What is Insolvency?

Legal Definition and Signs of Company Insolvency


The legal definition of insolvency is set out in Section 123 of The Insolvency Act 1986 and sets out main two tests to consider whether a company is insolvent.

  1. The Cash Flow Test says that a company is insolvent if it is unable to pay its debts as and when they fall due.  Therefore, while a company may have significant capital assets, if it does not have sufficient cash to pay a bill when it falls due then it is considered insolvent.
  2. The Balance Sheet Test says that if a company’s liabilities are greater than its assets then it is insolvent.


Put simply if creditors are chasing for amounts that are owed to them, and there is insufficient monies available to pay them at the time the company is likely to be insolvent.


The other definitions of insolvency section out in Section 123 are:

  1. Statutory Demand for a sum greater than £750 has been served on the company, but remains unpaid after 3 weeks.
  2. If an execution process is returned unsatisfied, for example bailiffs have attended and removed goods, but the value of those goods was insufficient to settle the debt in full. 


If a company is considered insolvent then it can be placed into an insolvency procedure such as:

  1.   Creditors Voluntary Liquidation
  2.   Compulsory Liquidation
  3.   Administration
  4.   Company Voluntary Arrangement


(More information in respect of each procedure can be found by clicking on the above links.)


More often than not however action can be taken before a company or business is formally insolvent to try to prevent a formal insolvency, or to implement a controlled wind down of the company.


Signs of Insolvency

Typical signs of insolvency are:

  1.   The company is constantly juggling which creditor to pay over another.
  2.   The company is “robbing Peter to pay Paul.”
  3.   There are arrears with HM Revenue and Customs or the landlords.
  4.   The company is constantly making late payments or extending credit terms.
  5.   There are threats of Court action, statutory demands or winding up petitions.
  6.   Bailiffs are threating to attend the company's premises.
  7.   The company is constantly up to its overdraft limit with the bank.
  8.   The directors are using their personal funds each month to top up the company's funds.


If any of these signs are present then it may be a good idea to speak to a Licensed Insolvency Practitioner to obtain advice on the Company’s finances and the options available to it.


Quite often insolvency does not have to be a terminal situation and the underlying business or company can be saved as a going concern provided that advice is taken early.  In particular a procedure such as a Company Voluntary Arrangement is designed to save a company as a going concern.  The key issue is taking advice, identifying what the problems are, and then taking steps to address them.


An Insolvency Practitioner does not only just deal with liquidating companies, they are also able to assist directors restructure and turnaround their businesses arounds. This can include obtaining further finance, restructuring the debt/loan structure, reducing unnecessary staff costs, improving processes and internal systems.


If you would like to discuss your company’s affairs and obtain some free insolvency advice please contact Chris Parkman on 01305 458 383 or email him at chris@purnells.co.uk.