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IS MY COMPANY INSOLVENT?
A DIRECTOR'S DUTY OF CARE TO COMPANY CREDITORS...
Cash-Flow Pressure vs Insolvency: Understanding the Warning Signs
Experiencing cash-flow pressure does not automatically mean your business is insolvent, but it is a significant warning sign that should not be ignored. Once a company becomes insolvent, there is a crucial shift in a director’s legal duties: instead of acting primarily in the interests of shareholders, directors must act to protect and maximise the position of creditors. Many directors are unaware that small or seemingly insignificant financial issues—if left unaddressed—can quickly escalate and lead to full insolvency.
Potential Personal Liability for Directors
If directors continue to trade while the business is insolvent, they may be at risk of wrongful trading. In such cases, directors can potentially be held personally liable for some or all of the company’s debts incurred from the point the business was first deemed to be insolvent.
This is why early action is essential,as insolvency does not go away, and delaying the process can significantly increase the risk to directors.
What Should a Director of an Insolvent Company Do?
If you believe your company is insolvent or is likely to become insolvent, it is vital to take immediate steps to address the situation. Once insolvency is present, directors have a legal duty to act at all times to protect creditor interests. If there is no realistic prospect of raising new capital, obtaining additional finance, or resolving the company’s cash-flow pressures in the short term, then proactive action is essential. Failing to act promptly can place both the business and the directors at serious risk. Reaching out for professional insolvency advice early ensures that you understand your responsibilities, protect your position, and explore all available business rescue and restructuring solutions.
THE 3 DEFINITIONS OF INSOLVENCY
The definitions of insolvency, as defined in the Insolvency Act, give a clear indication whether your company is insolvent, or is likely to become insolvent
The Cash-Flow Test
The cash-flow test asks a straightforward question: Can the company pay its debts as they fall due?
If the answer is no, the company may already be insolvent.
For example:
- If deductions for PAYE and NIC are not paid to HMRC by the 19th of the following month, the company is considered unable to meet its statutory obligations.
- If trade suppliers offer 30-day terms, but payments routinely fall significantly overdue, the company may be viewed as insolvent on a cash-flow basis.
Directors have a legal responsibility to understand and monitor this test. If you believe the company does not have sufficient cash to meet its liabilities on time, you must seek advice and take prompt action.
The Balance Sheet Test
The balance sheet test considers whether the company’s total liabilities exceed the value of its total assets. If liabilities are greater than assets, the company is insolvent. Importantly, this test must include contingent and prospective liabilities - future or potential obligations that may not yet be reflected in the accounts.
Many balance sheets appear healthy at first glance but contain asset values that are overstated, such as:
- Stock or work-in-progress valued above realisable market value
- Debtors that are unlikely to be collected and should be written off
Once these adjustments are made, many companies find that their balance sheet is, in reality, insolvent. Directors are legally required to ensure accounts provide a true and fair view of the business.
The Legal Action Test
A company is also likely to be considered insolvent if a creditor has taken formal legal action. Examples include:
- County Court Judgment (CCJ): Even if a debt was previously disputed, the issue of a CCJ can be taken as evidence of insolvency.
- Statutory Demand: If a statutory demand remains unpaid for more than 21 days, the creditor is entitled to petition the court to wind up the company.
These legal steps demonstrate an inability to pay debts, meeting the statutory definition of insolvency.
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LOW-COST, FIXED PRICE LIQUIDATION
We offer a low-cost, fixed-price liquidation service, tailored specifically to your company’s circumstances. This approach also allows your business to continue seamlessly through a debt-free phoenix company, which can acquire your company’s assets and operations, ensuring continuity while eliminating historical debt.
PRE-PACK ADMINISTRATION
In certain circumstances, Pre-Pack Administration may be the most suitable solution. This procedure allows an agreement to be arranged in advance for the sale of the business to a debt-free phoenix company before the formal insolvency process begins. The sale is then ratified as part of the administration.
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