However, insolvency is not always an incurable situation for a business. The law enables businesses to manage their insolvency through a range of methods.
What is insolvency?
A company becomes insolvent when it can’t pay its debts. This means a company either can’t pay bills when they become due or has more liabilities than assets on its balance sheet.
Although insolvent companies are at risk of being closed down, there are actions that can be taken by the company’s directors to avoid this and continue trading.
To avoid closure, directors have 3 options. They can:
- Contact all creditors to see if an informal agreement can be reached: for example, an extension of time to pay debts
- Enter into a Company Voluntary Arrangement (CVA)
- Put the company into administration, which can offer some respite from creditor action and can allow the company to continue and property to be sold.
Alternatively, the directors have the option of liquidating/winding up the company, the outcome of this being that the company is closed down and its assets are sold and distributed to any creditors.
What is a Company Voluntary Arrangement?
This is a formal insolvency process which serves as a legally binding payment plan and is entered into by the insolvent company and its creditors. There are advantages and disadvantages to a CVA; therefore, it is important to obtain advice before entering into one.
Action that can be taken against an insolvent company
Creditors can take action to recover debts owed to them by getting a court judgment or issuing an official request for payment, known as a statutory demand.
Court Judgment:
A company has 14 days to respond to a court judgment. If the company does not respond within this time, creditors can apply to have its assets seized. To respond, a company must either:
- pay the debt owed to the creditors;
- reach an agreement with the creditor to pay the debt in future (a CVA);
- put the company into administration;
- apply to liquidate/wind up the company, or
- challenge the court judgment.
If a company does not dispute that they owe the money, but can’t afford to pay it back immediately, the company can request to change the terms of the judgment or pay it back in instalments.
If a company disputes that they owe the money, or did not receive/respond to the original claim from the court, an application to set aside the judgment can be made.
We recommend that you seek advice if you receive a court judgment in respect of debts owed by you.
A statutory demand:
If a company is unable to pay its debts, creditors can issue a statutory demand to recover them. If you receive a statutory demand for debts your company owes, you must do at least one of the following:
- Pay the debt
- Reach an agreement with the creditor (CVA)
- Put your company into administration
- Apply to liquidate/wind up your company voluntarily
Creditors can also apply to wind up your company if it is insolvent. You can apply to the court to stop this, but any application must be made within 21 days of receiving the statutory demand from creditors. The court to which you must apply depends on how much money shareholders have paid into your company by buying shares. It is therefore important to take legal advice if you receive a statutory demand so you can deal with it correctly.
What are the implications when a company is declared insolvent?
If your company is declared insolvent, there are many possible consequences to be aware of.
- Directors of an insolvent company are required to act in the best interests of their creditors, as opposed to the company when they are declared insolvent. Failing to do may lead to accusations of wrongful trading. This occurs when the director of a company continues trading when they know, or should know, that the company is insolvent and at risk of liquidation. Directors can be found personally liable for the company’s debts if this occurs.
- When a company becomes insolvent, creditors can initiate legal proceedings to recover money owed to them.
- Employees could face losing their jobs as a result of a company being declared insolvent. However, they do have legal protections and could be entitled to a redundancy payment or other compensation.
- If a company cannot be saved through reaching an informal agreement, entering into a CVA or going into administration, the businesses assets will be sold off to pay creditors and the company will be dissolved.
Creditor companies
If your company finds itself in a situation where it is a creditor of an insolvent business, you may face challenges in recovering the sums owed to the company. If it appears that the company’s debtor is on the verge of insolvency, it is important to seek to recover as much cash towards the debt as possible before the debtor enters into administration. In such a situation, seeking professional legal and financial advice is crucial. rradar can assist policyholders in this situation by providing advice on how to approach this situation to recover sums owed to them.