FAQ – Answers to Frequency Asked Questions relating to insolvent, director’s duties and decisions to cease trading.

1. How to close a company?

If the company is solvent, a strike off or a Members Voluntary Liquidation are options. If the company has debts it cannot pay and has no option but to cease trading a Creditors Voluntary Liquidation is a common route. In any case it is recommended to take specialist advice.

2. Can you liquidate a company yourself?

No, a company can only be liquidated by a licensed Insolvency Practitioner (or, in the case of a compulsory liquidation, the Official Receiver). If certain conditions are met it may be possible to apply to Companies House for the company to be struck off. That won’t be possible, though, where the company has traded recently or has pressing creditors.

3. When does a company become insolvent? What is insolvency and why is it important?

The point at which a company becomes insolvent is critical because, from that point, the directors’ duties are owed to the company’s creditors rather than the company itself. They need to be able show that they took every step with a view to minimising the potential loss to creditors.

A company is insolvent when it cannot pay its debts when they are due (known as cashflow insolvency) or if its liabilities are greater than its assets (balance sheet insolvency). Insolvency is defined by s123 of the Insolvency Act 1986. A creditor can petition for a company to be wound up if it is owed more than £750 and it can prove the company cannot pay the debt (e.g. by evidencing that a statutory demand has gone unpaid).

4. What are some typical signals that a company is, or may become, insolvent.

Signals, for those external to the business, that a company may be insolvent.

(In addition, some creditors may also become aware of some of the internal signs listed below.)

  1. Statutory accounts – filed late, negative net assets, negative net current assets.
  2. Late payments.
  3. Dishonoured payments (e.g. bounced cheques).
  4. Lack of communication – evasive.

Signals, for those internal to the business, that a company may be insolvent.

Those in the business who may have access to the data may notice:

  1. Late payments – rent, suppliers, utilities, wages, HMRC
  2. Use of overdraft facilities
  3. Building up tax arrears

In addition, there are normally longer terms signs that a company may come under pressure in the future if the company is not able to take action.

  1. Declining sales
  2. Lost contracts

5. How much debt has to be owed to make a company insolvent?

There’s no minimum amount that must be owed for a company to be insolvent. However, a creditor can only petition for the winding up of a company if is owed at least £750. When petitioning for the winding up of a company the petitioning creditor must pay a deposit. At the time of writing the deposit to be paid was £1,600. There is no guarantee that the deposit will be refunded and therefore, in ordinary circumstances, creditors are unlikely to petition for a winding up unless they are owed considerably more than £750.

6. What are the duties of, and risks to, company directors when a company becomes insolvent?

From the point a company becomes insolvent the directors’ duties are owed to the company’s creditors rather than the company itself. They need to be able show that they took every step with a view to minimising the potential loss to creditors.

The Insolvency Act puts in place a number of specific protections for creditors so directors need to be very careful not to breach them. These include: misfeasance; wrongful trading; fraudulent trading; transactions at an undervalue; and transactions defrauding creditors.

If found to have breached the protections directors can be held personally liable for company debts (including HMRC debts) which could even lead to their own personal insolvency. Negligent directors also risk being disqualified from acting as directors. More serious offences can also bring custodial sentences.

7. Why is it important to seek advice when a company is insolvent?

There are a number of potential options available to insolvent companies. The earlier advice is taken the more options will be available. The rescue of a business as a going concern is far more likely if it has resources available to fund ongoing trading while a rescue plan is put in place. If it has no such funds the only option may be to cease trading and liquidate.

The point at which a company becomes insolvent is critical because, from that point, the directors’ duties are owed to the company’s creditors rather than the company itself. They need to be able show that they took every step with a view to minimising the potential loss to creditors.

If they cannot show this they could be held responsible for some of the company’s debts. This could lead to their disqualification as directors and they can be made personally liable for company debts even to the point of their own personal insolvency.

8. If a company is insolvent what should happen next? What should the directors do?

At this point a director’s primary duty is to the creditors of the company.

Directors should ensure that they document all their decisions. It is very difficult to predict how things are going to turn out and it is unlikely everything they try will work as they hoped. If directors have records to demonstrate that everything they did was reasonably in the best interests of creditors and based on the best available information they will be in a better position to defend their actions.

Directors should seek insolvency advice. This is crucial because there are risks for directors:

  • If directors continue to trade and the company builds up further debt the directors can be made personally liable for that debt. They can also be disqualified as directors.
  • On the other hand, depending on the circumstances, it may not necessarily be in the best interests of creditors to cease trading immediately, especially where the core of the business is viable.

9. When should a distressed business stop trading?

This depends on what is in the best interests of creditors. Having considered the company’s finances the directors may be able to see that the company can take steps to turn its fortunes around. For example, it may have become distressed due to a temporary issue external to the company and the directors may be able to see ways to resolve the problem themselves.

If the problem is more serious but if the core business is viable then it is likely that a form of rescue will be the best option as this is likely to preserve more of the value of the business and will keep creditor claims to a minimum. If so, it may be preferable for the company to continue to trade, at least for a period of time. However, this will only be possible where there are sufficient funds available to fund further trading.

Examples of formal rescue procedures are Administration and Company Voluntary Arrangements (CVA). Administrations may be structured as trading Administrations or as pre-pack business sales.

If there are no funds available to continue to trade then a liquidation may be the only available option. This however is likely to be the least favourable option from a creditor’s point of view.

In all cases it is advisable for the directors to take insolvency advice to ensure they understand their duties and the risks of the situation.

10. What happens if an insolvent business continues to trade?

It is possible for an insolvent business to continue to trade. If a company is temporarily unable to pay a debt, but the directors are satisfied that it will be able to in due course, they may decide to continue to trade.

  • There are risks for the directors. If the company subsequently fails they could be held liable. HMRC may seek to pursue them for liabilities of the company. They could be disqualified as directors.
  • There may be practical difficulties. The company may breach contracts or financial covenants (e.g. on loan facilities). If unpaid, suppliers may demand to be paid up front or may claim back stock. Creditors may petition for winding up or commence legal proceedings. The bank may freeze account. Utility providers may cease supply.

Despite insolvency there may be steps directors can take, both formal and informal, to protect the interests of creditors, the company and themselves. It is recommended that directors always seek insolvency advice when continuing to trade while insolvent.

11. What happens to the employees when a company goes into CVL?

When a company goes into CVL most of the employees will normally be made redundant straight away. It is likely that the employees will be owed money by the company. This may include:

  • arrears of wages – for work done for which they have not been paid);
  • accrued holiday pay;
  • notice pay – most employees are entitled to advanced notice of being made redundant but this is not always possible. If employees are dismissed without sufficient notice they may have a notice claim;
  • redundancy pay – when dismissed employees have a right to a lump sum amount based on their wages, their age and their length of service;
  • other claims – employees have many rights and protections so they may have other claims too.

As the company is insolvent it is likely that the company will not be able to afford to pay all these claims. If this is the situation the government’s Redundancy Payments service makes payments to employees from the National Insurance Fund (NIF). Employees can apply online to the Redundancy Payments service to claim what they are owed. The NIF payments are capped in various ways. Those employees who earn less than £538/week are likely to find that the government will cover most or all of their claims. [The weekly figure is revised on a yearly basis.] The Redundancy Payments service aim to get payments to most employees within 3-6 weeks of the commencement of the CVL.

The NIF only covers statutory minimum claims. If employee rights under their contracts are more generous these will not necessarily be covered from the NIF and employees will only be able to claim their further rights from the company itself.

For employees who earn more, the first £538/week will be covered from the NIF but for the rest they will only be able to claim against the company. Employees claims for accrued holiday pay and arrears of wages have preferential status which means that they will be paid in priority to most trade creditors. However, payment of these preferential claims is not in any way guaranteed.  Whether they can receive any money or not will depend on the circumstances for the company subject to CVL.

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