A Guide to Business Insolvency

If a company is unable to pay the money it owes, maybe due to cash flow problems, or if its liabilities outweigh the assets on its balance sheet, it can be described as business insolvency. There are some warning signs to look out for if you are worried about insolvency – read on to find out more.

Jeff Salway Last updated on 15 October 2021.
A Guide to Business Insolvency

When a company enters insolvency the assumption is usually that it will go out of business.

But while that may sometimes be the case, there are also measures that firms can take to ensure that insolvency doesn’t result in complete closure.

Understanding whether or not the company can continue trading is one of the many challenges faced when it comes to insolvency.

Here we look at some of the questions that are likely to arise if you have to head down this route.

What is business insolvency?

As with individuals, businesses are considered insolvent when they are no longer able to pay their debts. This may be because of cash flow problems that mean bills aren’t paid and/or that there are more liabilities than assets on the balance sheet.

» MORE: Everything you need to know about insolvency

What is the difference between business insolvency, bankruptcy and liquidation?

Insolvency is the umbrella term used when a person or business has insufficient assets to cover its debts and liabilities. In this respect, business insolvency is effectively the same as personal insolvency.

Bankruptcy is a common term when we talk about insolvency. However, it mainly applies to individuals and sole traders.

When it comes to limited companies, the equivalent of bankruptcy is a process referred to as liquidation. This is where the business is effectively wound up or closed down so its assets can be sold and the proceeds used to repay creditors.

What happens when a company declares itself insolvent?

Declaring insolvency means the company is prioritising the repayment of its debts, which means it may well need to stop trading straight away so that those debts don’t mount any further.

Usually, the business would engage an insolvency practitioner to decide whether or not this needs to happen, or if the business might improve its chances of making its repayments by continuing to trade.

It’s important to note that there are some procedural differences between the insolvency process in Scotland compared to in England and Wales.

What are the warning signs of an insolvent company?

If you’re concerned that your own business is at risk of insolvency there are a number of red flags to look out for. These include:

  • threats of legal action from creditors who haven’t been paid
  • the company overdraft hitting its limit
  • credit applications being rejected
  • wages going unpaid
  • missing HMRC’s tax payment deadlines

If you want to know if another company is insolvent and/or in liquidation proceedings, the UK government website has a page where you can check a company’s status. You can find it here.

» MORE: How to identify business risks

What does it mean when a business is in liquidation?

Liquidation is where a business closes down so that its assets can be sold in order to repay its debts. Sometimes it’s a voluntary process for a company that is solvent but wants to close.

But, in most cases, it involves a business that’s insolvent and isn’t able to carry on because of its financial problems. This is a compulsory liquidation, where creditors have asked a court to grant a winding up order.

Ideally, selling the assets means that all the creditors can be repaid, but this doesn’t always happen.

Liquidation doesn’t apply to sole traders, however, as there’s no legal distinction between the individual and the business.

The insolvency routes for sole traders are the personal options, such as individual voluntary arrangements (IVAs) and bankruptcy (or sequestration and Protected Trust Deeds (PTDS) in Scotland).

» MORE: What does it mean to dissolve a company?

Can a business survive insolvency and still trade if insolvent?

Having to stop trading due to insolvency doesn’t necessarily mean the end of a business. In some cases, the steps taken in the insolvency process can allow the company to bounce back and move on.

For example, some companies use corporate recovery specialists to find solutions to the debt issues and potentially help the company to continue or resume trading.

However, continuing to trade while insolvent can be a criminal offence, if the court thinks the company can’t or won’t be able to repay its debts and decides it's guilty of wrongful trading. This could mean that the directors of a limited company have to help repay its debts personally, whereas previously they would usually have been protected.

» MORE: Are directors liable when a business is insolvent?

How to fix insolvency

There are ways of dealing with insolvency that don’t require entering liquidation or other legal procedures.

Companies often seek informal agreements with creditors, with a repayment plan put in place that suits all parties. This may come at a cost, such as higher interest payments, but it may be a viable option where there is a good relationship between a business and its creditors.

A company voluntary arrangement (CVA) is similar to the informal arrangement with creditors and means the company can continue trading.

Some companies opt to go into administration in a bid to stave off liquidation. Administration involves an insolvency practitioner effectively taking control of the business, putting together a recovery plan and seeking a repayment agreement with the creditors.

It’s often followed by liquidation, but not always, giving the company some hope of being able to continue trading while it deals with its debts.

Can I start a new company after liquidation?

There’s no single reason why you can’t start a new business when you’ve been through a company liquidation. There are a few important considerations, however.

For instance, your new company should avoid using the same or similar name or you risk being guilty of an offence known as ‘passing off’. This is set out in Section 216 of the Insolvency Act, 1986.

More practical barriers may arise, especially if you’ve been associated with more than one company liquidation. HM Revenue & Customs can insist on a security deposit if one of your previous companies fell behind on tax payments, while some suppliers may be wary of setting up arrangements with a company linked with previous liquidations.

Image source: Getty Images

About the author:

Jeff is a freelance journalist who writes across finance & business. He was the personal finance editor at The Scotsman & Scotland on Sunday & a member of the Financial Services Consumer Panel. Read more

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