Insolvency is a term that can apply to either an individual or a business, but is more often used in relation to a business or company. A business is said to be insolvent when it cannot pay its debts when they are due. It is an offence if the directors continue to operate and incur more debts when a company is insolvent.
If a company is facing financial difficulties and the directors or creditors believe that it is, or may become, insolvent, it may end up in one of the following types of formal administration:
- Liquidation, also known as winding up;
- Voluntary Administration or Deed of Company Arrangement;
The appointment of a formal administrator may be voluntary, when it is initiated by the company itself, or involuntary when it is made by a person or organisation that is owed money, or by the courts.
The options for a business that is insolvent include:
- Liquidation: a Liquidator is appointed to wind the company up, and its assets are sold to pay outstanding debts. The company is then deregistered and ceases to exist. The most common types of liquidations for insolvent companies are court liquidation and creditors’ voluntary liquidation.
- Voluntary Administration, possibly leading to a Deed of Company Arrangement: a voluntary administration is a formal standstill type administration where the voluntary administrator investigates and reports on the company’s history and financial position to creditors and makes a recommendation about its future. Creditors then decide whether to accept a Deed of Company Arrangement if one is proposed by the directors, liquidate the company or return the company to the control of the directors. A Deed of Company Arrangement is a procedure that permits a company to make a compromise or arrangement which is binding on all creditors. Subject to the terms of the arrangement, the company may then be saved and continue to operate.
- Receivership: a receiver or receiver and manager is usually appointed by a secured creditor, or in some cases by the court. The assets of the company are realised for the benefit of the secured creditors. This type of appointment can occur at the same time that a company is in liquidation or voluntary administration.
Regardless of the type of appointment, the person appointed must be a registered Insolvency Practitioner and ideally a member of the IPA.
The earlier you take action the better and you should talk to an insolvency professional before the situation in your business or organisation becomes critical.