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What is Insolvency

Insolvency. A condition whereby an individual or a separate corporate entity has liabilities (Monies owed) which are more significant than assets owned (Cash Property, Cars Machinery.)

Insolvency definition Business

What is company insolvency in the UK? In the UK, a limited company and Limited Liability Partnership are separate legal entities away from individuals.

The 1986 Insolvency Act 

Lord Neuberger in the Court of Appeal stated that the s123(2) insolvency test remains connected to a company reaching a “point of no return“, as insolvency remains inevitable.

Proving a company is insolvent by the balance sheet test remains problematic.

Section 123 of the Insolvency Act 1986 states, a limited company may be “unable to pay its debts” when:

  • The worth of the company’s total assets remains less than its total liabilities while considering contingent and assumed liabilities (the balance sheet test see below).
  • The company has not satisfied a claim of £750 or more within three weeks of receiving a statutory demand).
  • A creditor enforces collection from a creditor, though failed.
  • The company remains not able to settle its liabilities as they fall due (cash flow test, see below).

For a limited entity to be deemed insolvent as trading entities, two tests exist:

  1. Balance Sheet Test

    • By way of an example:
    • Balance Sheet 
      • Fixed Assets     100
      • Current Assets 300
      • Total Assets             400
      • Current Liabilities  500
    • Net Current Liabilities   -100

The above balance sheet test demonstrates the company has liabilities exceeding the assets of the company by 100. They are therefore considered insolvent.

A further review requires doing to prove the debt difference is growing, demonstrating losses in the profit and loss account.

Perhaps when considering a balance sheet insolvency test, may it be also a medium to long term test of the company’s liquidity? 

A director needs to review the Insolvency of their company’s balance sheet. 

2. Cash Flow Test

Reviewing the above Balance Sheet as at a date demonstrates the company has 300 current assets (Assumecash) to pay 500 as and when due.

Therefore, the company has 200 less by cash flow to pay its creditors as and when due.

However, in 2013, a supreme court ruling held that determined the term’reasonably near future.’

Material risk 

The exception requires failing to attempt a restructuring of a company. Then a’material risk’ involves consideration as to the company however being unable to satisfy its debts. However, a conditional test that examines the position ‘as would be’ without the release or accompanying arrangements. Therefore, it requires a significant chance of insolvency for directors.

So, the test therefore for an exemption to apply remains different to the condition in section 214((2)(b) of the Insolvency Act of there being ‘no reasonable prospect’ that the company will not avoid Insolvency. Importantly, it does not, therefore, mean that directors remain exposed to charges of wrongful trading.

How a company becomes insolvent

Companies may discover themselves in the adverse position of Insolvency. However, there are a few fundamental reasons:

  • The business has fallen behind in its market;
  • Failing to adhere to growth plans, absorbing business resources;
  • Fraud in and out of business;
  • Insufficient key performance indicators;
  • Poor management individuals;
  • Failing to maintain daily bookkeeping thoroughly.

Any breaches of:

  • Financial contracts; 
  • Discussions with lenders; 
  • Insolvent balance sheet. 

Remain evidence the company would therefore be in the position of being unable to pay its debts within the next 12 months. However, no single factor will necessarily be determinative, and such evidence will usually comprise many elements taken together. 

Sole traders and owners of small businesses can face insolvency. The two tests above expose if a company has become insolvent.

If in doubt, ask. Directors remain under demanding pressures. Therefore, don’t assume for your sake as a director, but more importantly for your company’s creditors.

What are the symptoms of Insolvency?

Symptoms include:

  • Chasing Overdue Creditor Letters;
  • Bailiff Attendance requesting payment;
  • Paying suppliers of the company delayed;
  • HMRC arrears accumulation;
  • Essential Staff migration to competitors or setting up in competition;
  • The Directors are indifferent concerning maintaining bookkeeping and annual account preparation;
  • CCJ registered;
  • Dwindling profit margins.

Insolvency Register

When an individual uses an insolvency procedure for personal insolvency debt, then their name is added to the Individual Insolvency Register once the insolvency practitioner is therefore appointed. The register maintains data for those who then live in England and Wales only. Individuals who live in Northern Ireland remain entered on the Individual Voluntary Arrangement Register. People in Scotland remain entered on The Register of Insolvencies

For further help and support on any matters relating to Insolvency. Please contact the team at HBG Advisory on:

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