A common example of the misuse of ‘insolvent’ is in relation to a company that is being wound-up. Whilst insolvency could potentially lead to a company being wound-up, there can be many different consequences of being insolvent.
As insolvency is a very real threat, it is vital that business owners, directors and shareholders understand the correct legal definition of insolvent in order to understand which steps should be taken to protect their company and how to protect their company should they face financial struggles.
When can a company be classed as legally insolvent?
Simply put, a company is insolvent when their liabilities exceed their assets, meaning that they would not have sufficient funds to repay all money owed to creditors, even if they were to sell all assets. If a company’s assets are of a slightly higher value than their debts, then they are close to insolvency and should take steps to protect themself.
There are four different ways a company can be tested to determine whether they are insolvent or not.
Cash flow - under the cash flow test, if a court accepts that a company cannot pay its debts, then it will be classed as insolvent.
Balance sheet - a balance sheet test is used to satisfy a court that a company’s assets equate to less than their liabilities. If a company is found to have assets that are less than their debts, they will be classed as insolvent.
Statutory demand - when a company fails to pay a creditor for an amount that exceeds £750, the creditor is entitled to serve a ‘statutory demand’ for payment. The company then has 21 days in which to satisfy the terms of the statutory demand, come to another arrangement with the creditor, or dispute the debt. Should they fail to do so, the company is classed as legally insolvent and a wind up petition will follow. This means that a company is likely to face compulsory liquidation should they fail to pay or dispute the statutory demand.
A statutory demand should always be taken very seriously, and it is advisable to ask for advice from a licensed insolvency practitioner.
Judgement enforcement - if a company has been served a judgement debt order, such as a county court judgement (CCJ), but fails to pay back money owed to the creditor by a certain date, then it is classed as insolvent.
What does insolvency mean for a company?
Just because a company is insolvent, this does not automatically mean that it is beyond rescue. Whilst insolvency will entitle creditors seeking payment to petition to the courts to liquidate the debtor, there are options available to a company that may lead to getting them back on track and continuing to trade.
If your company is insolvent or close to insolvency, then your first step should be to ask for professional advice. For help understanding what to do if your company becomes insolvent, contact us on 02380 651 441. We are here to help you choose the right company insolvency options.