What is company insolvency?

What is insolvency? How do you know if your company is insolvent? And what happens when a company is insolvent? In this article, we answer some company insolvency FAQs.

What is insolvency?

Insolvency refers to the various legal procedures for dealing with ‘insolvent’ companies and individuals under the Insolvency Act 1986.

Both individuals and companies can be described as insolvent, but bankruptcy is just one of the formal insolvency procedures for individuals, as is an individual voluntary arrangement (IVA).

A company is considered insolvent when either:

it cannot pay its debts as and when they fall due
from a balance sheet perspective, the value of its liabilities is greater than the value of its assets

The main aim of any insolvency process is to recover all available assets and generate as much money as possible which can be distributed to creditors (persons owed money by the insolvent company) to satisfy their debts.

What happens when a company is insolvent?

A company that is insolvent is in danger of being closed down. However, company directors may be able to take action that allows the company to continue trading.

If your company has financial problems, you should immediately get professional advice from someone such as a solicitor, qualified accountant or licensed Insolvency Practitioner. As well as offering advice on the best course of action, speaking with a qualified professional will help you understand how to protect yourself from accusations of wrongful or fraudulent trading.

How do you know if your company is insolvent?

Generally, there are two simple tests you can run to see if your company is solvent or insolvent:

1. Cash flow test

Can your company pay its bills and liabilities as they fall due? If you cannot, then it may be insolvent. A creditor only needs to be owed over £750 which has not been paid by the time the debt fell due according to the contract to send a statutory demand to the debtor. If the debtor cannot pay in full in 21 days, then the creditor could issue a winding up petition. In effect, this application asks the court to liquidate the company as the creditor believes it is insolvent.

2. Balance sheet test

Is the amount your company owes to creditors more than the value of your assets? If so, it’s likely that your company is insolvent.

What are a company director’s responsibilities during insolvency?

If a company is struggling financially and potentially insolvent, a director’s duty is no longer to the company. Instead, it turns to minimising the risk and exposure of the company’s creditors. If the director fails to do this, they could be made personally liable for any company debts.

When a company enters into formal insolvency proceedings, a company director will remain a director for statutory purposes, however their executive powers will end, and they will have a responsibility to cooperate with the administrator or liquidator.

How do you keep an insolvent company open?

If your company is facing financial difficulties, there are some options that allow the company to stay open:

Informal agreement with creditors

You might be able to make an informal agreement with your creditors to pay your debt on different terms. This can be an option when your financial difficulties are temporary and your creditors are not currently threatening formal action.

It should be noted that any informal agreement is not legally binding, and a creditor can withdraw the agreement at any time.

(CVA)

A CVA is a legally binding agreement between an insolvent (or contingently insolvent) company makes with its unsecured creditors, allowing a certain amount of its debts to be paid back over time. CVAs may also include the sale of assets and different business models.

The length of a CVA will depend on a company's financial situation and its ability to pay its creditors. While CVAs may only be in place for a year or even less, usually they last for a period of 2 to 5 years. The company can continue trading during the CVA and afterwards.

A CVA can be proposed by the company’s directors to its creditors.

What statutory options are available for an insolvent company?

Statutory options available to insolvent companies include:

When a company goes into administration, an ‘administrator’ is appointed who is given the powers to manage the company’s affairs, business and property. While the administrator is in charge, your creditors can not take legal action to recover their debts or start compulsory liquidation without the permission of the court. However, it is up to the creditors whether to agree to the administrator’s proposals.

Administration can mean your company doesn’t have to pay all its debts in full - but your company can still be wound up.

Company moratoriums were introduced as a result of the COVID-19 pandemic and the subsequent introduction of the Corporate Insolvency and Governance Act 2020. A company moratorium is a statutory breathing space where directors retain control of companies while considering restructuring options. During the company moratorium, the company has a payment holiday from supplier debts and no legal action can be taken against a company in respect of pre-moratorium debts without leave of the court.

While company directors remain in control of the company, a licensed Insolvency Practitioner is appointed as ‘Monitor’ to independently oversee the company moratorium and provide objective assessment of whether rescue as a going concern continues to be likely. The company moratorium lasts for an initial period of 20 days.

(CVL)

A CVA will need the help of a licensed Insolvency Practitioner who will act as the liquidator. All creditors and shareholders are notified of the process and the appointed liquidator will get in the assets and make a payment to creditors based on what is realised.

Typically, the initial cost is between £3,000 and £5,000 pounds +VAT, however it can be higher and further costs will likely add up as the process moves forward.

If there are insufficient funds to pay a liquidator, then another route can be compulsory liquidation. This is a process of petitioning the court for the winding up of the company.

The costs associated with petitioning for a company to be wound up through the courts must be paid. If the company petitions for its own insolvency, currently these comprise a court fee of £280 and a petition deposit of £1,600. If a solicitor is used to file the petition there will be legal costs to pay.

Is the insolvency of a company advertised?

All formal insolvency procedures are advertised in The Gazette, the UK’s official public record. There is also a government search tool available which lists companies that are in liquidation. All formal insolvency procedures must also be notified to creditors.

If your company has financial problems or you think it may be insolvent, you should immediately get professional advice from the likes of a solicitor, financial adviser, qualified accountant or licensed Insolvency Practitioner.

See also

Gazette insolvency notices

Place an insolvency notice

What are the responsibilities and duties of a company director?

How do you close a limited company?

Find out more

Insolvency Act 1986 (Legislation)

Options when a company is insolvent (GOV.UK)

Check if a company is being liquidated or in provisional liquidation (GOV.UK)

Enterprise Act 2002 (Legislation)

Corporate Insolvency and Governance Act 2020 (Legislation)

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