash flow problem, then what to do in a cash flow crisis.
When the tests point to insolvency
If the company fails either test and no realistic plan closes the gap, the board’s question becomes which procedure to use, and how soon. Waiting does not keep options open. It closes them.
The rescue routes are a company voluntary arrangement, in which the company repays part of its debts over time and which needs the approval of 75% by value of the creditors who vote, and administration, which protects the company from creditor action while an administrator tries to rescue the business. Where neither will work, a creditors’ voluntary liquidation begins when the directors decide to propose it and the members pass a special resolution to wind the company up, rather than on a creditor’s petition.
Every one of these routes needs a licensed insolvency practitioner, and every one is easier to take before a creditor petitions. AABRS® takes these appointments. To test where your company sits, call us on 0208 444 3400 or send us your details.