Insolvency means that an individual or a company cannot pay the money they owe.
However, in England and Wales the term more commonly refers to companies, whilst bankruptcy is used to denote personal insolvency. In Scotland, the personal process is called sequestration.
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, under section 123 of the Insolvency Act 1986, means the value of a company’s assets is less than the amount of its liabilities, taking into account contingent and prospective liabilities. It is a legal test applied by a court, not simply a negative-net-assets figure from the latest accounts.
As a starting point, list your assets (including cash) against your liabilities. If liabilities exceed assets, that is a strong sign of balance sheet insolvency, though contingent and prospective liabilities also need to be weighed, so it is worth taking advice before treating a single snapshot as conclusive.
Cash Flow Insolvency
Cash flow insolvency means the company is unable to pay its debts as they fall due (section 123(1)(e) of the Insolvency Act 1986). The court looks at the company’s position as a whole, including debts falling due in the reasonably near future. A single late bill or a genuinely disputed debt is not conclusive, so take advice before treating a short-term cash shortage as a failed 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.
Be careful about which creditors you pay. Do not favour one creditor, or yourself, over the others without advice. Payments that are necessary to protect creditors as a whole, including wages, can be proper. The risk is a preference (section 239 of the Insolvency Act 1986), a transaction at an undervalue (section 238) or a breach of the duty to give weight to creditors’ interests.
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.
Your duties are owed to the company, and normally that means acting for the shareholders’ benefit. That does not simply end. Once you know, or ought to know, that the company is insolvent or close to it, or that an insolvent liquidation or administration is probable, you must consider creditors’ interests and give them proper weight alongside shareholders’. Once insolvent liquidation or administration is unavoidable, creditors’ interests come first. If you carry on trading after you knew, or ought to have concluded, that there was 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. You have a defence if you took every step you ought to have taken to minimise the potential loss to creditors. It is not a criminal charge.
As to what the situation means for your company, this will depend on the facts. In most cases 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
A licensed insolvency practitioner is required by law for the formal procedures — liquidation, administration, a CVA — under sections 388 to 390 of the Insolvency Act 1986. The exception is a court-ordered liquidation, where the Official Receiver usually acts as liquidator first. Not every route out of insolvency needs one: a company can sometimes resolve its position informally, through refinancing or a Time to Pay arrangement with HMRC, without a formal appointment. Once you are in one of the formal procedures, though, only a licensed practitioner or the Official Receiver can act.
In Great Britain, an insolvency practitioner must be authorised by a recognised professional body (the IPA, ICAEW or ICAS) in order to act; an authorisation granted in Northern Ireland also counts (Insolvency Act 1986, section 390A).
The industry is carefully monitored and regulated.
It’s important to realise that, while the directors usually choose which IP to approach (in a creditors’ voluntary liquidation the creditors can nominate someone else), once appointed the insolvency practitioner acts as an independent office-holder with statutory duties that depend on the procedure. In liquidation, this means realising assets and distributing funds to creditors in the statutory order of priority. In administration, the administrator must pursue the statutory objectives in Schedule B1 of the Insolvency Act 1986, in order, starting with rescuing the company as a going concern unless that is not reasonably practicable or the next objective would give creditors as a whole a better result.
The office-holder will also review the conduct of directors in the period preceding insolvency and submit a statutory conduct report to the Secretary of State. It is the Insolvency Service, not the office-holder, that then decides whether further investigation or director disqualification action is in the public interest.
Insolvency Law in England and Wales
The key pieces of legislation pertaining to insolvency in England and Wales are as follows (Scotland and Northern Ireland have their own insolvency rules):
- 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 companies have access to several main processes, including:
- 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
- Moratorium – a standalone breathing space under Part A1 of the Insolvency Act 1986, introduced by the Corporate Insolvency and Governance Act 2020. It gives an eligible company an initial 20 business days’ protection from creditor action while a monitor, a licensed insolvency practitioner, assesses whether rescue remains likely. The directors can extend it once by a further 20 business days if the conditions are met; with creditor consent it can run for up to a year from the start; and the court can extend it to a date it sets
- 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