When is a Company Insolvent?

There is no doubt that we are in a recession. Most businesses have been fundamentally affected by the COVID 19 pandemic. It is important for a company directors to be mindful of the possibility of insolvency and the implications.

When a business is unable to meet repayments on debt, or fulfil its financial responsibilities, it is considered insolvent.

For directors, this is a time fraught with risk, and it is up to them to manage the situation carefully and sensitively, in order to meet their obligations to the business and its shareholders, as well as creditors.

Should a director fail to act appropriately when a business becomes insolvent, there is a chance that they could face legal action and personal liability.So, it is very important to know what you need to do if you find yourself in this position.


What are the Warning Signs?

Before a business becomes insolvent, there will be an abundance of warning signs to be on the lookout for. It is helpful to know what these warning signs are, so that you can take timely action either to avoid insolvency, or to wind up the company in an orderly fashion.

Some of the signs to look out for include:

  1. Decreased sales or revenue
  2. Increased costs (e.g. of supplies, staff, etc)
  3. Difficulty in securing loans, finance or other facilities
  4. Suppliers or customers having difficulty in supplying or paying you
  5. You are unable to pay staff wages
  6. You cannot keep up with demands for payment
  7. Other

Smaller signs that you are reaching a dangerous financial point include:

  • Constant ‘firefighting’ with regards to staying on top of payments to creditors
  • Paying bills later and later each month
  • Stock deliveries being delayed due to non-payment, affecting your ability to make sales


Do you have Key Performance Indicators (KPIs) in Place?

A business which is running effectively will have several business performance systems in place to give you information about where your business stands financially.

You should have cash flow forecasts, aged debtors’ reports, and sales forecasts available to you at all times so that you can refer to them when examining the health of the business, and prior to making any important financial decisions.

Without these, it is impossible to identify your weak points, identify areas of improvement and make any business or strategic decisions confidently.


Company Insolvency Tests

If you think that you are in a tenuous position and might be on the way to insolvency, there are a couple of company insolvency tests which are generally used to determine whether your business is insolvent.


Balance Sheet Insolvency Test

A balance sheet insolvency test is designed to determine whether the shareholders’ funds are in the red, i.e. a negative figure. If your company liabilities are greater than your company assets, then your company is balance sheet insolvent. Your balance sheet should include future liabilities as well as contingent liabilities, for a more accurate overview of your position.


Cash Flow Insolvency Test

The cash flow test analyses your company’s ability to pay debts when they are due, or very near to the payment due date.

The cash flow test relies on simply looking at incomings and outgoings to determine whether your company can pay its bills in a timely manner.


What to do if your Company is Insolvent

If, as a director, you suspect that your company is insolvent, it is your responsibility to take appropriate steps to avoid increasing loss to creditors as this could make you personally liable for the company debts.

Once a company is insolvent, a director’s responsibilities crucially pass from having to act in the interests of the shareholders to one where they must actin the interests of creditors.

If you do not do this, then you could be guilty of “wrongful trading” under s214 of the Insolvency Act 1980 and could be made personally liable for creditor debts.

It is very important for directors to realise that they cannot rely on the “shield” of limited company status, which in normal times protects directors from being personally liable for any company debt.

Failing in your statutory duties as a director leaves you open to prosecution and may result in you having personal liability for company debts, a situation that must be avoided at all costs.


Are you worried about your Company?

If you are worried that your company may be insolvent now or that it may become insolvent soon it is vital that you act immediately.

By acting quickly you can initiate a process  which may save your business (for example administration or company voluntary agreement) or at least take steps towards an orderly winding up (which will hopefully minimise loss to creditors and the potential for claims against you).

If you wait until things are too late, then there is the possibility that you could be put into compulsory liquidation. When this happens, the court will appoint an insolvency practitioner, who has no prior relationship with you and may pursue a more aggressive stance in terms of viewing your conduct within the business. This could result in legal issues and financial loss for you as the winding up proceeds.

Vyman Solicitors are an accomplished and experienced firm in all areas of insolvency law and have established good working relationships with a number of insolvency practitioners and would welcome the opportunity to have a sympathetic discussion with you regarding any worries you may have about you and your Company’s financial position.

Please call us on 0208 427 9080 to find out more.