Business owners need to understand insolvency, including how to define insolvency and the implications it has. We take a look at the insolvency of meaning and what steps to take to protect your interests if you are facing it.
The Definition of Insolvency
While there is no exact definition of insolvency included in the Insolvency Act, a company is considered insolvent if:
- Its liabilities exceed its assets – the balance sheet test; or
- It cannot pay its debts when they are due – the cash flow test
What does Insolvency Mean for a Business?
First things first, trading while insolvent is known as wrongful trading and is a civil offence. If you are a company director and you continue to trade when you know or should have known that there is no reasonable prospect of avoiding insolvency, you can be held personally liable for losses sustained from the point you should have known until the point that the company is formally insolvent.
Once a director is aware that there is a real risk of insolvency, they are bound to act in the best interests of the creditors and take steps to minimise the creditors’ losses.
Factors Leading to Insolvency
A range of difficulties can lead to insolvency. Common factors include:
- Problems with cash flow so that a business has trouble paying debts as they fall due
- More debt than the business can manage to repay
- Late payment by organisations that owe you money and not enough emphasis placed on debt recovery
- The inability of other organisations to pay you the money you are owed - Read our article on whether you should accept part-payments and instalments
- Loss of a key client or customer
- A change in the market
- Unexpected global or national events, e.g. the coronavirus pandemic
What Happens When a Business Becomes Insolvent?
If you become aware that your business is insolvent you will usually need to cease trading straightaway.
You should seek advice from a licensed insolvency practitioner who will be able to advise you of the options open to you and how best to protect the interests of your creditors. The only time you should continue to trade is if you are advised to do so by the licensed insolvency practitioner.
They will also be able to negotiate with your creditors to try and agree on payment plans and, where necessary, start the formal insolvency process.
Dealing with Insolvency
Involving a licensed insolvency practitioner as early as possible will give you the best chance of recovery or, where this is not possible, will ensure that the insolvency is dealt with efficiently and effectively, reducing your risk for personal liability.
Your insolvency practitioner may help your business in the following ways:
- Making informal arrangements with your creditors, who may prefer this option to bring legal proceedings
- Entering into a company voluntary arrangement, a formal agreement with creditors setting out a repayment plan
- Refinancing, if your insolvency practitioner believes it is viable to take on secured financing
- Administration, which prevents creditors from taking legal action and gives a company time to consider options such as sale, restructuring or liquidation
- Liquidation, if the company cannot be saved the insolvency practitioner will deal with the sale of assets and distribution of funds to creditors in order of priority
Court Judgements
If creditors are not satisfied that the situation is being addressed, they may take steps to try and recover the money they are owed.
A county court judgement or CCJ is an order of the court requiring payment of a debt. It will be entered on the Register of Judgments, Orders and Fines and unless it is paid in full within one month and removed from the Register, it will stay on the Register for six years. This will affect your company’s credit rating. It could also affect your personal credit rating.
An unsatisfied CCJ can form the basis of a bankruptcy petition or winding-up petition.
A statutory demand is a formal request for money owed to a creditor. It is a serious step and could be followed by a winding-up petition if the debt remains unpaid.
How to Keep the Company Open
If your company’s financial issues can potentially be resolved and your insolvency practitioner advises that it is possible to keep trading, you may be able to keep the company going. This should only be attempted on the advice of your insolvency practitioner, however.
It will generally be based on either an informal agreement with creditors or a company voluntary arrangement.
You should ensure that you avoid certain actions, including:
- Paying some creditors in preference to others
- Taking money from clients or customers knowing that you will not be able to fulfil your obligations
- Paying yourself a high salary that the company cannot afford or taking money for non-essentials
- Transferring assets out of the company for less money than they are worth
Your insolvency practitioner will be able to advise you on the best course of action in attempting to return to solvency.
Our Insolvency Solicitors
At Witan Solicitors, we help companies and individuals during financial distress and insolvency. If you are concerned about the future of your business and you would like advice on the options open to you and the best course of action, we will be happy to help.
If you would like to speak to one of our expert insolvency solicitors, you can send us an email at info@witansolicitors.co.uk or fill in our contact form. Talk through your business’ situation with us and let us help you understand your available options.
FAQ
What is voluntary insolvency?
A company voluntary arrangement or CVA is an insolvency process that allows the directors to continue to operate the business as a going concern.
It is arranged by an insolvency practitioner, who will put together a CVA proposal for consideration by the creditors. For the CVA to be implemented, it must:
- Be approved by 75% of the creditors who vote on it; and
- No more than 50% of unconnected creditors can vote against it
Creditors will need to be reassured that the repayment proposals are realistic and that the process will be overseen by a licensed insolvency practitioner.
How do I deal with my employees if my business is insolvent?
Once a business enters into liquidation, all employees’ jobs will end. Employees are entitled to receive an unpaid salary, holiday pay and other money that is owed with certain maximum limits. Some debts owed to employees are preferential, meaning they will be paid before the money is owed to unsecured creditors. This is not the case if an employee is made redundant within the first 14 days of the administration, in which case the employee is ranked with unsecured creditors.
Where there are insufficient funds, employees are covered by the Redundancy Payment Service.
If an employee continues to work for a company after it enters into the insolvency process, they will still be entitled to claim redundancy pay if they are made redundant but will not be entitled to claim money owed for work done during the insolvency process.
The situation with regard to employees in insolvency is complex and you are strongly advised to seek legal advice to ensure that you deal with the situation correctly.
What are the implications of insolvency for sole traders?
As a sole trader, you will be personally liable for your business debts. You may be able to enter into informal arrangements with your creditors or enter into individual voluntary arrangements or IVA.
An IVA is a legally binding agreement with creditors under which they will agree to accept a specified sum in payment of their debt. It will enable you to avoid bankruptcy, assuming you comply with the terms.
