In the world of business, insolvency is a term no company wants to encounter, but it is a reality that many face. Whether it is due to cash flow issues, increasing debts or an unexpected downturn, insolvency means your company can no longer pay its debts as they fall due. It is a serious situation, but not necessarily the end of the road. So, what exactly happens if your company becomes insolvent?
First, understand if your business is insolvent
There are two main forms of insolvency:
- Cash Flow Insolvency: This occurs when your company cannot pay its bills on time, even if it owns valuable assets.
- Balance Sheet Insolvency: This means your company’s liabilities are greater than its assets, in other words, it owes more than it owns.
Understanding which category your business falls into is essential for choosing the right approach.
Immediate Steps You Should Take
As a company director or owner, you have legal responsibilities if your business becomes insolvent. Continuing to trade as usual can make matters worse and may result in personal consequences if creditors are disadvantaged.
Here are the key steps you should take immediately:
- Stop trading straight away to avoid increasing the company’s debts.
- Seek professional advice from a licensed insolvency practitioner or a qualified business advisor.
- Inform key stakeholders such as creditors, employees and suppliers. Being transparent helps build trust and protects your reputation.
What Are Your Options?
Becoming insolvent does not always mean the company must close. Depending on your circumstances, there are several possible outcomes:
- Company Voluntary Arrangement (CVA)
A CVA is a formal agreement with creditors to repay debts over a set period. It allows the business to continue operating while working through financial difficulties.
- Administration
An insolvency practitioner takes control of the company and attempts to rescue the business, sell assets or find a buyer. Administration provides temporary legal protection from creditors.
- Liquidation
Liquidation is the process of closing the company and selling its assets to repay creditors. There are two common types:
- Creditors Voluntary Liquidation (CVL): This is initiated by the directors when the company cannot pay its debts and requires a licensed insolvency practitioner to carry out the formal procedure. It will close and liquidate the company, ceasing it’s trading operations.
- Compulsory Liquidation: This occurs when creditors apply to the courts to wind up the company. It is forced upon your company by the courts, meaning you have no control over the process.
Impact on directors and employees
Directors must act carefully during insolvency. Trading irresponsibly or allowing debts to increase can lead to personal liability. Keeping proper records and seeking advice is crucial.
Employees may face redundancy. However, they are usually entitled to redundancy pay, unpaid wages and holiday pay, which can often be claimed through government schemes.
Personal Liability and Personal Guarantees
While operating as a limited company generally protects directors from personal financial responsibility, there are situations where that protection can be lost. Directors may become personally liable for company debts in the following circumstances:
- Wrongful trading: If directors continue trading when they knew, or should have known, that the company was insolvent and that there was no reasonable prospect of avoiding further financial loss, they can be held personally responsible for additional debts incurred during that time.
- Fraudulent trading: In cases where directors intentionally mislead creditors or take on debts without any intention of repayment, this may be considered fraudulent trading. This is a serious offence and can result in personal liability, director disqualification and even criminal charges.
- Personal guarantees: Directors often sign personal guarantees when taking out business loans, entering property leases or setting up supplier agreements. If the company cannot repay these debts, the director who signed the guarantee is personally responsible. Creditors can pursue personal assets, such as savings or property, to recover the outstanding amount.
Because of these risks, directors should act with caution during financial distress, keep accurate records, and seek early professional advice. Understanding the implications of personal guarantees and acting within legal duties is essential when navigating insolvency.
What About Creditors?
Creditors are often the most affected in an insolvency. In a liquidation, the company’s assets are used to repay creditors in a set order of priority. Secured creditors are paid first, followed by employees and then unsecured creditors such as suppliers. Unfortunately, not all debts may be recovered.
Summary
Insolvency is undoubtedly challenging, but with early action and professional guidance, it does not always mean the end of your business. There may be options to restructure, recover or close the company in a controlled and responsible way.
If you suspect that your business is heading towards insolvency, do not delay. Taking timely action can help protect your company, your employees and your own responsibilities as a director.