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A company becomes insolvent if it can’t repay its liabilities as and when they fall due. This can be due to a sudden, unexpected expense or the loss of an important client, and can leave the company in a precarious situation, unable to deliver on orders or repay its creditors – including coronavirus Bounce Back Loans. Ultimately, this can lead to creditors pursuing the company for their money and legal action.
So, if you find yourself in the unenviable position of being a director of an insolvent company, what can you do to resolve the problem and close the company?
When is a company insolvent?
As a company’s director, you should always be aware of the company’s solvent position. While not every aspect can be factored in, there are several warning signs to watch out for that could indicate the company isn’t in a healthy financial state.
Warning signs that a company is insolvent could include (but are not limited to):
- An imbalanced cash flow.
The company is struggling to cover or is unable to repay its liabilities as and when they fall due. Any overdue payments to HMRC (PAYE, National Insurance, VAT etc.) should be noted – the tax office is likely to pursue the company for what it owes. You should also note if the company isn’t able to keep to any existing repayment agreements with creditors.
- An uneven balance sheet.
Weigh up what your company owes (its liabilities) and its assets (including cash at the bank) on the balance sheet. It should go without saying, but the company’s liabilities mustn’t outweigh its assets. This is a telltale sign of insolvency.
- Threats of legal action.
Threats of legal action are a clear sign that the company is insolvent and should be taken very seriously. This action could come as Statutory Demands or County Court Judgements (CCJ), which your company wouldn’t have if it were able to repay on time. Any legal action or threats thereof should be dealt with quickly. Leaving them can damage the company’s credit rating, making it harder to obtain funding in the future.
These criteria are sometimes called the ‘solvency tests’. Failure to pass these tests should indicate that action needs to be taken to prevent the situation from worsening.
Will I be personally liable for the company’s debts?
If your company has debts it can’t repay, you might worry about ramifications for your personal finances.
Fortunately, limited companies come with limited liability protection. This acts as a form of separation between the company’s finances and your own. As such, the company’s financial difficulties won’t affect your personal finances unless you’ve signed personal guarantees, or committed an act like wrongful trading which could bypass the limited liability.
Can an insolvent company be dissolved?
Closing a company and dissolution may be the first option that comes to mind. The process involves directors striking off the company of the register at Companies House, ending its legal existence.
While striking off an insolvent company can be a tempting prospect, any creditors are likely to object to striking off a company that owes them an outstanding amount. As such, a dissolution isn’t designed for insolvent companies.
Closure options for insolvent companies
So, if dissolution isn’t an option for insolvent companies, what can directors do? If the company’s debts are of such a level that recovery is not possible, and you wish to close it in an orderly manner, you should opt for an insolvent liquidation. In the UK, this is called a Creditors Voluntary Liquidation (CVL).
The process stops all legal action against the company, with leases also cancelled. Ultimately, a liquidation ends with the company’s closure.
Choosing to enter liquidation voluntarily reduces the risks of wrongful trading accusations or the company’s creditors forcing it into compulsory liquidation. It also shows you, as director, are willing to prioritise the company’s creditors.
Once the process is complete, directors can even start afresh in a new limited company should they wish to.
Does the company have to close?
While you might want to close the company and draw a line under its debts, closure isn’t the only option to deal with insolvency. If the company’s business model could be viable if not for its debts, then it might be possible for the company to consolidate its outgoings into a single monthly repayment tailored to an affordable rate. Limited companies can do this by entering a Company Voluntary Arrangement (CVA). A licensed and regulated insolvency practitioner oversees the process, which usually lasts around five years. Once the arrangement concludes, any outstanding unsecured debt is written off.
Entering a CVA can demonstrate a willingness by the directors to repay what the company can afford. It also allows trading to continue for the arrangement’s duration, maintaining goodwill with customers and suppliers.
Summary
If your company has debts it can’t repay, more liabilities than assets, or creditors filing legal action against it, it may be insolvent. While it shouldn’t affect your personal finances if you haven’t signed personal guarantees, you should look to tackle the insolvency, which could involve closing the company.
Dissolution isn’t designed for insolvent companies, so if you want to close your company, you should explore Creditors Voluntary Liquidation (CVL), closing it through an orderly process.
