If a company is in financial difficulty, not doing anything about it is the worst mistake anyone can make. First and foremost, seek professional advice as soon as possible. However, it is always handy to know where the company, and its directors/owners, stand in regard to business recovery and insolvency. So, let’s take a look at some of the facts.
The Insolvency Act 1986
Let’s start with a few important facts about the UK’s Insolvency Law. The specific laws, or government legislation, that applies to companies in the UK is the Insolvency Act 1986. The Act provides the rules and regulations that apply to limited companies, limited liability companies, partnerships and sole traders. Specific areas that are covered by the Act include:
- Company Voluntary Arrangements (CVAs)
- Company administration
- Receivership
- Members Voluntary Liquidation (MVLs)
- Creditors Voluntary Liquidation (CVLs)
- Compulsory liquidation (winding up order from a court)
- Dissolution of a company following a winding up procedure
- Liquidators
- Malpractice before, during and after liquidation.
The Insolvency Act’s legal definition for a company’s “inability to pay debts” is:
“If a creditor to whom the company is indebted in a sum exceeding £750 has served on the company a written demand requiring the company to pay the sum due and the company has for 3 weeks thereafter neglected to pay the sum or to secure or compound for it to the reasonable satisfaction of the creditor.”
What is insolvency?
According to HMRC, a company is insolvent when it can’t pay its debts because either:
- It can’t pay its bills and monthly commitments when they are due (the cash flow test)
- Its liabilities outweigh that of its assets (the balance sheet test).
A company that is insolvent faces the possibility of being closed down and removed from the Companies House register, thereby ceasing to trade.
Does insolvency mean liquidation?
Not necessarily. There are three options that can allow an insolvent company to carry on trading. The directors of the company can:
- Endeavour to negotiate an informal agreement with creditors
- Enter into a Company Voluntary Arrangement (CVA) with creditors
- Enter into administration enabling the company to sell any assets to raise funds in order to pay creditors and continue trading
- Enter into administrative receivership which is started by a holder of a floating charge, such as a bank, who appoints a receiver to recover money owed (the court is not usually involved in this action).
Creditor action against an insolvent company
If the directors of an insolvent company have not taken one of the voluntary decisions above, or voluntarily decided to liquidate the company, its creditors are allowed to take action including:
- Apply for a winding up petition from the court to force the company to close (compulsory liquidation)
- Issue a statutory demand, i.e. an official payment request.
Winding up a company
Liquidation, or winding up a company, is the official procedure for closing a business and it being removed from the Companies House register. For an insolvent company, the options are a Creditors Voluntary Liquidation (CVL) or compulsory liquidation. For a solvent company, the option is a Members’ Voluntary Liquidation (MVL).
A company’s liquidation is handled by a licensed insolvency practitioner acting as the liquidator and includes:
- Ensure all the company’s contracts (including staff contracts) are completed, ended or transferred
- Resolving any legal disputes and/or claims
- Arranging for the valuation or and subsequently selling of the company’s assets at market value
- Collecting any monies owed to the company
- Distributing any funds to the company’s creditors, in a set order of priority according to the Insolvency Act 1986
- Repaying share capital to shareholders, if sufficient funds are available
- Closing the company’s business and removing it from the Companies House register.
Business recovery options
There are five principal business recovery options open to companies that are struggling with cash flow issues, are potentially insolvent or are technically solvent, i.e. the company’s assets outweigh its liabilities.
- Enter into a Company Voluntary Arrangement (CVA) with its creditors. A company, or insolvency practitioner, proposes a formal agreement, which could be making smaller monthly payments towards the debt. If the creditor accepts the CVA, they are unable to take any further legal action against the company unless it defaults on the terms of the CVA.
- Consider asset financing whereby the company uses assets as collateral against a secured loan on the condition that the lender can seize the asset should the company default on payments.
- Work with a third party with regards to invoice factoring, or invoice discounting, whereby the third party buys the company’s outstanding invoices and pays the company the total value of the invoices, less their fees.
- A director of the company is allowed to financially support a company from their own personal funds. However, the director must be aware that they are personally liable for the debt and of their legal duties when trading with an insolvent company and failure to fulfil these duties will result in unlawful trading, and potentially arrest.
- Enter into voluntary company administration which is a formal procedure where the directors of the company appoint a licensed insolvency practitioner to act as an administrator, or legal executive, of the business. All legal actions against the company are stopped for a period of eight weeks for the administrator to potentially sell the business. If unsuccessful, the company is usually wound up.
The stages of business recovery
There are essentially four steps to business recovery that can help to guide a company in resolving its financial crisis. These steps are:
- Rescue – seek professional advice with the aim to stop the financial crisis becoming worse, and work with an accountant, solicitor or licensed insolvency practitioner to decide on the best solution for the company.
- Restructure – work to identify the areas of the business where restructuring can cut costs and potentially start to turn the company around.
- Recovery – to monitor the company over a sustained period of trading time in order to demonstrate the restructured business is able to resolve its financial issues.
- Reward – moving the company into a solvent position where its assets outweigh its liabilities, cash flow is good and it is able to not only meet its monthly commitments, but also pay back its creditors.
If your company is struggling financially and you’re not sure which direction to go, contact us to discuss your situation confidentially with one of our licensed insolvency practitioners on 0800 246 5895 or visit our website for more information.
