Insolvency is a serious issue that can affect businesses of all sizes. Whether caused by poor planning, rising costs, or a drop in sales, insolvency can create significant problems for company directors, employees, and creditors. At Campbell Crossly & Davis, we help companies understand their options and deal with insolvency clearly and professionally. This guide explains what insolvency means in business law, how the legal process works, and what steps you can take if your business is facing financial difficulties.

What Is Insolvency in Business Law?

In English law, a company is insolvent when it cannot pay its debts or when its total liabilities are greater than its company assets. This is often called balance sheet insolvency. A company may also be classed as insolvent if it runs out of cash and cannot cover day-to-day bills; this is known as cash flow insolvency.

There are two main tests used to work out if a company is insolvent:

• The cash flow test: Can the company pay its debts as they fall due?
• The balance sheet test: Does the company owe more than it owns?

If a company fails either of these tests, it is considered insolvent under the Insolvency Act 1986, which sets out the rules for what happens next.

Common Causes of Insolvency

A company may become insolvent for many reasons. These include taking on too much debt, losing key customers, or failing to manage cash properly. Directors may not notice problems early if financial records are unclear or payments are delayed.

External events, like changes in the economy, rising costs, or legal claims, can also cause insolvency. In smaller businesses, one missed payment, or a cancelled order can cause serious cash flow problems and make it hard to continue to trade.

Insolvency vs Bankruptcy

While the words insolvency and bankruptcy are often used in the same way, they have different meanings in UK law. Insolvency describes a financial situation—a person or company is insolvent when it cannot meet its debts. Bankruptcy, however, is a legal process that applies only to individuals.

For businesses, the legal process is called liquidation or winding up, and it can happen voluntarily or through the court.

Legal Consequences of Insolvency

If a company becomes insolvent, the directors must act in the best interests of its creditors. This means they must avoid doing anything that worsens the position of those who are owed money. Continuing to trade and take on more debt once a company is clearly insolvent may lead to serious legal consequences, including being held personally responsible.

Creditors can also take action. If a business fails to repay what it owes, a creditor can submit a winding up petition. If the court accepts it, a court order will start compulsory liquidation. At this point, a liquidator will take over, the company will stop trading, and its company assets will be sold to pay back creditors.

Some actions taken by directors in the period before insolvency, such as selling assets cheaply or favouring one creditor over others, can be challenged and possibly reversed if the business enters an official insolvency process.

The Insolvency Act 1986

The Insolvency Act 1986 is the main law covering both personal and business insolvency in the UK. It lays out the procedures that must be followed when a company is insolvent. This includes the appointment and duties of insolvency practitioners, the rights of creditors, and how directors must behave.

The Act allows companies to use different options to deal with financial difficulties, such as restructuring debts or entering formal procedures like administration or liquidation.

Formal Insolvency Procedures

If a company is insolvent, it can take several legal routes. The right option depends on the company’s situation and ability to recover. All procedures must be overseen by a licensed insolvency practitioner.

Company Voluntary Arrangement (CVA)

A company voluntary arrangement is a formal deal between a company and its creditors to repay part or all of its debts over a set time. If enough creditors agree, the plan becomes legally binding, and the company can continue trading.

This option is helpful for companies that are struggling but still have a chance of recovery. It also helps protect the business from further legal action while payments are being made.

Administration

In administration, a company hands over control to an insolvency practitioner who tries to rescue the business. While the company is in administration, creditors cannot take legal action without permission from the court.

The goal of administration is to give the company a better chance of survival or, if not possible, to sell assets in an organised way to get the best return for creditors.

Voluntary Liquidation

Voluntary liquidation is when the directors decide to close the company. There are two types:

• Creditors’ Voluntary Liquidation (CVL): This is used when the company cannot pay its debts. The business stops trading, and its assets are sold to repay creditors.
• Members’ Voluntary Liquidation (MVL): This is used when a company is solvent but the owners want to shut it down for other reasons.

In both cases, a licensed insolvency practitioner is appointed to manage the process, make payments to creditors, and remove the company from the official register.

Compulsory Liquidation

This happens when a creditor applies to the court for a winding up petition. If granted, the court issues a court order, and the company is forced into compulsory liquidation. A government officer called the Official Receiver may be appointed, or a private insolvency practitioner can be brought in later.

Once the order is made, the company’s bank accounts are frozen, and the company must stop trading. Its company assets are sold to pay creditors in a set order of priority.

Who’s Involved in an Insolvency Case?

Insolvency affects several parties. Understanding their roles can help make the process clearer.

Insolvency Practitioners (IPs) manage formal insolvency procedures. They make sure the law is followed and try to get the best results for creditors.

The Official Receiver is a government officer who deals with compulsory liquidation if no IP is appointed right away. They may also investigate the company’s affairs.

Creditors are the people or organisations the company owes money to. There are three types:

• Secured creditors: These have legal rights over specific assets (like a mortgage on a property).
• Preferential creditors: These include employees owed wages or holiday pay.
• Unsecured creditors: These have no special claim over assets and are usually last to be paid.

The law sets out the order in which each group is repaid. No creditor can be given special treatment without a valid reason.

What to Do if Your Company Is Facing Insolvency

If your business is showing signs of trouble, such as late payments, poor cash flow, or pressure from creditors, you should act quickly. At Campbell Crossly & Davis, we work closely with directors to understand the full picture and suggest the best way forward.

Ignoring the problem may make things worse and reduce your options. You may be able to negotiate with creditors, arrange a company voluntary arrangement, or enter administration to protect your business while a plan is made.

Acting early also helps avoid claims of wrongful trading. If directors keep trading when they know the business is not viable, they may face personal consequences.

How to Avoid Insolvency

Not all insolvencies can be prevented, but good planning can reduce the risk. Here are some helpful steps:

• Keep regular cash flow forecasts and update them often.
• Avoid taking on too much debt.
• Speak to advisers early if problems arise.
• Keep accurate records to track income, costs, and debt.

Even healthy businesses can face sudden problems. By staying in control of your finances, you’ll be better prepared to take action if needed.

Key Terms Explained

To make sense of insolvency, it’s useful to understand a few key terms:

• Insolvency Practitioner: A licensed expert who manages formal insolvency procedures.
• Company Voluntary Arrangement: A repayment plan between a business and its creditors.
• Balance Sheet: A financial statement that shows what a company owns and owes.
• Unsecured Creditors: Creditors with no special claim over a company’s assets.
• Winding Up Petition: A legal request to close down a company.
• Court Order: A legal instruction issued by a judge.
• Compulsory Liquidation: A forced closure of a company ordered by the court.

Final Thoughts

Dealing with insolvency can feel overwhelming, but help is available. At Campbell Crossly & Davis, we work with businesses to make sense of the situation and offer practical solutions. Whether you need to close down your company, restructure your debts, or explore other insolvency procedures, we’re here to guide you through every step.

If your company is facing financial difficulties or you’re worried about being able to pay its debts, get in touch with us today. With the right advice and a clear plan, your business can move forward with confidence.