IS MY COMPANY INSOLVENT?

Being under cash-flow pressure is not the same as being insolvent, but it is clearly a significant warning sign. It is imperative to understand that, if your business is insolvent, there is a fundamental shift in the director’s duty of care, from acting for the shareholders, to ensuring the creditors position is protected and maximised. So how do you know if your business is insolvent? Beware that apparently insignificant issues can lead to the business becoming insolvent when ignored.

Potential personal liability

If company directors are found guilty of continuing to allow a business to trade whilst insolvent, they may be held personally liable for the debts incurred by the company from the time the business was deemed to be first insolvent.

What should a director of an insolvent company do?

If you believe that your company is, or is likely to become, insolvent, then it is vital that you take action to immediately address the insolvent position. Remember, if your company is insolvent, you are under a legal duty to act at all times to protect and maximise creditors interests. If there is no reasonable prospect of new and/or additional capital being introduced to the business to return the balance sheet to a solvent position, or at the very least to remove the cash-flow pressures, then you must act now to protect both you and your business.

The cash-flow test 

Simply, can the company pay its debts as and when when they fall due for payment? For example, if you are not paying the deductions from employees for PAYE & NIC across to the Inland Revenue on the 19th of the month after the month they were deducted, then your company is insolvent. Your trade creditors will normally sell to you on 30 days terms; if you are not paying within 30 days, then your company could be deemed to be insolvent. A director has a legal requirement to understand this issue. If he/she believes that the company has insufficient cash to pay its liabilities on time, then they must take advice/action.

The balance sheet test

Simply, does your company owe more than it owns, or are the company’s assets exceeded by its liabilities? If yes, then your company is insolvent. It is important to point out that this test should include contingent and/or prospective liabilities. An apparently healthy, solvent balance sheet may include a number of assets that are overstated, particularly stock and work in progress, or debtors that are not really collectable and should have been written off. After deducting these items, many balance sheets become insolvent. Be prudent, as you are legally required to present accounts to reflect a true and fair picture of the business.

The legal action test

If a creditor has obtained a County Court Judgement, even if the debt was disputed, this is deemed to demonstrate the company’s insolvency, and the creditor may well present a petition to the court wind up the company. If a creditor has served a statutory demand which remains unpaid for more than 21 days, then the creditor may petition the court to wind-up the company.