Helpful information

Warning signs
Is my business solvent?
Positive steps to help your business
Directors responsibilities
Dealing with legal action

Warning Signs

Formal insolvency may be prevented by early action. Consider the warning signs below. Do the warning signs apply to your business?

If you recognise the signs, your business may be under pressure and could be at risk of insolvency. For an explanation of the meaning of ‘insolvent’ see Is my business solvent.

If you consider that your business can continue see Positive steps to help your business and Rescue procedures.


You need to recognise the warning signs of insolvency and take action if necessary. If you do nothing, it will be more difficult for the business to recover and, if you are a director of a company, you could be at risk of an action for breach of your duty of care to the company.

DO YOU RECOGNISE ANY OF THE FOLLOWING?

CREDITORS

1. You find it difficult to pay bills when due.
2. You cannot get credit or extend credit terms with suppliers.
3. You find it difficult to obtain stocks or services.
4. You receive lots of creditor calls, demands for payment, threats of legal action or creditors have commenced legal action to recover payment.
5. You ‘rob Peter to pay Paul’.

HM REVENUE & CUSTOMS

1. It is difficult to make the PAYE/NIC payment on 19th of each month.
2. It is difficult to find the cash to pay the VAT at the quarter end or part payments are made.
3. You are paying surcharges on amounts due or received penalty warnings.
4. You are behind in filing returns with HM Revenue & Customs
5. The Debt Recovery Department is dealing with your business

COMPANY ASSETS


1. You don’t know the value of debts or consider that the debtors are uncollectable
2. Company assets are under threat from distraint action
3. Assets are old, in need of repair and you cannot afford to replace
4. Factors are disallowing invoices or clawing back funds
5. Factoring is too expensive

YOUR BUSINESS

1. You do not know what your profit margin is or what the company needs to do to break even.
2. You have no accurate management information, for example, monthly accounts, cash projections, business plans.
3. No regular management meetings are held.
4. You have no idea where money is being spent and where savings could be made
5. Staff are demoralised or are leaving the business

YOU

1. You have guaranteed some of the business debt or have put money in the business to ‘help out’.
2. You are experiencing personal financial difficulties.

3. The stress of the business is affecting your relationships with other people or health.

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Is my business solvent?

It is important to be able to identify if your company or business is insolvent. The directors of an insolvent company have a duty to protect creditors’ interests and maximise funds for creditors.

If as a director you fail to take correct action you may be found to be in breach of your duty of care to the company. This could result in you being required to make a contribution out of your private funds to the company’s assets or disqualified from acting as a director.

For further information on directors’ responsibilities read Directors’ Responsibilities.


THE TESTS OF INSOLVENCY

There are three recognised tests of insolvency.

1. The Cash Flow Test - Can the business pay its debts when they fall due for payment?

Example - if the company does not pay deductions for tax and NIC on 19th of each month, then debts are not being paid as and when they fall due and the company may be insolvent
Example - if the company pays trade creditors after 90 days when the terms are 30 days terms, then debts are not being paid as and when they fall due and the company may be insolvent

2. The Balance Sheet Test - Are the business’ liabilities (*1) ie amounts owed to creditors greater than it assets (*2)?

(*1) Liabilities include contingent or prospective debts. These are debts the value of which is uncertain or cannot be quantified until the happening of some event in the future.

(*2) Assets must be valued prudently. This means that if debts are not collectable or stock values too high, appropriate adjustments must be made.


Example
- A company has assets of £100,000 of which £20,000 relates to a debt which is disputed. The company’s liabilities are £95,000. The company has given notice to a landlord to quit premises. The lease has 3 months left to run and rent for the 3 month period is £5,000. On a balance sheet test the company has assets adjusted to £80,000 and liabilities of £100,000 and may be insolvent.

3. The Legal Test - Has a creditor has obtained a County Court Judgment or obtained a statutory demand for greater than £750 which has remained unpaid for more than 21 days?
For an explanation of county court judgement or statutory demand read Legal Action.

INSOLVENCY IS AN ISSUE, HOW CAN WE HELP?

We can assist you in taking the correct action to protect the company’s position, that of creditors and to ensure that you do not breach your duties to the company.

If rescue is appropriate we can advise, see Rescue Procedures. If insolvent liquidation is the only option, we can deal with creditors and conclude the affairs of the company efficiently and quickly, see Creditors Voluntary Liquidation. Alternatively we can advise you how to prepare for the Official Receiver dealing your company, see Compulsory Liquidation.

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Positive steps to help your business

Once you have identified that your business needs help, what sort of things can you do to try to turn things around?

 

• Reduce risk

Awareness of your company's financial position is key, so constantly monitor the situation and take action if insolvency is likely. As a director, if you fail to act appropriately and your company goes into liquidation, you could face the possibility of being disqualified from acting as a director.


• Credit control

Make sure you have a clear credit control system that sets out procedures for dealing with overdue accounts. This will help you to identify problem customers. Don't extend customers' limits without talking to them and thinking through the situation carefully.

It is important to stick to your credit policy, no matter how well you know the customer. Many businesses have gone under because they extended credit to someone for the sake of a friendly relationship with a long established customer. It's worth a little embarrassment to save your business.

If a company's payment period suddenly lengthens, why not carry out a credit reference check to see if they are as reliable as they seem?


• Contracts

It is essential that both contracting parties (ie buyer and seller) agree terms of trade between them before or at the time that a contract of sale is made. This will set the ground rules between the contracting parties. It will mean that both parties know exactly what is expected of them and may prevent unnecessary disputes.

Terms and conditions of trade on the back of invoices is not sufficient to demonstrate that your terms are properly incorporated into the contract. Put your terms and conditions in your letter which sets out your payment terms, or confirms receipt of your customers order.


• Know who you're dealing with and carry out a credit check

You can reduce your risk by checking out the company you're dealing with. This will help you to avoid fly-by-night companies, phoenix companies or simply businesses that will not be able to pay you.

There are many ways you can do this including obtaining bank references, trade references and obtaining company accounts. In addition, you may wish to purchase a status report from a credit reference agency.


• Keep an eye on your debtors

Debts owed to your company are assets. Unpaid debts undermine your business. If your customer's business fails, then you, as a trade (unsecured) creditor will rank last after secured creditors such as banks and other charge holders, and preferential creditors which are employees.

Trade only as long as you think the company owing you money can overcome its problems and do not extend any further credit unless your company can withstand the exposure if you remain unpaid.


• Insurance, factoring and third-party instruction

You might consider using credit insurance or factoring which, in addition to helping you reduce the risk of non-payment, means the credit insurer or factor will undertake some of the credit checking process.

Using professional debt collection companies or solicitors who specialise in debt collection are also cost-effective ways to help avoid potential debt problems and speed up cashflow.


• Review your cashflow on a regular basis

When you initially set up your business, you may have had to draw up a cashflow forecast to present to an investor, say the bank, in order to secure funding for your business.

Drawing up regular forecasts will help you to identify any future pitfalls you may encounter and will allow you to re-assess your position and make any adjustments to your trading practices.

Cashflow is key to the survival of your business. Your ability to generate sufficient cash determines how well you can manage your business expenditure and pay your creditors as and when debts fall due. Failure to monitor this appropriately could have a knock-on effect on other areas of your business.


• Embrace change

Nothing stands still in the world of business. Things are constantly evolving. If you fail to adapt, you may be left standing as other competitors pass you by.

It’s up to you to keep abreast of any industry changes in the law, in working practices and methods and technological updates.

Find out if there are any professional bodies which your business can subscribe to and receive regular updates of any changes that you can implement to keep your competitive edge.


• Don’t ignore the signs!

If, despite everything, you still find your business is struggling, DON’T IGNORE THE SIGNS.

If creditors start banging on your door, threatening legal action that is your cue to seek advice. If you are a director, you have a duty to act in the best possible interests of the company. If the company eventually becomes insolvent, it will look favourable if it can be shown that action was taken at an early stage to mitigate any losses.


• Take advice

By using the Solution Finder you can explore a range of possible solutions for your business. Don’t be afraid to pick up the phone, it’s free and our team want to help.

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Directors' duties and responsibilities


WHAT IS A DIRECTOR?


As defined by the Company’s Act a director is "Any person occupying the position of director by whatever called".

A shadow director is "any person in accordance with whose directions and instruction, the directors of the company are accustomed to act".

A de facto director is someone who is not formally appointed as such but holds himself out as a director e.g. signs letters as a director. Non executive directors are subject to the same duties and responsibilities as directors.

DIRECTORS’ DUTIES

Common Law/Fiduciary Duty

A director must always act in accordance with what s/he believes to be in the best interests of the company and must avoid any conflict of interest between company and personal matters.

Statutory Duties

1.Loans

A company may not make a loan to, or provide a guarantee for, a director (or director of its parent company) or enter into indirect arrangements to achieve this.

These restrictions do not apply to loans under £5,000, loans made to a director to perform his duties or loans to meet expenditure for company purposes.


2. Substantial Property Transactions

Substantial property transactions by a company involving a director or connected person must first be approved by the company at a General Meeting. Such transactions include those where a director or connected person buys from or sells an asset to a company, the value of which exceeds the lower of £100,000 or 10% of the company's net assets. Transactions where the value is less than £2,000 are not relevant.

For definition of connected party see Glossary of Terms.


3. Interests in Contracts
A director must disclose his/her personal interest and the interest of connected persons in company contracts.

4. Service Contracts
Directors' service contracts must not exceed 5 years, unless shareholders have approved the contact at a general meeting.

5. Statutory Books and Records
Directors are responsible for preparing a profit and loss account and a balance sheet, ensuring that proper accounting records are kept and taking all possible steps to ensure that the accounts show a true and fair view.

Directors and the company secretary are jointly responsible for maintaining registers of directors, members, interests in contracts and minutes of board, general and annual meetings.

Directors and the company secretary are jointly responsible for filing documents at Companies House such as annual returns, accounts, change in registered office, directors, shareholder or secretary.

HOW DOES A COMPANY’S INSOLVENCY AFFECT A DIRECTOR’S DUTIES AND RESPONSIBILITIES?

The directors of an insolvent company have a duty to protect creditors’ interests and maximise funds for creditors.

To check whether your company may be insolvent, read ‘is my business solvent’.

The conduct of a director is subject to investigation by an Administrator, Administrative Receiver and Liquidator if appointed. These office holders are obliged to report to the Department of Trade and Industry which can result in disqualification action being taken against directors.

Office holders, in certain circumstance, can take action to recover funds for creditors.


ACTIONS THAT CAN BE TAKEN TO RECOVER FUNDS FOR CREDITORS

Wrongful Trading S214 Insolvency Act 1986

This is allowing the company to continue to trade whilst insolvent in the knowledge that there is no prospect of avoiding insolvent liquidation.

A liquidator can apply to court for an order making a director, or a person who was a director at the time, responsible to contribute towards the company's assets

A defence to the action is to prove that you took every step possible to minimise the loss to creditors.

Wrongful trading actions are expensive to pursue and generally a liquidator will have to obtain creditors' permission to use creditors' money to finance the legal fees.


Fraudulent Trading S239 Insolvency Act 1986

This is carrying on trading with the intention to defraud your creditors or for a fraudulent purpose.

A liquidator can apply to court for an order that, any person knowingly party to fraudulent trading, contribute towards the company’s assets. In addition, there are criminal sanctions being an unlimited fine and imprisonment for up to 7 years.

This action is more difficult to pursue than wrongful trading as ‘intent to defraud’ must be proven.


Preferences S239 Insolvency Act 1986

This is a transaction which places a creditor in a better place than they would have been, in the event of an insolvent liquidation, than if the transaction had not taken place.

The transaction must be made at a time when the company was insolvent and be within a ‘relevant period’. The relevant period is within 6 months of the date of administration/ liquidation where the person who has benefited is not a connected person or within 2 years where the person is deemed to be connected.

Where the transaction is with a person who is not connected ‘desire to prefer’ must also be proven.

Example – the repayment of a director’s loan. The director, being a creditor is preferred because s/he has received payment in full, whilst other creditors may only receive a percentage of their debts from the company in liquidation. As the director is a “connected person” it is assumed that there was “a desire to prefer” the director.

An administrator or liquidator can apply to court for the transaction to be reversed.


Transactions at an Undervalue S238 Insolvency Act 1986

This is a transaction with another party where they receive goods, money, etc which is worth significantly more than they have paid for it.

The transaction must be made at a time when the company was insolvent and be within a ‘relevant period’. The relevant period is within 2 years of the date of administration/ liquidation.

Where the transaction is with a person who connected ‘insolvency’ is presumed.

Example - the wife of the director is gifted an expensive car owned by company in settlement of "secretarial fees

An administrator or liquidator can apply to court for the transaction to be reversed


Misfeasance S212 Insolvency Act 1986

This is a breach of a fiduciary duty/duty of care to the company by misapplying, retaining or becoming accountable for any money or property of the company.

If you are involved in the promotion, formation or management of the company, or been an officer, liquidator, administrator or administrative receiver of the company, you could be found liable of misfeasance.

Example - Director sets up new company and transfers stock to new company for no consideration.

A Liquidator or the Official Receiver can apply to court for an order that monies be repaid, property be restored, for interest or for a contribution to the assets of the company in compensation.


Transaction defrauding Creditors S423 Insolvency Act 1986

This is similar to Transaction at an Undervalue (S238 IA1986) but there is no time limit.

The penalties for a successful prosecution by a liquidator, administrator or Supervisor of a voluntary arrangement are similar to that detailed for Transactions at an Undervalue.

Restriction on reuse of company name S216 Insolvency Act 1986 known as Phoenix Companies

This applies to any person who was a director or shadow director of a company in the 12 months prior to that company being placed into insolvent liquidation. That person is unable, subject to certain exceptions, to be involved in a new company using a name, registered or trading, similar to that of the company in liquidation. The prohibition applies for a period of 5 years.

Example - A director of ABC Ltd (In Liquidation) sets up a new company ABC 2003 Ltd in which he is a director and Court's permission is not obtained to re-use the company name.

The penalties include imprisonment and or a fine. In addition, the guilty party, together with any person who knowingly acts in accordance with the instruction of the guilty party can become personally liable for the debts of the new company.


Illegal Dividend Distribution S263-277 Company’s Act 1985


This is when a distribution to shareholders has been made at a time when the company had insufficient profits to make the distribution. The distribution may be unlawful and a request can be made for repayment of the monies.

REPORT ON DIRECTORS’ CONDUCT AND DISQUALIFICATION


The report made to the Disqualification Unit of the Department of Trade and Industry includes most of the matters referred to above. The DTI will decide whether to pursue an action for disqualification.

A successful action by the DTI will result in a person being disqualified from being a company director or being involved in the formation, promotion or management of a company or limited liability partnership for a period of between 2 and 15 years.

A public register of disqualified directors is maintained and information is also registered at Companies House.

Any person who contravenes a disqualification order or undertaking can be subject to a fine and/or imprisonment for up to 2 years and may be held personally liable for the debts of the company incurred whilst that person was acting in contravention of the order or undertaking.


Carecraft Orders


It is possible to mitigate the potential period of disqualification by reaching an agreement with the DTI on those arrears of your conduct as a director which you consider were “lacking”. If an agreement can be reached with a director as to the statement of fact the DTI and the director attend the court with an agreement and apply for a carecraft order. This avoids the costs of full court proceedings. The court makes an appropriate order on the basis of the agreement.

Undertakings

From April 2001, a director is able to give an undertaking to the DTI. This has the same effect as disqualification order but does not require court involvement.

STEPS TO AVOID DISQUALIFICATION/PERSONAL LIABILITY

Take professional advice, our specialist advisors trained to deal with all aspects of business debt and rescue solutions.

• Don't carry on taking goods/services on credit if you know the company cannot pay for them.
• Don't take deposits if you think the company will be unable to supply the goods/services for which the deposit is paid.
• Try to pay creditors evenly, don't specifically prefer creditors
• Pay PAYE/NIC and VAT on time.
• Keep proper accounting records
• Ensure that appropriate management information is provided at regular intervals and that action is taken where necessary
• Ensure your annual returns and company's accounts are filed on time.
• Don't allow your Directors' loan account to be overdrawn.
• Make sure that directors' remuneration packages are not excessive, expensive cars are a luxury not a necessity.
• Don't allow the company to carry on trading when you know there is little chance of avoiding formal insolvency, i.e. writs and judgments are mounting.
• Keep notes of actions taken to try and minimise losses to creditors, e.g. Injection of cash from directors/shareholders, reduction in salaries, etc.

If you are at all concerned about any of the above issues, please call us on our FREE 24 hour helpline 0800 781 0990 or contact us using our Contact Form.

Please note: This guide is intended to provide basic information only. Where specific advice is required, we recommend that you seek proper professional help; either from this firm or other suitably qualified person or practice.

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Dealing with legal action

If your company is faced with a legal action, although the temptation may be to shelve the problem until you are less stressed, you will actually feel better if you deal with it.
Below are some practical tips on what to do but the most important first step is communication. Talk to the person on the other side of the action, let them know you are keen to resolve the issue, if this is appropriate and put forward a sensible and achievable solution. If you cannot get their agreement and your company is clearly not in a position to pay sums to stave off the action, give us a call because there are solutions which can give you time to pay.

County Court Summons

This is a form which is issued by the Court and will be at the request of a creditor who has asked the Court to enforce payment. Don’t panic. The form is designed to encourage your company to pay the debt. You will have 14 days to reply to the claim and can request an extra 14 days.
If the claim is incorrect and should be defended, you can file a defence using the defence form. If you believe that you owe nothing and in fact the creditor owes you money, then you complete the defence and counterclaim. The creditor will be asked to complete an allocation questionnaire so that the Court can decide how the claim should be heard. If there is just a small element of the claim that is disputed this is unlikely to be adequate grounds for the claim to be set aside.

Judgment

If you do nothing at the end of the permitted time, the creditor will apply for judgment which will be given unless you defend the claim. Your company will have 30 days from the date of the Judgment to pay in full plus any costs incurred. Otherwise the Judgment will be registered at the courts and with credit reference agencies.
If possible always try to pay the debt within 30 days of Judgment. This will ensure that the Judgment is "set aside" and will not be registered with credit reference agencies. If you cannot pay the judgment this will be evidence that the “company is unable to pay its debt as they fall due” which is one of the definitions of insolvency see Is my business solvent. If the company is subsequently wound up, a liquidator will look for evidence of insolvency and if the company continues to trade and incurs further debt, this could lead to an action for wrongful trading which may result in the directors having to personally contribute to the assets of the company.
If the company is experiencing real cash flow pressure do give us a call there are a number of solutions for financially ailing companies, see Rescue Procedures.

Warrant

As the creditor has not been paid under the judgment, the creditor can apply to the court for a warrant of execution. A notice of warrant will be issued to the company and if payment is not made, a bailiff of the court can be sent to collect payment or seize goods.

It is still not too late to agree a deal with the creditor but you will have to pay the Bailiff’s costs. The Bailiff is likely to make a list of the company’s saleable assets and get you to sign a “Walking Possession” order. You will be given five days to find the money unless the creditor agrees a longer payment period. If you don’t pay, the goods will be removed and eventually sold at auction.
An administration order will prevent execution from being completed. Also if it is appropriate to wind up the company, the passing of an extraordinary resolution to wind up the company will prevent the Bailiff from continuing the action, see Creditors Voluntary Liquidation.

Statutory Demand

This is a demand for payment giving the company 21 days to pay. If the debt is not disputed and wholly payable – the creditor can then follow the statutory demand with a petition to wind up the company.

If you cannot pay the debt, call us immediately. A petition can have a devastating effect on the company as the mere issue of a petition could have a domino effect on borrowing and also provide grounds for contracts to be terminated. Again an unpaid statutory demand is further evidence of the company’s inability to pay its debts.

Distraint

Action by a landlord, rating authority, Inland Revenue or HM Customs & Excise to recover arrears of rent, rates, tax or VAT. The landlord, Inland Revenue and HM Customs and Excise can distrain without obtaining a court order.

Distraint means that an agent of the creditor can remove goods belonging to the business, or assets for sale to pay for the debt due. Depending on the company’s financial situation, there are a range of steps that can be taken to prevent the distraint from continuing. For example an administration order (link) will prevent the distraint action from continuing unless the court sanctions further action.

URGENT ACTION IS REQUIRED


Winding Up Petition


A winding up petition can follow a judgment or a statutory demand and is the most serious action that can be taken against the company. Clearly the company has failed to come to a satisfactory agreement with a creditors about payment and they have now lost all faith.

If your company is facing a petition, it is possible to get the creditors’ agreement to postpone the advertising and hearing of the petition on the basis that you have appointed an insolvency practitioner to investigate alternative rescue procedures. For example is the company is viable but does need time to pay, the company could apply for an Administration Order which would prevent the petition from proceeding. Alternatively the company could propose a CVA with a moratorium which would have the same effect.

If nothing is done then in due course the petition hearing will be published. At this stage the bank will find out and they will FREEZE the company’s bank account to prevent any misfeasance or sale of assets at undervalue or other illegal acts by the directors. At the hearing of the petition, a winding up order will be made and the company will proceed into compulsory liquidation.

Make very sure that all board and management actions have been carefully noted and the assets of the business have not been disposed of.

Please note: This guide is intended to provide basic information only. Where specific advice is required, we recommend that you seek proper professional help; either from this firm or other suitably qualified person or practice.

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All debt solutions should be very carefully considered. Fees will be charged if a solution is taken in order for us to advise and administer the most appropriate action - all fees will be outlined during your consultation. Retained payment may place you further into arrears. You have the right to a cooling off period of 14 days. It is likely that your ability to obtain further credit in the short term will be affected and this may also be the case over the medium to long term.
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The Business Debt Advisor is a trading style of The Debt Advisor Ltd.

The Debt Advisor is regulated and authorised by the Financial Conduct Authority Reg No : 606669