Facing company insolvency can be overwhelming for any director. However, early and informed action can significantly reduce personal risk and improve outcomes for creditors and stakeholders.
If your limited company is experiencing financial distress, understanding your duties and the available options under the Insolvency Act 1986 is essential. South Bank Legal explains what company insolvency means, how it is assessed, and what steps directors should take if their company is unable to continue trading safely.
What is company insolvency?
Company insolvency arises when a company can no longer meet its financial obligations. Under the Insolvency Act 1986, insolvency is typically determined using two legal tests; the cash flow test and the balance sheet test.
A company does not need to fail both tests to be insolvent. Failing either one may establish company insolvency.
The cash flow test
The first and most common indicator of company insolvency is cash flow insolvency.
Under the cash flow test, a company is insolvent if it is unable to pay its debts as they fall due. This means the company cannot meet immediate liabilities such as:
- Supplier invoices
- HMRC tax demands
- Loan repayments
- Employee wages
If the company cannot pay its debts on time, even if it owns valuable assets, it may already be insolvent.
Repeated creditor demands, overdue taxes or bounced payments are strong warning signs that a company is unable to meet its short-term obligations.
The balance sheet test
The second form of company insolvency is balance sheet insolvency.
Under the balance sheet test, a company is insolvent if its liabilities exceed its assets. In simple terms, if the total value of the company’s debts is greater than the value of its assets, the company may be insolvent even if it is still managing to meet some payments.
Balance sheet insolvency often becomes apparent during detailed financial review or where significant contingent liabilities exist.
What are the signs of company insolvency?
Common indicators of company insolvency include:
- Persistent cash flow shortages
- HMRC arrears or enforcement threats
- County Court Judgments
- Threatened or actual winding-up petitions
- Inability to obtain further credit
- Reliance on director loans to survive
If your company is unable to meet these obligations, it is critical not to ignore the situation.
Directors’ duties during company insolvency
Once company insolvency becomes likely, directors’ duties change.
Normally, directors must act in the best interests of shareholders. However, when a company is insolvent or at risk of insolvency, directors must prioritise the interests of creditors.
Continuing to trade irresponsibly while the company is insolvent can expose directors to personal liability.
Can you continue trading during company insolvency?
One of the most common questions is whether a company can continue trading during company insolvency.
The answer depends on whether there is a realistic prospect of rescue.
If there is genuine evidence that restructuring or refinancing can restore solvency, limited continuing to trade may be justified. However, if there is no reasonable prospect of avoiding insolvent liquidation, continuing to trade may constitute wrongful trading under the Insolvency Act 1986.
Wrongful trading claims can require directors to personally contribute to company losses.
Seeking early legal advice is essential before deciding to continue operations.
Formal insolvency options
If rescue is not viable or creditor pressure is increasing, directors must consider formal insolvency procedures.
Formal insolvency involves the appointment of a licensed insolvency practitioner and compliance with statutory procedures.
The main forms of company insolvency include:
Creditors Voluntary Liquidation (CVL)
Creditors voluntary liquidation (CVL) is the most common procedure where a company cannot continue.
In a CVL:
- Directors acknowledge insolvency
- Shareholders vote to wind up the company
- Creditors appoint a liquidator
- Assets are realised and distributed
Choosing a CVL allows directors to take proactive control rather than waiting for compulsory liquidation.
Company Voluntary Arrangement (CVA)
A company voluntary arrangement (CVA) is a restructuring tool used during company insolvency where the underlying business remains viable.
Under a CVA:
- The company proposes a structured repayment plan
- Creditors vote on the proposal
- If approved, unsecured creditors are bound by it
- The company continues trading
A CVA can be an effective alternative to liquidation in cases of temporary financial distress.
Administration
Administration is a rescue-focused form of formal insolvency. An administrator, who must be a licensed insolvency practitioner, takes control of the company. A statutory moratorium prevents most creditor legal action, allowing time to restructure or sell the business.
Administration may ultimately lead to rescue, a sale of the business, or liquidation.
What happens if you ignore company insolvency?
Ignoring company insolvency rarely improves the situation. If creditors pursue enforcement, the company may face:
- County court judgments
- Bailiff enforcement
- Winding-up petitions
- Compulsory liquidation
If the court makes a winding-up order, the company will enter liquidation and may eventually be removed from the register at Companies House.
However, dissolution does not protect directors from investigation. The Insolvency Service will review conduct and may pursue disqualification proceedings.
The role of Companies House
During company insolvency, various filings must be made at Companies House, including:
- Notice of appointment of administrators or liquidators
- Shareholder resolutions
- Final returns
Once liquidation is complete, the company may be struck off and removed from the register. However, improper strike-off procedures can be reversed if creditors apply for restoration.
What happens to directors after company insolvency?
Following liquidation, directors’ conduct is reviewed.
Potential consequences include:
- Wrongful trading claims
- Misfeasance proceedings
- Preference or undervalue transaction claims
- Director disqualification
Early engagement with a licensed insolvency practitioner and obtaining independent legal advice can significantly reduce risk.
Can company insolvency be reversed?
Not all cases of company insolvency result in closure.
If addressed early, options such as:
- Refinancing
- Asset sales
- A company voluntary arrangement CVA
- Administration
may preserve the business.
However, delay reduces available options. Once creditor enforcement begins, rescue becomes more difficult.
Practical steps if your company is insolvent
If you suspect company insolvency:
- Stop incurring unnecessary credit
- Review financial records immediately
- Avoid preferring certain creditors
- Preserve company assets
- Seek professional advice
Acting responsibly demonstrates compliance with directors’ duties and reduces exposure to personal claims.
How South Bank Legal can assist
South Bank Legal advises directors and businesses across England and Wales on all aspects of company insolvency.
We provide:
- Early-stage insolvency assessments
- Advice on directors’ duties
- Implementation of formal insolvency procedures
- Guidance on creditors voluntary liquidation CVL
- Structuring of company voluntary arrangement CVA proposals
- Protection against wrongful trading and disqualification claims
If your company is unable to continue trading or pay its debts, seeking immediate advice is the safest course of action.
For confidential, commercially focused guidance on company insolvency, contact South Bank Legal today.
Michael Czechyra is a senior commercial solicitor and the founder and Managing Director of South Bank Legal, a commercial law firm in Central London.
Michael primarily acts for business clients in corporate and commercial transactions and disputes, focussing on fintech startups, mergers and acquisitions, commercial contract drafting, as well as assisting with insolvency matters on behalf of technology companies and service providers, intellectual property issues, and complex business disputes.
Michael is known for his practical approach, his accessibility and his ability to meet his client’s timelines. His clients have included global corporations, private equity investors, financial institutions and trading firms, political parties and a national competition and consumer law regulator.
Michael has practised as a commercial solicitor since 1998. Prior to founding South Bank Legal, Michael held various senior and board positions at City of London law firms for several years.