Insolvency refers to the state of being unable to pay your debts when they fall due, or when your liabilities exceed your assets. In other words, when you owe more money than you can afford to pay.
Insolvency is a term which can apply to both individuals and businesses and often signals the need to seek professional advice.
How do we test for insolvency?
In the UK, there are two key tests which can determine whether a person or business is insolvent:
Test 1: The Cash Flow Test
Are you or your business unable to pay your debts as they become due?
Do you have an outstanding overdue tax bill that you are concerned about paying? Or are you concerned about insufficient funds to meet an upcoming obligation?
Test 2: The Balance Sheet Test
Does the total amount of your debts exceed the total value of your assets?
Failing either of these tests may mean that you or your business is legally classified as insolvent, and you likely need to speak to an expert.
What causes insolvency?
Insolvency isn’t necessarily an indicator of poor financial management and can occur for a number of reasons. Some of these include:
- A downturn in sales or revenue
- Unexpected expenses or legal claims
- The loss of a major contact
- External economic factors, such as inflation, interest rate increases or supply chain issues.
- Poor cash flow management
- Excessive borrowing
In many cases, insolvency develops gradually. Proper maintenance and regular reviews of financial records can help you spot the warning signs early.
Typically, the sooner you seek professional advice, the more options are available for you or your business. We recommend that you seek advice as early as possible when you recognise these warning signs.
How much does a formal insolvency procedure cost?
The costs associated with the insolvency process vary depending on the complexities of each unique case. Typically, the more assets involved in a case, the higher the cost.
Importantly, however, the fees taken by an officeholder are taken from the assets of the company during the process and are seldom paid directly by individuals or directors of the company.
If you are concerned about the costs associated, please reach out for a fee-free, zero-obligation meeting where we can guide you through the fee structure in detail.
The Types of Insolvency & The Solutions Available
Broadly, insolvency can be broken down into two categories: personal insolvency and corporate insolvency.
Personal Insolvency:
Personal insolvency affects individuals unable to meet their financial obligations. For example, declining revenue resulting in monthly loan repayments becoming unaffordable.
Common solutions to personal insolvency include:
Debt Relief Orders (DROs)
DROs are a solution for those with low income and minimal assets who are struggling to pay their debts. In essence, it allows individuals to pause payment on their debts for a 12-month period or until their financial situation improves. Should the individual’s circumstances not have improved by the time the DRO ends, most of their debts will be written off.
Individual Voluntary Agreements (IVAs)
An IVA is a formal agreement with a creditor to repay all, or part of the debt owed over time. The terms of the agreement determine how much you can afford to pay and over what timeframe. Payment from the sale of assets or from surplus monthly income is made to an insolvency practitioner, who acts as an intermediary and divides your payment between your creditors.
Bankruptcy
Bankruptcy refers to the legal process of writing off debts that you cannot afford to pay. While an individual is in an undischarged bankruptcy, they will be subject to certain restrictions. These include an inability to be the director of a company or take out new credit over the value of £500 without declaring your state of bankruptcy.
Therefore, it is recommended that you seek professional advice regarding how these restrictions will impact on your personal circumstances.
Corporate Insolvency:
Corporate insolvency applies to limited companies. The most common types are:
Company Voluntary Agreement (CVA)
A company unable to pay its debts can propose a CVA to its creditors, who must collectively agree to the proposal. A CVA can be drafted with the help of a licensed insolvency practitioner. The CVA outlines how the business intends to continue trading while making regular payments, typically from surplus profits, to the insolvency practitioner, who acts as an intermediary. These payments, after costs, are then distributed amongst creditors in line with the agreement.
Administration
Administration is a formal legal process designed to protect a company from creditor action whilst a licensed insolvency practitioner takes control of the business. Most commonly, administration is used when a company is insolvent but has potential to be rescued, restructured or sold in a way that achieves better outcomes for creditors than ceasing trade or liquidating the business.
Liquidation
Before a company enters liquidation, it will typically cease to trade and employees are likely to be made redundant. A licensed insolvency practitioner is appointed to sell the business’ assets to pay creditors. Liquidation can either be voluntary (as Creditors’ Voluntary Liquidation) or compulsory (ordered by the court).
What happens when a company becomes insolvent?
Once a company is insolvent, the company’s directors have a legal obligation to act in the best interests of the creditors, not the shareholders.
Continuing to trade while insolvent (unless carefully done with a view to minimise the potential loss to creditors) is known as wrongful trading and can result in personal liability for directors.
At this point, the directors should seek professional advice, following which the business may do several things, including:
- Propose a CVA to creditors
- Enter administration in an attempt to rescue or sell the business
- Be wound up through liquidation
The role of an insolvency practitioner
Insolvency practitioners are licensed professionals who specialise in dealing with financial distress. The key role of a practitioner is to:
- Provide objective advice to individuals or directors on the options available
- Act as an officeholder (e.g. administrator, liquidator, supervisor or trustee) during insolvency proceedings
- Manage the process of making repayments to creditors in relevant situations
- Maximise the value of assets for the benefit of creditors
It should also be noted that recognising the warning signs of insolvency early and engaging with an insolvency practitioner at this point may allow you to explore options to avoid formal insolvency altogether.
How can Cooper Associates Accountancy help?
We understand that facing insolvency can be an emotional and overwhelming experience. Our dedicated insolvency team offer clear, confidential and practical advice tailored to your unique circumstances.
Whether you’re an individual struggling with personal debt or a business facing increasing financial pressures, we’ll guide you through the entire process with empathy, integrity and professionalism.
Our services include:
- Insolvency advice and financial assessment
- Debt restructuring and negotiations
- Formal insolvency procedures
- Support for directors, business owners and individuals
Please reach out today for a confidential, fee-free, zero obligation meeting and discover how Cooper Associates Accountancy can help.
