Company insolvency options

This is one of the most important questions a director can face, because getting it wrong can lead to serious personal liability. Let me walk you through the legal position and your practical options.

Understanding insolvency:

A company is insolvent if it cannot pay its debts as they fall due (the cash flow test) or if its liabilities exceed its assets (the balance sheet test). These tests come from section 123 of the Insolvency Act 1986. In practice, many companies become insolvent on one test before the other, and you need to be alert to both.

Your duties shift when insolvency arises:

The critical legal point is that once you know or ought to know that the company is or is likely to become insolvent, your duties as a director change. You must act in the interests of the company's creditors as a whole, not just the shareholders. This is now codified in section 172(3) of the Companies Act 2006 (as amended by the Rating (Coronavirus) and Directors Disqualification (Dissolved Companies) Act 2021 and confirmed by case law including BTI 2014 LLC v Sequana SA [2022] UKSC 25).

If you continue trading and the company's position worsens, you risk personal liability for wrongful trading under section 214 of the Insolvency Act 1986. You can also face liability for fraudulent trading under section 213 if you knew there was no reasonable prospect of the company avoiding insolvent liquidation and carried on regardless. Directors can also be disqualified under the Company Directors Disqualification Act 1986.

Practical steps you should take now:

1. Stop and assess the position honestly. Get up to date management accounts and a clear picture of assets, liabilities, cash flow, and creditor exposure. Do not bury your head in the sand, because delay almost always makes things worse and increases personal risk.

2. Take proper advice from a licensed insolvency practitioner without delay. This is not optional in any practical sense. An insolvency practitioner can assess whether the company can be rescued or whether a formal process is needed. Taking early advice also protects you personally, because it demonstrates that you acted responsibly.

3. Keep detailed records of every decision you make from this point. Document why you made each decision and what advice you relied on. If your conduct is later scrutinised by a liquidator or the Insolvency Service, contemporaneous records are your best defence.

4. Do not prefer certain creditors over others. Paying a friendly creditor or a creditor you personally guaranteed ahead of others can be challenged as a preference under section 239 of the Insolvency Act 1986. Be especially careful about payments to connected parties such as family members or companies you control.

5. Do not strip assets out of the company. Transactions at an undervalue (section 238) can be reversed and will attract serious scrutiny.

6. Do not take on new credit or accept deposits for work you know the company cannot deliver. This is the kind of conduct that leads to findings of wrongful or fraudulent trading.

The main formal options available:

Company Voluntary Arrangement (CVA): This allows the company to reach a binding agreement with its creditors to pay a proportion of its debts over time, while continuing to trade. It requires the support of 75 per cent by value of creditors who vote.

Administration: An administrator is appointed to rescue the company as a going concern, or if that is not possible, to achieve a better result for creditors than would be achieved in a winding up. This gives the company a moratorium against creditor action.

Creditors' Voluntary Liquidation (CVL): If the company cannot be saved, the directors can resolve to wind it up voluntarily and appoint a liquidator. This is the most common route for companies that are clearly insolvent with no realistic prospect of rescue.

Compulsory liquidation: This happens when a creditor petitions the court to wind the company up, typically after an unpaid statutory demand. You want to avoid being forced into this if possible, because it removes all control from the directors.

Restructuring plan: Under Part 26A of the Companies Act 2006, a company can propose a restructuring plan which can bind dissenting classes of creditors if the court approves it. This is mainly used by larger companies but is available in principle to any company.

What matters most right now:

The single most important thing is to act quickly and take advice from a licensed insolvency practitioner. Many directors delay because they hope things will improve, but delay is the main source of personal liability. If you can show that you took advice early, acted on it, and made reasonable decisions in the interests of creditors, you are in a far stronger position to defend your conduct.

If you have given personal guarantees for any company debts, you should also understand your own exposure, because those guarantees survive the company's insolvency and creditors will pursue you personally.

Finally, do not resign as a director thinking this protects you. Liability for wrongful trading and other misconduct relates to the period when you were a director and knew or ought to have known about the insolvency. Resigning does not wipe the slate clean and can actually look worse if it appears you were trying to distance yourself from the consequences.