The point at which a company cannot pay its debts is a legal turning point, not just a cash flow problem. Here is what changes, what your options are, and what happens if you wait.
There is a moment in the life of a struggling company when the problem stops being a cash flow problem and becomes a legal one. Most directors pass that moment without noticing it. This article is about recognising it, and about what to do next.
The point at which things change
A company is insolvent if either of two tests is met:
- Cash-flow insolvency: it cannot pay its debts as they fall due.
- Balance sheet insolvency: the value of its liabilities exceeds the value of its assets.
Either is sufficient. You do not need both, and a company can be balance sheet insolvent while still paying everyone on time.
What changes at that point is who your duties are owed to. In normal trading, directors’ duties are owed to the company and, through it, to shareholders. Once you know (or ought to conclude) that insolvency is likely, those duties shift towards the interests of creditors as a whole. That is not a technicality. It is the standard against which your decisions will later be measured if the company does fail.
The warning signs that matter
In our experience, these are the indicators that a company has crossed the line, or is about to:
- Using money set aside for VAT or PAYE to fund day-to-day trading
- Paying suppliers on the basis of who is shouting loudest rather than who is due
- Relying on a single customer, sale or funding round to make the numbers work
- Directors lending money to the company, or funding it on personal credit
- A statutory demand, a county court judgment, or a winding-up petition
That last group is a different order of urgency. If a winding-up petition has been issued, the practical options narrow within days; see compulsory liquidation.
What your options actually are
The honest answer is that it depends on whether there is a viable business underneath the debt.
If the business is viable but the balance sheet is not, the routes worth examining are a company voluntary arrangement, which compromises the debt while you keep trading and keep control, or an administration, which gives you statutory protection from creditor action while a rescue or a sale is put together.
If the business is not viable, a creditors’ voluntary liquidation closes it down in an orderly way, allows employees to claim their statutory entitlements, and concludes matters properly rather than leaving them to drift.
If the problem is really a timing problem, it may not need a formal process at all. Negotiated terms with creditors, a Time to Pay arrangement with HMRC, or a restructured funding position resolve a great many situations; see managing financial distress.
What happens if you do nothing
Three things, usually in this order.
First, the deficiency to creditors grows. That matters because it is the measure used to assess whether directors continued trading when they should not have, which is the essence of a wrongful trading claim.
Second, the options narrow. A rescue that was available in month one is frequently gone by month four, because the goodwill, the customers or the key staff have gone with it.
Third, control passes to someone else. A creditor petitions, the court makes an order, and the process is no longer yours to shape.
The first conversation costs nothing
Directors delay this call because they expect judgement, or a bill, or an irreversible step. In practice it is a conversation, it is free, and a good proportion of them end with us saying that no formal process is needed.
If any of the warning signs above are familiar, talk to us. Earlier is genuinely better.