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FAQ's

1. What is insolvency?
2. How can I reduce the risks of insolvency?
3. How can I protect myself, family and friends who invest in my business?
4. What should I do if my business seems likely to become insolvent?
5. How can I pay for help when I am already in financial trouble?
6. Can I take money or assets out of my business before it becomes insolvent?
7. What is a 'preference'?
8. Who can start insolvency proceedings?
9. What are the options for an insolvent company?
10. What are my liabilities as a director of an insolvent company?

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1. What is insolvency?

A company, partnership or soletrader is insolvent if it cannot pay debts when they become due (either now or, because of some contingent liability of the business, in the future) or if its assets are worth less than the total liabilities.

Having a profitable business is not, in itself, a guarantee that you will not be insolvent. Cashflow problems - for example, if customers fail to pay money they owe you, or if you over-invest in equipment - that mean you cannot pay your debts as they fall due could still push your business into insolvency.

The consequences of failing to take the proper steps once your business becomes insolvent can be dire and could affect you personally whether you are a sole trader or a director of a company. It is essential that proper insolvency advice is taken from a professional specialising in insolvency, at as early a stage as possible, to ensure that you minimise your personal exposure. Blindly trading on in the hope that you will be able to turn the business round may prove very costly to you personally if it does not work and you actually make the position worse.

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2. How can I reduce the risks of insolvency?

You can reduce the risk of becoming insolvent by ensuring that your business is soundly financed and by keeping good control of your cashflow. These are issues you should discuss with your advisors and your bank.

Building a good relationship with creditors - for example, your bank - can help to reduce the risk that they will instigate proceedings against you if your business does run into financial difficulties. The bank (and other creditors) can be more supportive if you keep them informed and have a good previous record of prompt payment.

Choosing an appropriate business structure will help to reduce the potential consequences should you become insolvent in the future.

Finally, as a director it is essential to keep a close eye on the company's financial position. As well as improving your chances of avoiding insolvency in the first place, this will reduce the likelihood that you will be held personally liable for wrongful trading, or be disqualified as a director, if the company does become insolvent.

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3. How can I protect myself, family and friends who invest in my business?

A simple practical step is to limit investments to amounts people can afford to lose. If you are trading as a sole trader (or in a partnership), you should also ensure that your spouse has a separate bank account, and that you do not give a charge over your home to secure a loan.

More broadly, it may be possible to provide some protection to investors by ensuring that their investments to the business take the form of secured loans, so that they rank higher in the list of creditors should the business fail. By contrast, investments in the form of shares will be most at risk if a company fails. However, taking investments in the form of loans may adversely affect the company's solvency position: loans will be treated as liabilities whereas share capital will be treated as an asset. This is clearly an area in which specialist advice should be sought.

Be aware that for these steps to be effective, you should put them in place when the investment is made. Trying to protect favoured investors when the business is already in difficulties could be construed as creating preferences (see question 7).

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4. What should I do if my business seems likely to become insolvent?

The worst thing you can do is to bury your head in the sand. If you are a company director, you should certainly not resign.

You stand a better chance of reaching a successful resolution if you take action as soon as you identify a potential problem, instead of letting things drift until the business is in crisis. Jennison's can advise on the best course of action and will offer a free initial consultation.

If long-term prospects are good, you may be able to arrange additional financing: for example, by taking out a new loan, factoring your debts, chasing customers who owe you for prompt payment, or selling non-essential assets. You may also be able to negotiate a compromise agreement with your creditors – in the form of a Company Voluntary Arrangement ("CVA"). If your prospects are poor, you may have little option but to cease trading. Beware of creating 'preferences' when paying creditors (see question 7).

If you allow your limited company (or a limited liability partnership) to continue trading with no reasonable prospect of avoiding insolvency, you may be held liable for 'wrongful trading' if it does, in fact, become insolvent. This means you could become Personally liable for the company's debts (as well as being disqualified from being a director). This personal liability can apply even if you did not know there was no reasonable prospect of avoiding insolvency - it is sufficient if you ought to have known. This makes it vital to keep close tabs on the financial state of your company's business at all times, so you spot any potential financial problems as early as possible. If you do, it is essential to seek specialist advice as soon as possible.

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5. How can I pay for help when I am already in financial trouble?

Paying professional advisors will not usually constitute a preference (see question 7) provided the payments are justifiable. Obviously, funds will be tight but that makes it all the more important that proper advice is obtained.

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6. Can I take money or assets out of my business before it becomes insolvent?

Actions such as taking money out of the business, or transferring assets at less than their value, may constitute fraud. You could face criminal charges.

In addition, transfers of the company's assets shortly before the onset of insolvency may constitute a preference or undervalue transaction and be overturned by the court (see question 7).

Even legitimate transactions which you would have carried out in the normal course of business may seem questionable if you subsequently become insolvent. Take insolvency advice from a specialist insolvency practitioner, and if appropriate discuss what you are doing with your creditors.

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7. What is a 'preference'?

A preference is anything which puts one of the insolvent company's creditors (or someone who has guaranteed your debts) in a better position than he would otherwise have been in had that thing not been done. For example, repaying one creditor ahead of others, or granting new security for a debt. Preferences can be 'set aside' if your company is liquidated (or you become personally bankrupt) within set time limits. The court can require a creditor who has been repaid to return the money. In practice, attempting to create preferences can also encourage other creditors to press for liquidation or bankruptcy to protect their interests. Causing a company to prefer one creditor over another would be a breach of the directors' duties and they could, in an extreme situation, be made personally liable to repay the monies to the company in liquidation.

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8. Who can start insolvency proceedings?

Any creditor or group of creditors owed more than £750 can ask the court to wind up your company (or to make you bankrupt if you are personally liable for the debt). Additionally, you may decide to start insolvency proceedings yourself if you feel you have no reasonable chance of avoiding insolvency and want to resolve matters (as well as minimising the risk of accusations of, for example, wrongful trading). Shareholders in a company can decide to wind it up without involving the court (this is called 'voluntary liquidation').

A secured lender can also start insolvency proceedings.

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9. What are the options for an insolvent company?

If the underlying business of the company is sound but it is technically insolvent either on a cash flow basis or a balance sheet basis, it may be possible to restructure the company in such a way as to protect the underlying business. The main vehicle for achieving this will be through an administration order or company voluntary arrangement.

If the business has no chance of surviving, it will be best for its operations to be wound up. By this process the company ceases trading, its assets are sold and the proceeds distributed amongst its creditors (this is known as 'liquidation' or 'winding up'). The directors' control over the company will cease and all powers will vest in its liquidator. You must take professional advice on the best option in your circumstances.

Please our section on CVAs, administration and liquidation for further information.

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10. What are my responsibilities as a director of an insolvent company?

Your first responsibility is to promote the success of the company, including the obligation to foster relations with customers and suppliers. If the company gets into financial difficulty, you should also ensure that the company does not continue incurring additional liabilities when there is no reasonable prospect of avoiding insolvency - you should not try to 'trade out of difficulty'. Doing this could constitute wrongful trading if you fail, and this could make you personally liable for the company's debts (see question 4). You must obtain specialist insolvency advice as soon as possible.

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Jennison's can advise you on the things a director can and cannot do during this period of uncertainty.

Jennison can make the difference.

Please call us now on 0800 107 8788.

© 2010 Jennison Insolvency is a trading name of Moorfields Corporate Recovery LLP.
Tel: 0800 107 8788. Fax: 0800 107 8788 | Registered in England. Company Number OC334837
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Jennison Insolvency are Insolvency Practitioners based in Leeds, serving throughout Yorkshire including Sheffield and York.