An insolvent company is one that can either no longer cover its day to day costs, pay its debts, has liabilities that outweigh its assets, or has had a formal payment demand imposed on it by a creditor that has gone unpaid.
If your company finds itself in this position, there are options. In fact, there are several paths open to insolvent companies, from liquidation, a Company Voluntary Agreement (CVA), Administration to a Scheme of Arrangement.
However, as every company’s situation differs, you must find the best route forward for you. Whatever the case, it’s important to act quickly before things get worse.
To help, we have compiled this handy guide outlining the 4 different options available to insolvent companies so that you can find the best one for you.
What is an insolvent company?
As we have already mentioned, an insolvent company can no longer afford to pay its day-to-day costs or has liabilities greater than its assets.
If you are unsure whether your company is insolvent, there are two tests you can take to check:
- The balance sheet test: establishes whether companies’ liabilities are larger than their assets. If this is the case, it is considered insolvent.
- The cash-flow test looks at whether a company can afford to pay its bills and its debts. Companies that cannot are classified as insolvent.
If your company passes either of these two tests, it’s time to look at what the next best steps will be.
There are several options available, from going into liquidation and ceasing to trade to find a solution for business rescue. To see which route is best for you, next, we will explore each option in-depth.
One option for businesses is to liquidate. This is best for companies that wish to close their companies formally and be forced on companies that have failed to pay their debts.
Liquidation officially winds-up a company and means it must stop trading. It is subsequently dissolved and taken off the Companies House Registrar.
It is important to note that liquidation is a formal insolvency process and a legal procedure. For this reason, companies that take this route must appoint a licensed Insolvency Practitioner to oversee and implement the process.
Although liquidation means that your business will cease to trade, there are different liquidation types that directors need to be aware of. These include a Creditors’ Voluntary Liquidation, Members’ Voluntary Liquidation (MVL), and Compulsory Liquidation.
To see which one is right for your company, let’s look at each in-depth:
Creditors’ Voluntary Liquidation
A Creditors’ Voluntary Liquidation, as the name suggests, is applied voluntarily by the company director. To be passed and processed, at least 75% of shareholders need to agree to it. This is the best option for businesses that can no longer feasibly operate, are deemed insolvent, and will wind-up and close your company.
Members’ Voluntary Liquidation
Solvent companies can only apply a Members’ Voluntary Liquidation. This means only those who can pay their bills and have assets over £25,000 can undergo a Members’ Voluntary Liquidation process, and those that are insolvent cannot. This is usually the best option for companies looking to retire, move abroad, or wish to close their business in a tax-efficient way.
Finally, unlike both a Creditors’ Voluntary Liquidation and a Members’ Voluntary Liquidation, a Compulsory Liquidation is mandatory. This is typically forced onto a company by creditors who want to retrieve money owed to them after several failed payment demands.
Just as it sounds, this is the most severe form of insolvency. Creditors that are owed money will issue a winding-up petition to the court and, if successful, the company will be forced to liquidate, and its assets will be sold. The funds from the sale will be used to settle debts.
Company Voluntary Agreement (CVA)
For insolvent companies that are instead looking for an option that will allow them to rescue their business, a Company Voluntary Agreement may be the best route forward.
With a Company Voluntary Agreement, a company can put a formal proposal to its creditors to help find a way to rescue the business. In this case, both parties, including the directors and creditors, come to an agreement where the creditors will accept a sum of money to settle towards the debts they are owed. Again, 75% of the creditors must agree for this to progress.
Once this has been agreed upon, the company can continue trading, and the director remains in control of the business.
Again, as a legal procedure, a licensed Insolvency Practitioner must be appointed to oversee and carry out the process.
Scheme of Arrangement
This is another option for those looking to turn around their insolvent company and find a business rescue solution.
A Scheme of Arrangement is made between the company and its creditors and again requires at least 75% of creditors to agree to progress. A Scheme of Arrangement can include reorganizing the company structure through a merger or demerger or debt for equity swap or other debt-reduction strategies.
Finally, another option for insolvent companies is to go into administration. This is usually the best option for larger companies and aims to control the company’s assets and repay creditors the money that is owed to them.
When a company goes into administration, they are automatically given protection against legal action. An Insolvency Practitioner is appointed as the administrator, and whilst they are overseeing the case, no other party can apply to wind-up the company.