Business insolvency is when a company cannot pay its debts and has no realistic chance of resolving this issue. Perhaps it cannot pay its bills when they become due, or it has more liabilities than assets on its balance sheet.
If a company is facing potential insolvency, it is a challenging period for any business, its directors and owners, also employees and impacted partners.
This article aims to detail all you need to know as a business owner about business insolvency, the difference between insolvency, bankruptcy or liquidation, and the steps you need to take if your business becomes insolvent.
What causes Insolvency?
If a company is insolvent, its assets (such as cash in the bank or funds due from sales) are insufficient to discharge its debts and liabilities. If a company director is concerned that the business might be heading towards insolvency, they should consider their actions as director carefully, and take advice from a professional, such as a solicitor, qualified insolvency accountant, authorised insolvency practitioner, reputable financial adviser or debt advice centre.
‘Insolvency of a company’ does not only refer to the situation an insolvent company is in but also the procedures for dealing with this situation (under the Insolvency Act 1986).
Commonly, a company can become cash flow insolvent if they cannot meet demands for payment when they become due. Other pressures may face a business as creditors become more demanding for monies owed, such as bank loans, business rates and taxes or the value of assets have been downgraded, for instance when a sale is forced at a low price.
Sometimes a Moratorium is granted, allowing a business some breathing space from its creditors. This could help the business form a plan to restructure the debts of a company before the creditors take action.
Are Insolvency and Bankruptcy the same thing?
Although insolvency and bankruptcy have similarities, they are not the same thing. Insolvency refers to a state where a company’s liabilities are greater than their assets and they cannot pay their debts. This Is known as balance sheet insolvency.
Bankruptcy, however, is a type of insolvency but is usually applied to an individual, used to describe a failure in financial terms. Bankruptcy is a form of personal insolvency, and is usually a state declared by a court, because an individual’s assets are worth less than their liabilities, and the company’s creditors do not have a chance of getting anything back from the business.
Crucially, someone who is bankrupt is insolvent, but being insolvent does not necessarily indicate bankruptcy.
What is the difference between insolvency and liquidation?
If you are wondering what is the difference between insolvency and liquidation, this article can be a guide for you.
Insolvency and liquidation are similar in that they are consequences of a company being unable to pay its debts. However, a company can have a solvent liquidation.
Liquidation is a process by which businesses are closed down, and their assets are distributed to creditors. Liquidation can follow when a company is insolvent. Once a business has been liquidated, it no longer exists.
Insolvency is when a business can no longer pay its debts. If more money is flowing out of the company than is coming in (with no expectation of this trend being reversed), a business might become insolvent.
One key difference between insolvency and liquidation is that whilst insolvency is a financial state where a company cannot pay its debts and has more liabilities than assets, liquidation is a state where a limited company comes to an end. Thus, even if a company is insolvent, it does not necessarily have to be liquidated.
What to do if your business is insolvent?
If your business becomes insolvent, there are steps you can take to deal with this to allow your insolvent company to continue trading. This might be known as resolving insolvency. The company director(s) can:
- contact all creditors to see if they can reach an informal agreement
- enter into a company voluntary arrangement
- put the company into administration, offering some respite from creditor action, and enabling the company to continue or property to be sold
There is also the option of liquidating your company, meaning the company is closed down and assets are sold and distributed to creditors.
The insolvency process, or administration process, allows the company to be handed over to an insolvency practitioner. The administrator will operate the company to try and reorganise it, perhaps selling some or all of its business or assets.
Whilst the administrator is in charge, your creditors can’t take legal action to recover their debts or start the liquidation process, without the permission of the court.
Action can be taken against an insolvent company. Creditors can get a court judgment or issue a statutory demand to recover debt from an insolvent company. If the creditors cannot recover the debts through a court judgement or statutory demand, they can apply for compulsory liquidation of the company.
LawBite provides key support services that offer guidance on insolvency. These are:
- avoiding insolvency
- directors’ responsibilities
- personal liability mitigation
- help with personal guarantees
- recovery of debt from an insolvent company or individual
- purchase of assets from insolvent estates
- protection of assets if a family member is deemed insolvent
- HMRC investigation assistance
- repayment agreement negotiation with creditors or debtors
- restructuring legal advice when facing insolvency
- court-ordered injunctive relief
- dispute resolution if you own shares in an insolvent company
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Managing a business through its final stages can be a stressful time. It can involve a number of internal and external stakeholders to bring matters to a conclusion.
Directors may have given personal guarantees, or the business may be trading insolvent and unable to pay its outstanding debts.
It is important to navigate carefully through the process with expert legal help from experienced insolvency solicitors to ensure that nothing is missed, and you have complied with all necessary regulations.
