It is important for all involved to know when a company is insolvent since it affects how the company will be run. The directors’ duties changes for example, and the company can no longer freely trade.
When is a company deemed insolvent?
S122 (1) (f) of the Insolvency Act 1986 defines insolvency. It states that the court will be able to wind up the company if it is unable to pay its debts. S123 of the IA 86 defines ‘unable to pay its debts’ as follows:
s123 of IA 86 – 'A Company is deemed unable to pay its debts:
- (1) (a): If a creditor:
- Is owed £750 or more.
- Has served a statutory demand on the company requiring the company to pay the sum and
- The company has, for three weeks thereafter, failed to pay or come to an alternative arrangement with the creditor.
- (1) (b): If a creditor obtains a judgment against the company AND tries to enforce it, but the debt remains unsatisfied.
- (1) (e): If the company is unable to pay its debts when they fall due (“cash flow” test)
- (2): If the total value of the company’s assets is less than the amount of its liabilities (“balance sheet” test)'
If a company is in this situation and is unable to pay its debts, then a creditor can bring a petition to put the company into liquidation.
What are the Directors duties on insolvency?
- Usually, the directors’ duties are to promote the success of the company. But when the company becomes insolvent, their duty switches to the benefit of the creditors.
- Directors must be careful to avoid wrongful trading upon insolvency. S214 (2) of the IA 86 provides – ‘If a company is insolvent and a director knew, OR ought to have known, that there was no reasonable prospect that the company would avoid insolvent liquidation, a director may be liable under s214(1) to “make such contribution to the company’s assets as the court thinks proper”.
So, when the company is getting wound up upon insolvency the Director needs to be very careful with his actions. To avoid wrongful trading, the Director needs to take a few steps. He should take legal and financial advice on what his next steps should be. He should also make sure not to take on any additional debt. Lastly, he will need to make very detailed notes and keep the company accounts up to date and relevant.