What are the options for an insolvent business?

Just because a business is insolvent, it doesn’t mean it is the end of the road. We look at the many options available to a board of directors or the shareholders in an insolvent company.

In this article, Gavin Clarke looks at the range of insolvency procedures available to a board of directors concerned about their company’s solvency.

Bust, failed, bankrupt. These are all terms variously (and sometimes incorrectly) used to describe the same thing: an insolvent business. There are options, though the range of options can appear to be a bewildering and complex maze too overwhelming to navigate just at the very time when it is most needed.

This is a quick guide through those options but before turning to them, it is worthwhile to consider exactly what the law means by ‘insolvent’?

What does insolvency mean?

There are two tests:

• Cash flow test. Is the business unable to pay its debts as they fall due?
• Balance sheet test. Are the assets of the business worth less than its liabilities (including its contingent and prospective liabilities)? 

If the time has come when the directors are asking themselves the question ‘is this business insolvent?’, then the answer is probably ‘yes’, but even if it is ‘maybe’ it is time for the directors to take professional advice.

It is never too early to take advice. Taking timely, informed advice is key to trying to preserve the business, safeguarding creditors and other interests and protecting the directors from the risk of personal liability.

How much is owed to creditors? 

The directors will have identified who the business owes money to.

For the directors of any business asking themselves if the business is insolvent, the number of creditors, the collective amount owed to creditors, the amount owed to any particular ransom or key creditor, the nature and rights of certain creditors will all be part of the myriad of factors which the directors shall need to take into account in order to identify which, if any, restructuring process (or combination) should be used to achieve a viable rescue of the business.

If money is owed to HMRC alone, then a time to pay agreement could be the answer.

If money is owed to a single creditor, a consensual compromise with that creditor could be the answer.

If money is owed to a range of creditors, such as HMRC, a landlord, a supplier, a bank, a finance house, or a mixture of all (and others) then the options expand and the directors should consider any of the following.

• A Company Voluntary Arrangement. This is a statutory compromise made between the business and its creditors without the involvement of the Court. If approved by a sufficient number of creditors, it binds all creditors to enable the business to restructure its debts and liabilities and can be used to amend existing contractual rights and obligations.
• A Scheme of Arrangement. This is similar to a Company Voluntary Arrangement, however it is overseen by the Court and can be used to effect either a solvent reorganisation or an insolvent restructuring.
• A Part 26A Restructuring Plan. This is similar to a Company Voluntary Arrangement in that it is also overseen by the Court but it is intended to be a hybrid of a Company Voluntary Arrangement and a Scheme of Arrangement. It is intended to be used by businesses that have encountered or are likely to encounter financial difficulties which are likely to affect the ability of the business to carry on as a going concern.
• A Part A1 Moratorium. This is intended to give financially distressed businesses ‘breathing space’ and a period of protection from enforcement action from creditors, whilst the directors take advice to identify which (if any) insolvency process (or combination of them) should be used to achieve a viable rescue of the business (or part of it) or to permit the business to trade out of its financial difficulties.

The directors should consider whether the business needs protection from creditors in order to give the directors time to take advice and identify the best route for that business, or part of it, to be rescued and returned to profitability.

Administration in the statutory process

Administration is probably the most well-known statutory process. It protects a business from its creditors and an insolvency practitioner takes over the management of the business.

Click here to read a clear guide on company administration.

It is possible to purchase the business, or part of it, out of administration immediately upon the business being placed into administration by way of a ‘pre-pack’.

To understand the risks and benefits of buying an insolvent business, you can read our related article here.

What does liquidation consist of ? 

Usually, the liquidation of a business means that it ceases to trade either immediately before or immediately upon being placed into liquidation. Whilst there is only one form of administration, there are three types of liquidation:

• Creditors’ Voluntary Liquidation – where the directors resolve that the business is incapable of continuing
• Compulsory Liquidation – triggered by a creditor presenting a winding up petition and an order for compulsory winding up is made by the Court
• Members’ Voluntary Liquidation – where the business is solvent, the assets of the business are realised, creditors are paid in full and surplus proceeds are distributed to the company’s shareholders.

In all cases of liquidation, the business is placed into the hands of an insolvency practitioner who will take control of the assets of the business and realise those assets for the benefit of the creditors as a whole. The allocation of proceeds is dealt with under a strict hierarchy.

To understand how assets are distributed in a company insolvency, read our helpful guide here.

The insolvency process that will work best for any specific business will depend upon a complex range of considerations, some of which may appear to conflict with each other. Specific industry sectors have tended to have ‘tried and tested’ means of restructuring, such as the use of CVAs by multiple site retailers, whilst the new Restructuring Plan is becoming more of an option for SMEs as complexities are streamlined and costs reduced. For all companies administration and liquidation continue to provide a solution.

Just as the particular financial and commercial circumstances will be unique to a particular business in financial difficulty, or likely to encounter financial difficulty, so the solution will have to be tailored in a way that achieves a viable rescue of the business (or part of it) at the same time as satisfying the necessary legal requirements. Early identification and proper assessment of issues which may cause financial difficulty for a business in conjunction with seeking timely professional advice is key, and by doing so directors can feel assured that they will be more likely to achieve a more positive outcome for all concerned, including themselves.