An insolvent company is one that can no longer afford to cover its daily costs or pay its debts, has liabilities that outweigh its assets or has had a formal payment demand by a creditor that has gone unpaid.
There are several options open to insolvent companies, from liquidation, administration, a Company Voluntary Arrangement (CVA) or a Scheme of Arrangement.
The best option for you will depend on your situation and circumstances, so it’s always a good idea to do your research and appoint the services of a licensed Insolvency Practitioner to find the best route for you.
To help, Clarke Bell has put together this handy guide outlining the 4 options available to insolvent companies, to help you find the best one.
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When is a company considered insolvent?
There are a couple of tests that determine whether a company is insolvent. These include:
- The balance sheet test: this test measures whether your liabilities are greater than your assets. If this is the case your company can be classified as insolvent.
- The cash-flow test: this test looks at whether a company can pay its bills and debts when they are owed. Again, if your company cannot, it can be deemed insolvent.
If either of these is true for your company there are a number of options available to you, ranging from whether you go into liquidation and subsequently close the business and cease to trade, to options for rescuing the business.
This is a formal insolvency process that legally winds-up a business – meaning it has to stop trading and is officially dissolved. This means it will be struck off the Companies House Registrar.
As it is a formal insolvency procedure, a licensed Insolvency Practitioner must be appointed to oversee and carry out the liquidation process.
There are 3 main types of liquidation, Creditors’ Voluntary Liquidation (CVL), Members’ Voluntary Liquidation (MVL) and Compulsory Liquidation.
Creditors’ Voluntary Liquidation
A Creditors’ Voluntary Liquidation is entered into voluntarily by the company director and needs the approval of at least 75% of shareholders to progress.
A CVL is the process of liquidating an insolvent company and realising its assets (if any) to pay back creditors what they are owed.
If you are experiencing financial difficulties, it is better to act quickly and enter into Creditors’ Voluntary Liquidation before matters get worse and you are forced into liquidation.
Members’ Voluntary Liquidation
A Members’ Voluntary Liquidation is also a voluntary process initiated by the company director, however the main difference between an MVL and CVL is that Members’ Voluntary Liquidation is only available to solvent companies (i.e. ones that have no debts).
A company director might choose to liquidate their company through an MVL if they are looking to retire, move abroad or take a step back from the company. This is a quick way to close a business and free up funds.
What’s more, this is considered a tax-efficient way of closing a company. This is because any funds taken out of the business are subject to capital gains tax which is set at 10% rather than income tax which is set at 18% or 28%. Furthermore, directors who qualify for Business Asset Disposal Relief can also benefit from further tax advantages.
The final form of liquidation, and the most serious, is compulsory liquidation. As the name suggests, this form of liquidation is forced onto a company by creditors looking to retrieve money owed to them after failed payment demands.
In the case of Compulsory Liquidation, creditors will issue a winding-up petition to the court. If this is successful, the company will be forced to liquidate and its assets will be sold, the funds from which will be redistributed to pay its debts as they are owed. An Insolvency Practitioner will be appointed by the court, and the directors will have to accept that decision – rather than being able to appoint an Insolvency Practitioner of their own choice.
As well as liquidation which completely closes a company, there are also other options open to insolvent companies such as administration.
When entering into administration, the end goal is to take control of the company’s assets and repay creditors what are owed money.
Whilst in administration, a company is offered protection against any legal action that might be brought against them.
An Insolvency Practitioner must be appointed as the administrator and they will be responsible for assessing the case and coming up with a solution. Whilst the IP is doing this, no one can apply to wind-up the company.
Whilst in administration there are a number of things that can happen, including:
- The company closes and ceases to trade
- A Company Voluntary Agreement (CVA) is reached – which will mean the business can continue to operate and trade
- The company can be sold as a ‘going concern’ to another company – meaning they continue to operate
- The company’s assets can be sold as part of a Creditors’ Voluntary Liquidation. Here, creditors will be paid back what they are owed and the company will liquidate
Company Voluntary Arrangement (CVA)
Another option is a Company Voluntary Arrangement.
A Company Voluntary Arrangement is entered into by an insolvent business looking to turn around and restore profitability.
Again, a licensed Insolvency Practitioner must be appointed and must believe that the business has real chances of rescue to enter into a CVA.
The Insolvency Practitioner will put forward a formal proposal to creditors to find a way of turning the business around. Both the company directors and creditors will come to an agreement where the creditors accept a sum of money as a way of settlement towards the debts they are owed.
This requires the approval of at least 75% of creditors and is a process that can last between 2 – 5 years.
Once the arrangement has been accepted by both parties, the company can continue to trade and the director can remain in control of the business.
Scheme of Arrangement
The final option for insolvent companies looking for business rescue is a Scheme of Arrangement.
This is made between the company and its creditors and requires the approval of 75% of creditors to progress.
A Scheme of Arrangement can include reorganising the company structure, whether by merger or demerger, or by a debt for equity swap or other debt-reduction strategies.
Get in touch with Clarke Bell to find the best way forward for you
Now you know what options are open to insolvent companies, Clarke Bell are here to help find the best way forward for you.
Whatever your situation, we can offer expert insolvency advice to help you reach the best possible outcome.