Introduction to Insolvency

Insolvency is the inability of a company to pay off the debts to its creditors. The complete details about insolvency and the various procedures involved are must-know concepts as they might help you save your company.

When the company or organization can no longer afford to meet the financial obligations with its lenders it leads to the company being termed insolvent. Once declared insolvent, legal proceedings will be taken against the company to liquidate its assets for paying off the debts. The term insolvency is generally used synonymously with the term bankruptcy, though both are used for different entities. Bankruptcy in UK is restricted to individuals while Insolvency applies to companies and organizations.

In UK, the Insolvency Act 1986, Section 123 defines a company or organization is deemed unable to pay debts if it proves it inability to pay debts as they reach their due and also if the liabilities of a company is more than its assets. Insolvency is generally of two types, Cash Flow insolvency and Balance Sheet insolvency.
1. Cash flow Insolvency – This is the kind of insolvency that arises due to the failure of payment of bills by a company due to its inability to do so. Sometimes the reduction in cash flow might cause the company assets to be written down to a forced sale value rather than their original value leading to cases of Balance Sheet insolvency.
2. Balance sheet Insolvency – The case of insolvency where the liabilities of a company exceed the assets owned by the company.
A company can be insolvent either under cash flow or balance sheet category. A cash flow insolvent company might not be able to release funds to clear debts, but might possess illiquid assets making it solvent under balance sheet insolvency terms. Similarly, a balance sheet insolvent company may have liabilities exceeding assets but steady revenue to pay off the debts might still make it fit to be cash flow solvent.

Insolvency Consequences
An insolvent company require adhering to certain serious restrictions that includes even discontinuation of business during insolvency in certain jurisdiction. It is also an offence to pay a single or group of preferred creditors during the state of insolvency.
The current insolvency law and provisions focus more on remodelling the financial structure of the debtors, so as to help the company rebuild the business. This option incorporated in the insolvency legislatures is termed as the Business turnaround or Business recovery.

Alternatives for Insolvency
There are alternatives available to solve debt issues or insolvent cases in an out of court fashion. This process that allows the organization or companies to negotiate the debt limits or the terms with the creditors to improve liquidity and thus save the concern is known as debt restructuring. These are also known as workouts and are normally handled by an insolvency practitioner. This is an alternative to insolvency or bankruptcy which is a preferred and less inexpensive option. There are many other alternatives like DRO (Debt Relief Order), IVA (Individual Voluntary Arrangement), etc. which are legal and possess less risks than declaring insolvency. So always think of all possible pros and cons before deciding on insolvency.

Steps that follow Insolvency
The company which has declared insolvency next passes into liquidation or winding-up. The company directors and the shareholders can proceed with the liquidation by appointing a licensed insolvency practitioner (IP) without the court interference. The liquidation process requires a shareholder resolution and a creditors meeting to fall into a legal binding. The creditor meeting ensure that they have the opportunity to appoint a liquidator of their choice known as the creditors’ voluntary liquidation or CVL.
Sometimes a creditor might even petition the court to grant a forced liquidation or the company by the court. In such cases, the liquidator releases the company assets and pays the creditors based on priority.
In the interest of the company, the Insolvency Act 1986 introduced the Administration and Company Voluntary Arrangement methods. The Administration is the procedure of appointing an administrator to protect the company assets from the creditors and also enable it to make operational changes to increase cash flow and liquidity. The administrator is normally a licensed Insolvency Practitioner who also aims to protect the interests of the creditors and balance them equally. Most of the times, the company is put into liquidation to compensate for the remaining debt amount. The other method known as the company voluntary arrangement is an arrangement between the negotiator and the company for payment of a fixed amount on a monthly basis which might be lesser than the actual debt amount. At the end of the repayment period accepted, the remaining loan is written-off. The negotiations are managed by a supervisor who is a licensed Insolvency practitioner who puts the company into liquidation in case of failure to adhere to the CVA (Corporate Voluntary Arrangement).

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