Navigating Insolvency

If your business has suffered a downturn in a trade that threatens financial stability, solvency or your ability to trade, then it is important to seek advice regarding insolvency at the earliest practical opportunity. Our latest post discusses insolvency in further detail and summarises some of the options that are available.

What is Insolvency?

A company is described as insolvent either (1) when its liabilities outweigh its assets, or (2) when the company cannot afford to pay its liabilities when they fall due.

The Insolvency Test

There are two ways to test whether your company is insolvent.

1. The Balance Sheet Test examines whether a company’s assets outweigh its liabilities.

2. The Cash Flow Test examines whether your company can pay its bills on time – to test this accurately, you must work out the amount of capital you have at any one time and the payments that are due.

The Cash Flow Test is often considered the most significant. A creditor can present a Winding-up Petition to the Court if they are owed £750 or more– and on the strict condition that they have firstly issued a prior “Statutory Demand” which effectively serves as a final demand for payment within 21 days. The Petition is essentially a request to the court to wind-up (liquidate) the Company on the basis that it is believed to be insolvent.

What is Liquidation?

Liquidation is the process of closing down a business to realise assets for Creditors.

There are three primary types of liquidation:

Creditors Voluntary Liquidation (CVL)

This process is carried out when the directors of a Company bring it to a close voluntarily, but comes usually after a financial struggle when all other options have been exhausted. During a CVL, assets will be realised in order to provide maximum return to creditors.

Compulsory Liquidation

This process follows a Winding-up Petition (from a Creditor) and is a court-based procedure where assets of a company are distributed to creditors.

Members Voluntary Liquidation (MVL)

This process enables shareholders’ to appoint a Liquidator in order to formally close down a solvent company.

What is Administration?

Any Limited Company or Limited Liability Partnership can be placed into Administration if it cannot pay the money it owes. The process of Administration stands as an alternative to Liquidation and is often viewed as a less contentious process which often aids business continuity.

Whilst in Administration, the business benefits from a “moratorium” period during which creditors cannot take legal action, or apply for a Winding-up Petition. The appointed Administrator must be a licensed ‘Insolvency Practitioner’ and they have 8 weeks to write a statement detailing what course of action they plan to take.

The outcome of the Administration process will depend entirely on the individual circumstances of the company, but may still result in the business closing down if there is no other alternative.

What is a Company Voluntary Agreement?

A CVA is a binding agreement between a limited, insolvent Company and its creditors. The arrangement allows a company to pay its debt over a period of one to five years and is there to help ease the strain of companies facing insolvency.

For the proposed CVA to be approved, 75% of the creditors (by debt value) must agree to its terms.

Information Included in the CVA Proposal

Alongside providing an explanation to creditors regarding how the company reached this stage, why they should agree to the CVA, and why it is a better course of action than Liquidation, the CVA provides various information:

– A cash flow forecast and amounts the company can afford to pay
– Any guarantees offered by the directors of a company
– The company’s financial position, including assets and liabilities
– Duration of the CVA

Advantages of a CVA

There are many advantages to a CVA:

– The directors will retain control of the Company and it may continue to trade (subect to conditions)
– Interest charges may be frozen
– May help to prevent a Winding-up Petition
– Alleviates pressure from creditors – thus facilitating cash flow.
– Clients of the business do not need to be informed
– Less costly than administration procedures

Disadvantages of a CVA

Whilst CVAs can be extremely helpful, it is important to understand any potential disadvantages to this course of action:

– The company’s credit rating will be affected for six years
– Obtaining agreement from the bank may be difficult
– Secured creditors are not bound by the terms and may push for liquidation

Speak to Our Corporate and Commercial Team

Seeking outside assistance regarding insolvency is invaluable to businesses. Our team can provide you with specialist advice to help you find the best solution, whilst avoiding personal liability or fraudulent trading.

If you need advice regarding insolvency, please call our corporate and commercial team today.