The UK economy remains challenging. Borrowing remains expensive, supply chains are still experience delays & shortages, and the public still struggle with the cost of living.
These are just some of the macroeconomic challenges that have caused businesses to enter insolvencies at record rates. The UK saw 25,158 corporate insolvencies, a thirty year high, and 2024 is expected to see more.
As a result, there is a record amount of bad debt snowballing through the UK economy, with each company that falls victim to it then threatening the solvency of their creditors.
When a company goes insolvent their assets are liquidated and the funds raised distributed between its creditors following the hierarchy of creditors described in UK insolvency law. Unsecured creditors, which trade creditors almost always are, fall lowest in the hierarchy and rarely see any meaningful repayment, forcing them to write off the remainder owed as a bad debt. The impact of this loss of revenue is so damaging that a company that experiences a bad debt is three times more likely to go insolvent in the following twelve months than one that has not.
Understanding commercial insolvency and how to minimise the risk of it affecting your business is therefore vital.
In this guide, we’ll cover:
Commercial insolvency (sometimes known as corporate insolvency) is when a business cannot meet its financial obligations and repay its debts when they are due. There are two main ways to define if a business is insolvent.
The aim of insolvency proceedings is to provide a transparent and fair process that minimises the losses to the company's creditors and decide whether the company directors have acted in an illegal or immoral way before or during the insolvency.
A company's directors can declare insolvency if they think the company is no longer financially viable or the courts can declare it insolvent and force it into a compulsory insolvency.
If you are an unsecured trade creditor and one of your customers enters commercial insolvency owing you money, you are unlikely to get it back and will have to write the money owed off as a bad debt.
That’s because there is a strict order of priority that decides which of a company’s creditors get paid first when insolvent company assets are sold off. That order is:
Once secured and preferential creditors have been paid off, there is rarely any money left for unsecured creditors.
Instead, your business would have to try to absorb the loss.
Companies can be declared insolvent by the courts but the most common type of insolvency is a voluntary insolvency, where directors willingly go to an insolvency practitioner (IP) and have their business declared insolvent, liquidated and wound up. However, IPs can also help insolvent companies restructure and negotiate with creditors to achieve viability.
Below we will look at some of the different insolvency procedures:
Administration is where directors of a company go to an IP in the belief that their company can be made viable. If the IP agrees then they will take over the running of the company as a administrator. Just as in normal insolvency proceedings the company directors lose the right to run the company and the IP will assume that responsibility. The IP will also perform an investigation into the actions of the directors
Despite trying to save the company administrators will still be acting in the best interests of its creditors and may still decide that eventual insolvency is the best course of action. The administrator may try to negotiate a CVA, restructure or sell off parts of the business.
In some cases, the IP may agree to become an administrator as they see the company will need to enter insolvency but see that some parts of the business are still viable and the best return for creditors is to sell them off. In this instance an administration allows these parts of the business to continue to operate until a buyer is found.
An administration can also serve as function to facilitate an insolvent business being sold to new owners without being liquidated first. This is known as a pre-pack administration.
There are three ways that administrators can be appointed:
A company voluntary arrangement is when the company engages an IP to restructure its debts with its creditors. This is undertaken when a company is still viable and generating good revenue but is unable to meet its debt obligations. A CVA can be a simple extension of payment terms, a reduction in debt amount of both. The reasoning for its acceptance being that recovering some to most of the debt is better than nothing.
A company voluntary arrangement needs to be executed through the courts, so it’s a good idea to seek legal advice if one of your clients enters a CVA. You should also be invited to vote on the insolvent company’s proposal. The majority of unsecured creditors need to agree to it for it to be enacted.
If a creditor has a charge over the majority of an insolvent business’s assets it can appoint an official receiver. The official receiver acts in the creditor’s interests to recover as much of the debt for them as possible. This differs from administration, where the primary aim is to pay debts and avoid entering the liquidation process. If an official receiver is called in it usually results in liquidation.
Administrative receivership is becoming less common as it can only be applied to charges placed before 15 September 2003. Charges placed after this date need to be activated via an administrator.
There are two types of liquidation: compulsory and voluntary. Compulsory liquidation is when a company is ordered to close down and its assets are sold to pay creditors. To be liquidated, a company must be unable to pay its financial obligations. It can also be forced into liquidation by a court.
If you are an unsecured creditor, forcing a customer company into liquidity is usually a last resort. There is very little chance that you will get back the money owed. We’ll explain why in the next section.
Another type of liquidation is a company voluntary liquidation (CVL). This is when at least 75% of shareholders vote in favour of liquidation. This is sometimes called a creditors’ voluntary liquidation. In a creditors’ voluntary liquidation, directors of the company in financial distress ask the shareholders to vote to liquidate the company so it can pay its debts.
Commercial insolvency can be confusing and frustrating for creditors, especially if they have never experienced it before. In this section we aim to answer a few common questions on commercial insolvency.
Commercial insolvency can be caused by a range of factors. Sometimes it is a mixture of several financial difficulties. This could include:
There are two ways that the commercial insolvency process can begin.
In the United Kingdom, insolvency is regulated by the UK Insolvency Act 1986, Section 123. You can read more about the Insolvency Act here. The Insolvency Act covers all matters relating to insolvency and winding up businesses—including unregistered companies and those that are not insolvent—as well as individual insolvency and bankruptcy.
The Insolvency Act also governs the work and qualification of insolvency practitioners and the public administration of insolvency, and can be used to deal with cases of malpractice.
If a company becomes insolvent the directors’ legal position changes. They need to act in the best interests of creditors—not shareholders. If they continue trading insolvently they become personally liable for any additional creditor losses that the business makes. If this happens they can be sued for wrongful trading or subject to director disqualification proceedings.
Insolvent companies can continue to trade. But it’s important that directors seek professional insolvency advice and minimise further creditor losses. If they don’t they could become personally liable for any further creditor losses.
A company could be forced into liquidation if a creditor files a winding-up petition with the courts and it is upheld as a winding up order.
Insolvency is a financial state of being. It is when a company can no longer pay debts when they are due, or when its assets exceed its liabilities.
Bankruptcy is a legal status in which a court decides how a business will pay off its creditors. Compulsory liquidation is a form of company bankruptcy.
You can have an insolvent company that isn’t bankrupt. Administration is a good example of this.
There are two main tests to determine whether a company is insolvent. They are the cash flow test and the balance sheet insolvency test.
Testing if a company is cash flow insolvent involves calculating whether a business can pay its debt obligations when they are due. If your customer needs to pay an invoice within 30 days, has no funds and won’t have any cash coming in before the period is up they are likely to be trading insolvently. There is a ‘reasonably near future’ rule which provides some flexibility with the cash flow insolvency test.
The balance sheet insolvency test determines whether the company’s assets are worth less than its liabilities. To do the balance sheet insolvency test you should seek advice from professional insolvency practitioners. If the value of a company’s assets and liabilities are similar it could be an insolvency early warning sign.
A business can be balance sheet insolvent but cash flow solvent if its revenue allows it to meet its financial obligations.
Insolvency scorecards like Red Flag Alert allow you to quickly and accurately assess how much risk a company poses.
Our database consists of over 100 data points on every UK company. Our predictive algorithm uses 15 years of insolvency experience to spot trends and predict which companies will fail.
We rate healthy companies gold, silver and bronze, while companies at risk of insolvency are rated one, two and three red flags.
This allows you to make decisions over whether to extend credit to a business or not.
Spotting clients at risk of insolvency is hard. It’s important to monitor your clients for insolvency warning signs. Signs that a company faces insolvency include:
How you deal with an insolvent customer depends on whether they are at risk of insolvency, technically insolvent, entering administration or being liquidated.
Here is an overview of what you should do in each situation.
If the customer isn’t already insolvent but is showing signs that it could be heading that way there are a number of things you can do. These include:
If the customer is continuously unable to pay their invoices it may be worth taking court action.
For example, if a company owes you more than £750 you may wish to submit a statutory demand. A company that receives a statutory demand has 21 days to pay the debt or reach another agreement. If they don't, their business could be wound up by the court.
The benefit of this approach is that the debtor commits to repaying you. The downside is that the business relationship will be damaged and unlikely to recover.
Furthermore, if the company is wound up they will be unable to pay you and you may not get any money back at all.
If a company enters a company voluntary arrangement it will invite you to a creditors’ meeting. Here it will propose an arrangement that you will get to vote on. If the proposal is accepted it becomes legally binding and the creditors retain control of the company.
If your client enters administration any legal action against it will be halted. This means that you won’t be able to pursue statutory demands or CCJs against it.
Contact the administrator and tell them how much you are owed. They can then let you know how to make a claim should the company be liquidated.
It might be worth maintaining good relations with the company directors despite their company’s insolvency. If the business gets back on its feet or the directors start a new company you may be able to keep their business.
A company can be liquidated either voluntarily or compulsorily. In both cases, the company’s assets will be sold off to pay creditors and the business will be closed down.
You should be contacted by the official receiver or a licensed insolvency practitioner, who will explain how you can make a claim. If you don’t hear from them try to get their details一they should be available on the commercially insolvent company’s website.
You can check if a company has entered corporate insolvency proceedings using the Companies House WebCheckservice. Or you can visit the government’s corporate Insolvency Service website for more help and information.
Understanding commercial insolvency is vital for company directors, especially during these challenging economic times.
Red Flag Alert allows you to spot the early warning signs among your customers and take proactive action to protect your business from risk.
Our experienced team collects real-time information on every UK company, while our algorithm uses 15 years of data to accurately predict which companies are at risk of corporate insolvency. Our monitoring alerts ensure you know as soon as a company’s financial position changes.
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