A City Law Firm’s Short Guide to Corporate Insolvency
Please note that this article should be read in conjunction with ACLF’s article on ‘Changes to Corporate Insolvency and Governance laws as a result of COVID – 19’
The main law that governs corporate insolvency in England and Wales can be found in the following statutes:
- Insolvency Act 1986; and
- The Insolvency (England and Wales) Rules 2016.
Insolvent or solvent?
Generally, a company is considered to be insolvent when it becomes unable to pay its debts when they fall due.
Under the Insolvency Act, there are 2 tests to help a company determine whether it is insolvent, these are:
- The balance sheet test. This test looks at a company’s balance sheet and determines in as ‘unable to pay its debts’ if the assets of a company is less than the value of its liabilities. It is worth noting here that liabilities should usually consider potential liabilities; and
- The cashflow test. This simple test deems a company to be insolvent if they are unable to pay their debts as they fall due.
What should directors do if they are facing financial strain?
- Ensure the company’s financial records are in order;
- Be aware that an administrator will investigate their prior actions;
- Seek professional guidance on the current financial health of the company;
- Hold sufficient board meetings, which are documented, with the aim of reviewing the financial health of the company; and
- Be aware that once insolvent, they have a legal duty to act in the best interest of the creditors, not the company and may face personal liability for a failure to comply with this.
Please note the above is not an exhaustive list and it is always advised to seek legal/financial advice.
When a company becomes insolvent the directors owe their duties to the company’s creditors, not its shareholders. It is important for directors to consider their actions very carefully and seek legal advice if in any doubt.
If the company becomes insolvent, or goes into administration the directors may be liable for:
- Breaches of duties owed to the company; and
- Losses made if director continues to trade after they are insolvent (this is a personal liability)
When a company is insolvent there are a few options open to it. It can either be resurrected or it can start the process towards winding up. Please note the below list is non-exhaustive.
In administration, a company will be protected from creditors enforcing debts whilst a qualified insolvency practitioner(also known as an administrator) takes over the management of the company. The administrator will operate the company with a view to reorganising it or sell some or all of its business or assets. This can sometimes be agreed in advance of the administrator taking control.
Liquidation is where the assets of a company controlled by a qualified insolvency practitioner (Liquidator). Usually in liquidation the company ceases to trade immediately on being placed into liquidation. The liquidator sells the company's assets and distributes proceeds to creditors.
Company voluntary arrangement (CVA)
A CVA is between the company in question and its creditors. A majority of creditors is needed to approve an agreement as to how (much) and when the debts will be paid. This agreement will then bind all creditors who do not have security over the assets of a company.
An insolvent company can use a moratorium under the Insolvency Act, to give it space while it finds a solution forits financial difficulties. During the duration of the moratorium, creditors are usually precluded from taking any action against the company. Suppliers also have to continue to supply goods and services to the company.