Insolvency means being unable to pay your debts. In UK law there are two tests, and failing either one is enough. The first is cash flow: you cannot pay your debts as they fall due. The second is balance sheet: your liabilities are greater than your assets. For a company, the Insolvency Act 1986 adds a deemed test. A company that ignores a statutory demand for a debt of more than £750 for 3 weeks is treated as unable to pay its debts. Insolvency is a state of affairs, not a procedure. Liquidation, administration, a CVA or bankruptcy are what may follow from it.
The legal tests
Section 123 of the Insolvency Act 1986 sets out when a company is deemed unable to pay its debts. These are the grounds on which a creditor can ask the court to wind it up. The practical ones are:
- Statutory demand. A creditor owed more than £750 serves a written demand, and the company neglects to pay, secure or settle the debt for 3 weeks;
- Unsatisfied judgment. Execution on a judgment is returned unsatisfied in whole or in part;
- Cash-flow insolvency. It is proved to the court that the company is unable to pay its debts as they fall due;
- Balance-sheet insolvency. It is proved to the court that the value of the company's assets is less than its liabilities, taking account of contingent and prospective liabilities.
The two main tests often disagree. A growing business with strong assets can be cash-flow insolvent because customers pay slowly. A company with negative net assets, perhaps propped up by group loans or deferred tax, can pay every bill on time. Directors need to watch both. Cash flow is usually the one that triggers creditor action.
For individuals the threshold is different. A creditor can present a bankruptcy petition only for a debt of at least the "bankruptcy level", which section 267 sets at £5,000. Several creditors can combine their debts to reach it.
Why it matters for directors
When a company is solvent, directors act mainly for the benefit of shareholders. Section 172(3) of the Companies Act 2006 qualifies that duty where the law requires directors to consider creditors' interests. As a company approaches insolvency, directors must give creditors' interests increasing weight. Two provisions put teeth on this:
- Wrongful trading (section 214). A director can be ordered to contribute personally to the company's assets if they knew, or ought to have concluded, that there was no reasonable prospect of avoiding insolvent liquidation or administration. The only defence is that they then took every step to minimise the potential loss to creditors. Our guide to wrongful trading covers the case law;
- Fraudulent trading (section 213). This applies where business was carried on with intent to defraud creditors. It is rarer and more serious, and section 993 of the Companies Act 2006 makes it a criminal offence as well.
The test is objective. Not looking at the numbers is no defence. Up-to-date management accounts, a rolling cash-flow forecast and minuted board decisions are what protect directors.
Corporate insolvency procedures
Once a company is insolvent or close to it, the Insolvency Service's guidance lists the main routes. Apart from an informal deal with creditors, each is a formal process with its own statutory rules, and most involve a licensed insolvency practitioner.
| Procedure | What it does | Company survives? |
|---|---|---|
| Informal arrangement | Agreed new payment terms; not legally binding, and creditors can withdraw | Yes |
| Part A1 moratorium | Breathing room overseen by a monitor, who must be a qualified insolvency practitioner; initial period of 20 business days, which can be extended | Aims to |
| Company voluntary arrangement (CVA) | Binding deal to pay all or part of debts over time; approved by 75% by value of creditors voting | Yes, if it works |
| Restructuring plan | Court-sanctioned compromise under Part 26A Companies Act 2006, which can bind a dissenting class if the conditions in section 901G are met | Yes, if it works |
| Administration | An administrator takes control; creditors cannot take legal action without the administrator's consent or court permission | Sometimes, or the business is sold |
| Creditors' voluntary liquidation (CVL) | Directors and shareholders start the process; assets are sold and the company is dissolved | No |
| Compulsory liquidation | Court winding-up order, usually on a creditor's petition | No |
A CVA also fails if more than half of the total value of unconnected creditors vote against it. That rule stops a company pushing a CVA through on the votes of insiders. For the cross-class cram-down mechanics, see our guide to the restructuring plan. A members' voluntary liquidation is the solvent counterpart of a CVL. It requires the directors to make a statutory declaration under section 89 that the company will pay its debts in full, with interest, within a period of no more than 12 months.
Personal insolvency
An individual or sole trader who cannot pay their debts has a different set of options. These are a debt relief order, an individual voluntary arrangement, or bankruptcy, plus informal debt management plans. In England and Wales, the Breathing Space scheme can pause interest and creditor action for 60 days while advice is taken. Our personal insolvency guide compares the three formal routes.
Early warning signs
In practice, insolvency rarely arrives all at once. These are the usual signs:
- Stretching creditors. Paying suppliers later and later, or paying only those who chase hardest;
- HMRC arrears. PAYE and VAT missed or paid late, or time-to-pay arrangements being requested repeatedly;
- Persistent overdraft or facility breaches, and lenders asking for more information;
- Statutory demands or county court claims starting to arrive;
- Losses funded by new borrowing rather than by a credible plan to return to profit.
The section 123 tests and the Insolvency Service's guide to options when a company is insolvent are the primary references.
The earlier directors act, the more options remain open. A company that is struggling but not yet insolvent can often refinance, restructure or sell. Six months later the same company may have only liquidation left. Our management accounts service gives boards the monthly figures and cash-flow forecasts they need, and our advisory team can review options before a formal process is needed. Formal appointments are taken by licensed insolvency practitioners.