Solvent or Insolvent? The Financials of Dissolving

When the marketplace shifts, or once an idea has run its course, the sensible way forward is often to call it a day and move onto the next project. Precisely how you close your company, however, depends largely on its solvency status. So what exactly do we mean by ‘solvent’ and dormant company ‘insolvent’? What does the distinction mean for someone who wants to move on?

When is a company insolvent?

Solvent or Insolvent? The Financials of Dissolving

From time to time, many companies find themselves in a position where they have to juggle creditors. For instance, where an unusually large number of invoices arrive at once or where you extend the grace period on a bill while you wait for a big customer’s payment to arrive. Short-term and occasional cash-flow issues are very often a fact of life. So long as a company remains able to meet its long-term financial obligations that company is solvent.

So how can you identify if you have gone beyond this, into an insolvency situation? Take a look at the following:

  • Cashflow— under the cashflow test, set out in the Insolvency Act 1986, a company is deemed insolvent if it is ‘unable to pay its debts as they fall due’. As such, if you are (or are soon to be) regularly defaulting on your suppliers’ standard terms, or are unable to meet your PAYE and VAT payment requirements, this is a sign your company is insolvent.
  • Balance sheet— this involves looking at the assets of the company. This includes cash, stock inventory, accounts receivable, property and equipment. If the combined value of these assets is less than the outstanding debts the company is considered insolvent. This is important because, if there is a deficit in the company’s assets versus liabilities, it will be impossible to repay creditors in full once the company’s assets are liquidised.
  • Legal action— if a creditor, who is owed more than £750, puts forward a formal demand for an undisputed sum and this is not paid within three weeks, or where a court order for payment is not satisfied, the law will regard the company as being insolvent.

Why you should act quickly…

Here’s why ‘business as usual’ isn’t an option if your company is or looks as if it is about to become insolvent:

  • In all your dealings as a company director, the law says you must act properly and responsibly. For companies that are insolvent, this means protecting the interests of creditors. Essentially, this is to stop you continuing to trade at a loss and running up even greater debts.
  • There are potential personal consequences if your company continues to trade while insolvent. You can be held personally liable for any additional debts accrued by your company. This could leave yourself exposed to allegations of wrongful trading, including disqualification as a director for up to 15 years.
  • You will increase the likelihood of creditors taking action against you. If a creditor issues a statutory demand for payment and this is ignored, it’s possible for that creditor to apply for a winding-up petition and for your company to be placed under compulsory liquidation.

Seizing the initiative: creditors’ voluntary liquidation (CVL)

When you suspect that your company may be faced with an insolvency situation, it’s essential to seek advice from an insolvency practitioner as soon as possible. Waiting for a formal summons from a creditor puts you on the back foot. You are essentially reacting to what other people are doing. By contrast, seeking advice potentially gives you options. You decide how and precisely when to approach your creditors to find a way forward.

In simple terms, the focus is on converting the company’s assets into cash. This will be used to pay off the company’s debts (i.e. liquidation). Where that business is insolvent, and once you’ve taken advice, you may conclude that the best way forward is via creditors’ voluntary liquidation. Here’s how it works in practice:

  • Once a director has identified that the company is insolvent a meeting of shareholders is called. At the meeting, 75% (according to the value of the shares) of shareholders must agree to pass a resolution to put the company in liquidation, and then appoint a liquidator.
  • You must hold a creditors’ meeting within 14 days of the resolution being passed. In most cases, the company’s insolvency practitioner will be involved here. This is to make sure you oblige the legal requirements for the meeting. This involves giving at least 7 days’ notice to creditors. It also involves advertising the meeting in ‘The Gazette’, the UK’s official public record. It also involves sending a copy of the resolution to Companies House.
  • At the creditors’ meeting, a statement of affairs is presented. This gives details of your company’s situation and assets. The creditors have the option of nominating their preferred choice of liquidator if a majority are in favour.
  • The liquidator’s job is to realise and collect the company’s assets. This is for the benefit of those parties with an interest in the assets of the company. This includes the creditors and the shareholders. He also has a duty to the court to submit a report on any misconduct by any of the directors. This is another reason why it’s important to avoid the situation where allegations of wrongful trading could be made.
  • Once assets have been sold and converted into cash, creditors are paid in priority. Fixed charge creditors first. This could be a bank loan for your property or equipment. This is followed by preferential creditors (such as outstanding pay due to employees). And lastly, any floating charge and unsecured creditors. The liquidator’s fees are also paid out of the assets. Any surplus assets are distributed to shareholders.
  • At the end of the process, the company is dissolved.

What if the company is solvent and I want to dissolve it?

Here, you may have the option of ceasing trading and selling your company’s assets before applying to Company’s House for the dissolution (strike off) of the company. On first glance, this may look like the cheapest and easiest option as the admin fee is just £10. But be sure to seek advice before you go down this road.

Members’ Voluntary Liquidation

Another option is members’ voluntary liquidation (MVL). This is a process similar to CVL above. Albeit there are no creditors meetings involved (but you must still keep creditors notified throughout the process). Here as well, assets extracted from a company via liquidation are all classed as capital rather than income. When you dissolve a company via a voluntary strike off application, up to £25,000 of the company’s assets can be distributed as capital, and the remainder is taxable as income.

If you’re a higher income tax ratepayer and the assets of your company, after paying off any debts, are likely to exceed £25,000, there’s a likelihood CVL will be preferable to an application for strike off.

Looking for tips on best business practices to avoid insolvency? Check out our help centre for more information – you can find further information there on the difference between dissolve and liquidate and on keeping a dormant company.

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