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 also sets out two tests to consider whether a company is insolvent.

  1. The Balance Sheet Test says that if a company’s liabilities are greater than its assets then it is insolvent.
  2. The Cashflow Test says that a company is insolvent if it is unable to pay its debts as and when they fall due.  Or put simply, creditors are chasing for amounts that are owed to them, and there are insufficient monies to pay them at the time. 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. 

Case Law

There has been a lot of debate and cash law over the years as to which test is the most appropriate in any given circumstance and the leading case is BNY Corporate Trustee Services Limited v Eurosail 2007 3BL plc, which is often called the Eurosail case.

Eurosail said that if a company had ceased to trade, or was unlikely to have any further income, then the most appropriate test would be the balance sheet test, and if its liabilities exceed its assets, including contingent liabilities, then the Company would be Balance Sheet insolvent.

However if the Company was going to continue to trade and was likely to receive further income, then the cashflow test would be the most appropriate option.

Signs of Insolvency

Typical signs of insolvency, and particularly cash flow insolvency are:

  • The company is constantly juggling which creditor to pay over another.
  • The company is “robbing Peter to pay Paul.”
  • There are arrears with HM Revenue and Customs or the landlords.
  • The company is constantly making late payments or extending credit terms.
  • The company knows there is a liability falling due in the future and there is no prospect of having funds to pay it.
  • There are threats of Court action, statutory demands or winding up petitions.
  • A statutory demand or winding up petition has been issued and cannot be paid immediately.

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.

Insolvency Procedures and Options

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 implement a controlled wind down of the company.

Quite often insolvency does not have to be a terminal affair and the underlying business or company can be saved as a going concern provided that advice and action is taken early.

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.

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