What is insolvency?

Insolvency is defined as when a company or individual is unable to pay debts as they fall due or where liabilities exceed assets. The term is used for both businesses and individuals.

It should be noted that although insolvency may have occurred, the situation is not always irrecoverable. Companies that are struggling financially should consult an insolvency professional as soon as possible, and the sooner the better.

The insolvency professional will always look at each case individually and will work to recover a struggling business if there is the slightest chance of recovery.

WHAT IS THE INSOLVENCY PROCESS?

The insolvency process can be split into two main types:

PERSONAL INSOLVENCY
CORPORATE INSOLVENCY

In personal insolvency (which is where an individual rather than a company enters insolvency) there are two main procedures:

An Individual Voluntary Arrangement is in effect a contract between a debtor and their creditors. The contract agrees on how the debtor’s debts will ultimately be resolved.

The debtor will prepare, with the assistance of an Insolvency Practitioner, a proposal to their creditors as an offer of settlement.

This usually includes:

details of contributions from surplus income;
the release of equity from property interests; and
the realisation of assets not required for everyday life.

Bankruptcy is the other personal insolvency process and is authorised by the Court in England and Wales.

Once a bankruptcy order has been issued, the bankrupt’s assets and liabilities become part of an estate which is presided over by the court appointed insolvency practitioner to deal with the estate, which may be the Official Receiver, or another insolvency practitioner, who acts as trustee of the estate.

CORPORATE INSOLVENCY (LIQUIDATIONS, COMPANY VOLUNTARY ARRANGEMENTS and ADMINISTRATIONS)

For corporate insolvency, there are a number of available processes:

Company Voluntary Liquidation and Compulsory Liquidation, Company Voluntary Arrangements and Administration

Company Voluntary Liquidation This is where the directors of a company have identified that it has reached the end of its natural life, or that it is insolvent.

Compulsory Liquidation This is where the company, its directors, shareholders and the company’s creditors can apply for an Order of the Court that the company is placed into liquidation and therefore is “wound-up”.

Company Voluntary Arrangement This is the same as an Individual Voluntary Arrangement detailed above but for a Company.

Administration This requires that a licensed insolvency practitioner (IP) is appointed to act as an Administrator and is given overall control and management of the company.

WHAT ARE THE FACTORS CONTRIBUTING TO INSOLVENCY?

Some of the most common factors leading to insolvency are:

A cash flow crisis, which may be caused by a number of factors such as a large unforeseen expense, tax bill or purchase or loss of an important customer (drop in sales).
External economic factors such as a recession.
Loss of business from increased competition.
Inefficient management, poor management decisions.
Key members of staff leaving.

It is important for individuals/businesses to anticipate and mitigate these risks through effective financial management and planning, and seeking professional advice when needed.

WHEN IS A COMPANY INSOLVENT?

A company is insolvent if its assets are insufficient to discharge its liabilities. This means that the insolvent company:

Is unable to pay its debts as they fall due (cash-flow insolvency).
Has liabilities in excess of its assets (balance-sheet insolvency).

WHAT HAPPENS WHEN YOU CLAIM INSOLVENCY?

As mentioned above, there are two main personal insolvency processes. These are either entering into an Individual Voluntary Arrangement (IVA) or being declared bankrupt.

Entering into an Individual Voluntary Arrangement is usually preferable to filing for bankruptcy as it has less serious and long-lasting consequences. An IVA is an agreement between the individual and their creditors that allows him/her to pay off their debts in manageable instalments over an agreed period of time.

When an individual applies for an IVA, a licensed insolvency practitioner will be nominated to communicate with creditors on their behalf and the insolvency practitioner (IP) will review the individual’s finances to ascertain whether the case would be suitable for an IVA.

If so, the practitioner will work with the individual to create proposals to send to creditors. The creditors then vote on the proposals as to whether they are agreeable to them, and if the proposals are accepted the individual makes payments to the creditors through the arrangement(IVA) until the arrangement has been fulfilled.

Details of an IVA remain on the Insolvency Register for 12 months and will be visible on credit histories for six years.

WHAT TO DO IF YOUR COMPANY IS INSOLVENT?

On discovering that your company meets the parameters of becoming insolvent (see the explanations above in the first paragraph) here are the steps to take:

Firstly, we recommend seeking professional advice. It’s important to seek the advice of a licensed insolvency practitioner who can guide you through the insolvency process and help you explore your options.

Next, you need to assess the situation. You need to understand the extent of the insolvency and the financial obligations that need to be addressed. This can be done by conducting a thorough review of the company’s finances.

Once you have a clear understanding of the company’s financial situation, you need to explore your options. This may include negotiating with creditors, entering into a formal insolvency process, or seeking additional funding.

Consider your position regarding a formal insolvency process. If the company is unable to pay its debts, a formal insolvency process may be necessary. This could include a voluntary arrangement, liquidation or administration.

An insolvency practitioner can advise on the best course of action.

Finally, attempt to keep your stakeholders informed of the current position. It’s important to keep all stakeholders informed about the situation, including employees, suppliers,and customers. However, please seek professional advice before entering into detailed communication with your stakeholders.

WHAT ARE THE RISKS FOR DIRECTORS OF AN INSOLVENT COMPANY?

When a company becomes insolvent, the directors have certain legal obligations and responsibilities to act in the best interests of the company’s creditors. Failing to fulfil these obligations and responsibilities can lead to significant risks for the directors.

The first one is personal liability for the company’s debts. Ifa director continues to trade the company while insolvent, they can be held personally liable for any new debts incurred during that time.

If a director is found to have breached their legal duties or acted improperly, they may be disqualified from acting as a director of any company for a period of time.

Creditors may take legal action against the directors for failing to fulfil their legal obligations and responsibilities. In some cases, the actions of the directors may be considered fraudulent or criminal, leading to criminal charges.

The insolvency of a company and any associated legal action can damage the reputation of the directors, making it difficult to secure future business or employment opportunities.

WHAT ARE THE ADVANTAGES OF INSOLVENCY?

Insolvency is generally considered a negative situation for a business, as it indicates that the business is unable to pay its debts as they fall due. However, there are some potential advantages to insolvency, depending on the specific circumstances of the business. These advantages may include the following:

Protection from creditors – When a company enters a formal insolvency process, it is protected from legal action by its creditors. This can provide some breathing space to explore options for restructuring or turning the business around.
Opportunities to restructure- Insolvency can provide an opportunity to restructure the business in a way that is more viable and sustainable. This can involve renegotiating contracts, reducing costs, or changing the business model.
Relief from debt – Depending on the type of insolvency process, the business may be able to reduce or eliminate its debt burden. This can provide a fresh start and allow the business to focus on growth and profitability.
Increased transparency – Insolvency processes generally involve increased transparency, with regular reporting to stakeholders on the status of the business. This can help to build trust and credibility with stakeholders.
Access to professional advice – Insolvency practitioners and other professionals can provide valuable advice and support to the business during the insolvency process. This can help to identify the underlying causes of the insolvency and develop a plan to address them.
It’s important to note that the potential advantages of insolvency are not guaranteed and will depend on the specific circumstances of the business.

WHAT ARE THE DISADVANTAGES OF INSOLVENCY?

There are a number of disadvantages of insolvency which comprise the following:

Risk of legal action – Insolvency can result in legal action from creditors or other parties, which can be costly and time-consuming for the business. However, as stated above, once a formal insolvency process commences, protection is provided from legal action by creditors.
Loss of control – When a company enters an insolvency process, control of the business is often taken over by an insolvency practitioner or another third party. This can be difficult for the directors and other stakeholders, who may feel that they have lost control of the business.
Damage to reputation – Insolvency can damage the reputation of the business and its directors, making it more difficult to secure future business or employment opportunities.
Impact on employees – Insolvency can result in job losses for employees, which can have a significant impact on their lives and families.
Financial losses – Insolvency can result in significant financial losses for the business and its stakeholders, including shareholders, creditors, and suppliers.
Limited options – Depending on the severity of the insolvency, the options for the business may be limited, with liquidation or closure being the only viable option.

WHAT’S THE DIFFERENCE BETWEEN BANKRUPTCY AND INSOLVENCY?

Bankruptcy and insolvency are two related but distinct terms that are often used interchangeably. However, they have different legal meanings and implications:

Insolvency is a financial state in which a company or individual is unable to pay its debts as they fall due. This can occur even if a company or individual has significant assets, as they may not have the cash flow to meet their obligations. Insolvency can lead to a range of legal processes, including liquidation, administration, bankruptcy and voluntary arrangements.

Bankruptcy is a legal process that is available to individuals who are unable to pay their debts. It is a type of insolvency legal process which applies specifically to individuals rather than companies. Bankruptcy involves a court process that transfers control of the individual’s assets and liabilities to a trustee, who is responsible for realising the individual’s assets and distributing the realisations from these to creditors.

While insolvency and bankruptcy are different legal terms, they both involve a financial state in which an individual or company is unable to pay their debts. The specific legal processes and implications will vary depending on the jurisdiction and circumstances involved.

WHAT IS INSOLVENCY LAW?

Insolvency law is a legal framework that governs the financial state in which a company or an individual is unable to pay their debts as they fall due. It provides a legal process for dealing with the situation, to ensure that creditors are paid as much as possible, while also providing some protection and relief to the insolvent party.

Insolvency law typically includes several legal processes and we have listed the procedures in depth earlier in this article.

Insolvency law also includes provisions for the treatment of secured and unsecured creditors, the sale of assets, and the appointment of insolvency practitioners. The specific rules and procedures will vary depending on the jurisdiction and the type of insolvency process involved.

Insolvency law is complex and can involve a range of legal,financial, and personal implications.

HOW DOES INSOLVENCY AFFECT SOLE TRADERS?

Insolvency can have a significant impact on sole traders, who are self-employed individuals who own and operate their own businesses. When a sole trader becomes insolvent, they are unable to pay their debts as they fall due, which can lead to a range of legal, financial, and personal implications.

One of the key risks for sole traders facing insolvency is the potential for legal action from creditors. This can include court proceedings, enforcement action, and legal judgments, which can be costly and time-consuming for the sole trader.

In addition, insolvency can damage the reputation of the sole trader, which can make it more difficult to secure future business or employment opportunities.

Insolvency can also have a significant impact on the financial well-being of a sole trader. Depending on the severity of the insolvency, the sole trader may be required to sell or liquidate their personal assets, which can result in significant losses.

Likewise the sole trader may be personally liable for any debts that are not covered by the sale of assets, which can have a long-term impact on their financial health.

For sole traders who are facing insolvency, it is important to seek professional advice to fully understand their options and obligations. By working closely with an insolvency practitioner or lawyer, a sole trader may be able to mitigate the negative impact of insolvency and explore alternative options.

WHAT IS AN INSOLVENCY PRACTITIONER?

In this article, we have made many references to insolvency practitioners, read our guide to insolvency practitioners here.

In explanation then, an insolvency practitioner (IP) is a licensed and regulated professional who is appointed to manage the affairs of an insolvent individual or company.

Insolvency practitioners are trained experts in insolvency law and process and have the legal authority to act on behalf of creditors and debtors in order to resolve financial difficulties.

The role of an insolvency practitioner may include a range of responsibilities, depending on the circumstances of the case.

Some of the key duties of an IP may include:

Investigating the affairs of an insolvent party in order to fully understand the financial situation.
Identifying any potential legal issues, and determine the best course of action.
They may take control of the assets of an insolvent party, including real estate, equipment, and inventory, and manage/sell them in order to maximise their value and repay creditors.
An IP may work with creditors to negotiate repayment plans, voluntary arrangements, or other solutions that can help resolve the financial difficulties of an insolvent party.
They may also oversee the process of liquidating the assets of an insolvent party, which involves selling off assets in order to repay creditors.

Insolvency practitioners play a crucial role in the insolvency process, helping to ensure that the interests of both creditors and debtors are protected. They are highly trained professionals who are required to meet strict legal and ethical standards, and they work to resolve insolvency cases in a fair, transparent,and efficient manner.

If you own a company and find yourself in financial distress, by seeking prompt advice from an Insolvency Practitioner, you can be supported through this difficult process by experts who understand the pressures you are facing and have experience in working swiftly to deliver a strategy to resolve the issues you face.

Chamberlain & Co offer a free initial one-hour consultation which is discrete and can be held via telephone, face-to-face meeting, or through a digital medium such as Microsoft Teams.

All matters are discussed confidentially, and the team is used to making discrete enquiries when working with you to produce a strategy to resolve your issues.

As with all insolvency practitioners, Chamberlain & Co are committed to delivering best advice in all scenarios, and the teamwork has been recognised regularly at the Yorkshire Accountancy Awards and Turnaround, Rescue and Insolvency Awards.

You can contact us by calling 0113 242 0808; or by emailing us at advice@quantuma.com or by completing our online contact form here.