Insolvency- The Ultimate Guide
In our ultimate guide to insolvency, we look into the basics of being declared insolvent and what the consequences of this could be. If you are experiencing any signs of potential insolvency, this information can help to guide you through your next steps and what the eventual process for you or your business may be.
We explore company and personal insolvency and how CVA’s, Administration and Liquidation are all forms of the Formal Insolvency Process. Understanding your options when dealing with insolvency is key, but can be tough to do.
The Insolvency Experts can help you to not only understand your situation, but guide you through your responsibilities during insolvency and what your future may look like once you have enlisted help.
Table of Contents
- What is insolvency?
- What does insolvency mean?
- What is an insolvency practitioner?
- How do i know if my business is insolvent?
- How does insolvency affect sole traders?
What is Insolvency?
Insolvency means that your business’s debts cannot be paid when they are due as the amount owed exceeds the value of the business’s assets. Insolvency is effectively, a business going bankrupt.
A business can be concerned with ‘cash flow insolvency’ or ‘balance sheet insolvency’. The former is the clearest indicator of insolvency. It means that a company cannot pay their debts- this could be due to their debts outweighing their assets, or that they cannot sell assets in time to pay the debts. The latter concerns a business’s liabilities that are not just immediate debts, and whether the company could fund these alternative debts if they were to arise.
Keeping an eye on your cash flow when striving for growth is important if you want to avoid insolvency. Be careful as to not over-invest in equipment and create an insolvency problem, regardless of whether your business is healthy in all other areas.
What does Insolvency mean?
Insolvency means that your company cannot afford to pay its debts and has effectively ‘gone bust’. You are classed as unable to pay debts if you have an outstanding court order against you for payments owed or a creditor has formally claimed that you owe them.
When a company is declared insolvent, there are a few routes that can be taken to ensure payments are fulfilled. These are highly dependent on the severity of the debts and future prospects of the company. Typically, an Insolvency Practitioner will be appointed to help guide you through the insolvency process.
The next step is the formal Insolvency Process, which could be:
The Insolvency Practitioner will discuss with you what the best option is for your company. If your company seems viable, a CVA could be a good option to keep your business running. If your company is too deep in debt and you are looking for a way out, Liquidation could be the answer. Either way, The Insolvency Experts are ready to help you no matter how severe the issue.
What is an Insolvency Practitioner?
An Insolvency Practitioner (IP) is someone who is qualified to give advice to individuals and businesses in relation to their debts and help in dealing with them.
Insolvency Practitioners are:
- Professionals, quite often accountants or lawyers, who have chosen to specialise in the technical area of Insolvency.
- Qualified by exam or, much less commonly, by experience.
- Licensed to act by an authorising body who is then responsible for the ongoing regulation and monitoring of the IP to ensure that they are acting legally and appropriately.
Do I need an Insolvency Practitioner?
It is important that you involve an Insolvency Practitioner as soon as you identify potential financial problems with your business. Introducing an IP quickly can limit company financial damage and allow you to move forward with the best option.
An Insolvency Practitioner will deal with:
Personal Insolvency- In relation to an individual’s credit cards, loans and other debts.
Corporate Insolvency- Concerns the debts of a business or company.
Most IP’s will be happy to provide initial advice on a particular situation free of charge. A good IP will ensure that you fully understand the advice being given and the reasons why an insolvency process is being recommended. They will rarely ask for money up front, but if they do, they will ensure that you understand the reasons for this being required. If any of these factors are not being met, then you should find an alternative advisor.
How do I know if my business is going to become insolvent?
It may not always be obvious that your company is going to become insolvent. There are a few ways in which you can test your business for potential insolvency. Being declared insolvent is a serious matter and it is important that you act on it as soon as you see the warning signs or the repercussions could be fatal for the company. An insolvency practitioner can guide you through your situation and be transparent with you about what is happening.
A general misconception is that it is a solvent Balance Sheet or profits that dictate the success or failure of a company. Whilst both of these are individually important, it is invariably cash flow issues that are the biggest warning sign. A simple cash flow test looks at:
- Problems ordering stock due to overdue debts
- Refusal of new credit
- Threatened legal action
- Creditors harassing you on a daily basis
- Refusal by creditors to extend payment terms
These are all signs which should alert you to the fact that your business is in financial distress. Your company could soon be insolvent if you don’t take action immediately- but don’t worry, friendly and professional insolvency practitioners such as ourselves, are here to help you.
External debts are other warning signs that your company could become insolvent. If you are late in reporting to or paying HMRC for example, they can act quickly when there is any question as to whether or not a company is insolvent.
Rather than be petitioned or penalised by HMRC, it is better to take a look at your payment history and view whether you have reported as you should. PAYE not paid by the 19th of the following month can quickly bring the bailiffs to your door.
If your debtors are not making payments as they should, this will have a negative impact on your cash flow because if you aren’t being paid, your creditors will not be paid. If you have used a factoring company and are not receiving funds as you had anticipated, it signals that either your customers are not paying them or they simply are not paying you as arranged.
In either case, The Insolvency Experts can assist you to help evaluate what is going on and can offer advice and a viable solution.
Companies heading towards insolvency tend to have problems with inaccurate or inadequate management information- this could look like directors and/or managers being unable to make decisions, solve problems and failing to complete work on time. If any or all of these issues are identifiable in your company, there is a possibility that your business is insolvent or is heading that way.
Sometimes it is only a matter of improving cash flow, cleaning up management issues or refinancing. Other times, more drastic action may be necessary.
The most important point is, if you identify any of the warning signs of insolvency in your business, it is important to seek advice as quickly as possible.
Get in touch with us today if you are experiencing any of these issues and we will help you through your situation.
What happens when a business becomes insolvent?
The Insolvency Process
There are a few different routes a company can take once they are declared insolvent. An experienced Insolvency Practitioner will help to guide you through a Formal Insolvency Process.
The Insolvency Experts can help you with the formal Insolvency Process. The main options include:
If a company is still potentially viable, a CVA (Company Voluntary Arrangement) can be considered. A CVA requires the company to be able to prove that, based on future capital, they can afford to repay the debts owed. This option is suitable for companies that are in temporary financial trouble and whose future projections show an increase in profit and an eligibility to pay debtors.
A CVA allows a business to pay off its debts over a fixed length of time. This allows companies to have extra time to pay off debts and enters them into a suitable payment plan for their situation. The business can continue trading during this time and is protected from creditors claims.
Once a company is declared insolvent, they can decide to enter a CVA if they are deemed a viable business. A CVA needs to be approved by creditors and shareholders before it can be accepted. An Insolvency Practitioner can help a company with a CVA proposal.
If you want to learn more about CVA’s, read our Ultimate Guide to CVA’s here.
An administration is effectively short-term protection for your company that allows time for measures to be made to help pay debts. If the decision is made to enter Administration, the company is handed over to the appointed Administrator.
Creditors cannot interfere in this process with legal action. A company can continue trading at this time, but the business will be controlled by the Administrator whilst in Administration.
Once in administration, more drastic steps than those in a CVA will be taken. These can include:
- Closing sites/branches
- Staff redundancies
- Selling assets and stock
- Selling part of or the whole business
The administrator will discuss the chosen options with creditors and shareholders, who may then request a meeting to vote on the decisions to be made. If the steps taken prove not to be sufficient enough to effectively pay creditors, then movement into liquidation or dissolution may occur. Read more about Administration in our guide here.
Liquidation is the most serious of the formal insolvency processes. It involves closing down the company completely. All assets and stock will be sold to pay off creditor debts as much as possible, then any remaining debts are written off.
Liquidation of an insolvent company can be decided in two ways. These are:
Creditors’ Voluntary Liquidation (CVL)
This process is initiated voluntarily by company directors. If directors decide that the debts owed are unlikely to be repaid and believe that the company will not improve, they can propose a CVL.
An Insolvency Practitioner is appointed as Liquidator and handles the sales of assets and stock in order to begin making repayments. They are then responsible for winding up the company. You can read more about CVL’s here.
This process is court ordered, usually following a winding-up petition made by creditors. The rest of the process mirrors a CVL, but in this case, the responsibilities lie with an appointed Official Receiver.
Both processes will include the sale of assets, loss of staff and director investigation. The end result is also the same for both, being that the company is shut down completely. If you want to learn more about Liquidation, read through our current information here.
Can I start Insolvency proceedings myself?
With the exception of compulsory liquidation and administration via the company’s secured lender, it is you as director who can initiate insolvency proceedings. However, this should always be decided upon with the assistance of professionals such as ourselves. For a company to enter a formal insolvency process, a licensed insolvency practitioner must be appointed.
How does insolvency affect employees?
If you are an employee of an insolvent company, it is likely that your employer will have involved an insolvency professional who should contact you to explain employment rights.
There are two likely outcomes of a formal insolvency process for employees:
Business Administration Proceedings
If a company is placed into Administration and a sale of the business is affected, then it is likely that employees contracts of employment will be transferred over as part of the sale.
The sale of a business in Administration will usually invoke the Transfer of Undertakings and Protection of Earnings Regulations (TUPE), meaning that upon transfer of employment, all of the employees historic rights, including the length of service, will transfer as well. Find out more about your company in administration.
If the sale of a business is not completed and it is necessary to make redundancies either in an Administration or Liquidation scenario, the Redundancy Payments Office (RPO) will be notified by the Insolvency Practitioner.
The RPO is a government body that will make payments out of the National Insurance Fund to employees of insolvent companies for redundancy, arrears of pay, holiday pay and payment in lieu of notice when the employers are unable to make these payments. The amount paid is fixed at a statutory weekly maximum of £479 and is usually received within 3-5 weeks of the appointment.
How does Insolvency affect Sole Traders?
When a limited company becomes insolvent, directors receive protection from personal liability through the ‘veil of incorporation’. A sole trader and their business are not regarded as separate legal entities so for a sole trader, it becomes a personal insolvency issue whereby they are wholly responsible for the debts of their business.
There are two formal routes taken when sole traders become insolvent:
Individual Voluntary Arrangement (IVA)
An IVA is a formal and legally binding insolvency procedure which can last up to 5 years. If a proposal for an IVA is agreed, creditors are not able to take legal action. The debtor must continue to repay the agreed amounts throughout the IVA term, otherwise they risk the IP forcing out the IVA and petitioning for their bankruptcy.
Benefits of an IVA:
- Cash flow is often improved
- Unsecured debts can be included in the arrangement
- Funds to repay an IVA can come from future projected profits of the business, the sale of an asset or refinancing
Personal Insolvency concerns the individual rather than a company. If an individual is declared insolvent, this is then usually referred to as bankruptcy. A petition can be made by debtors or creditors against you when they are owed over £5k and have unsuccessfully tried to recover their debt requesting bankruptcy be declared, or you can declare yourself bankrupt. Declaring bankruptcy is an unfortunate last resort for sole traders and can result in personal and business assets being lost.
Sole traders must petition for their own bankruptcy through the court, which then hands over control of assets to an appointed supervisor. The assets are then valued and can be sold in order to repay creditors. The bankruptcy period generally lasts for 12 months, though credit rating can be rebuilt during this time.
If you are declared bankrupt, this will be listed on the Individual Insolvency Register. This register is public record, and you will appear on the list until you are discharged from your bankruptcy period.
It is important to note that your name, address and occupation will be listed on the register, as well as the Official Receivers details.
The risks of trading whilst insolvent
Strictly speaking, it is not illegal to continue to trade under a company that is insolvent. However, there must be a strategy in place which is achievable and returns the company to profitability in the short term.
In this type of situation, it is imperative that:
- Decisions made by a board of directors are fully explained in writing with justification and reasoning.
- Directors are aware that in the event of the company entering a formal insolvency process, their actions will be fully scrutinised by the liquidator or administrator.
Wrongful trading occurs when it can be shown that a director “knew” or “ought to have concluded” that a company was unable to pay its debts. If wrongful trading is proven, then the directors can be held liable to pay compensation equivalent to estimated losses.
Misfeasance and Breach of Duty
A lesser used method of obtaining financial recompense against directors is that of Misfeasance or Breach of Duty.
Misfeasance is effectively the company suffering financially due to the actions taken by directors and if proven, can also lead to a financial penalty equivalent to the losses incurred by the company as a result of those actions.
Dealing with insolvency is difficult for any business owner, and the consequences can sometimes be drastic. If you are concerned about your business becoming insolvent, it is important that you involve an Insolvency Practitioner straight away to prevent your situation from worsening. We can help you to choose the right path for your business.
To receive professional business debt advice from one of the Insolvency Practitioners at The Insolvency Experts today, please get in touch.
Contact us online or speak to us directly by calling us on 01204 208 160. We understand how stressful it can be to face financial difficulties, we can help your business choose the best course of action.