What is Insolvency?
Insolvency is defined under Section 123 of the Insolvency Act 1986 and is reproduced in detail below.
Understanding Insolvency’s technical definition is only the start of comprehending its impact on business owners and directors.
Legal precedents through the courts are continually changing and because of this, the point of Insolvency is unfortunately often not black or white nor set in stone. However, even though there will be shades of grey, at the point where its debts cannot be paid in full, a business is definitely insolvent.
The Balance Sheet test and the Cashflow test are often referred to as ‘tests of Insolvency’.
The Cashflow Test is about being able to pay liabilities when they fall due – for example, are suppliers paid or HMRC tax liabilities paid on time? Does the business have sufficient short-term resources to deal with its imminent liabilities? This is potentially a situation for business owners if the answers to these questions are ‘no’.
The Balance Sheet Test compares all existing assets against all existing and potential liabilities as of today’s date, rather than the date of the last available annual or interim accounts. All potential and existing liabilities includes those which are known to exist as well as those that may come about as a result of any current existing circumstances – for example, damages or negligence claims for contracts terminated early, redundancy and notice pay costs of existing employees, etc.
It is extremely important at the point of insolvency being reached that advice is sought because should the organisation subsequently enter into any formal insolvency process, the actions of the directors from the point of Insolvency onwards will be under close scrutiny.