The Director’s Guide to Company Insolvency
A company is insolvent when it cannot pay its debts. In practice that is tested two ways: the cash-flow test, where the company cannot pay its debts as they fall due, and the balance-sheet test, where its liabilities are greater than its assets. A company can fail one test and pass the other, and it can be insolvent for an extended period. It is not the level of liabilities but how pressing those creditors are that forces a company to close down. What changes most for you as a director is not the label itself but your legal position: once insolvency is likely or established, your duty shifts towards protecting creditors, and the decisions you take from that point are judged against that duty.
This guide is written for directors. It explains how to tell whether your company is insolvent, the warning signs worth taking seriously, how your duties change, the risks of acting too late, and the options that remain open. It is general information, not advice on your specific situation. For the bare definition of the term, see our answer to what is insolvency?.
When is a company insolvent? The two tests
A company is insolvent if it fails either of two tests. The cash-flow test asks whether the company can pay its debts as they fall due. The balance-sheet test asks whether the company’s liabilities, including contingent and prospective liabilities, exceed its assets and a formal insolvency is probable. Failing either test can mean the company is insolvent, even if it is still trading and paying staff.
The cash-flow test is usually the one that bites first. A company can be profitable on paper or have a surplus of assets and still run out of cash to meet a VAT bill, a supplier payment or wages on the day they are due. If you are paying creditors late, juggling which bills to pay this week, or depending on one large incoming payment to stay afloat, the cash-flow position needs careful attention.
The balance-sheet test looks at the wider picture. It compares everything the company owes, including liabilities that have not yet crystallised, against everything it owns. A company can pass the cash-flow test today and still be balance-sheet insolvent because of a large future liability, a loan repayment falling due, or assets that are worth far less than their book value.
A company can be insolvent on one test and not the other, and being insolvent does not automatically mean closure. It does mean the company is in a position where your duties as a director change, and where the choices you make are looked at more closely if matters do not improve.
It helps to separate two things: a short-term cash pinch and genuine insolvency. Many healthy companies have a tight trading period and trade through it. The concern is when the tests are failed not as a one-off but as the settled position, with no clear and realistic route back. Insolvency describes the company’s financial state at a point in time. It is not a verdict on you as a director, and reaching it is not in itself wrongdoing. What counts is what you do once you can see it.
What are the warning signs your company is insolvent?
The clearest warning signs are cash running short, creditors chasing harder, and finance being used to cover everyday costs rather than growth. Late payments to HMRC, maxed-out facilities, county court judgments and pressure from suppliers putting your company on stop are all signals that the company’s solvency needs checking properly, not managing day to day.
Some warning signs are worth treating as prompts to take advice rather than to push on:
- You are paying suppliers, HMRC or wages late, or choosing which to pay each week.
- Your overdraft or credit facilities are at or near their limit and stay there.
- You are relying on one large customer payment, refund or new order to keep going.
- HMRC has refused or cancelled a Time to Pay arrangement, or a new one is hard to agree.
- You have received county court judgments (CCJs), statutory demands, or a threat of a winding-up petition.
- Key suppliers have put you on stop, shortened terms, or asked for payment up front.
- You are using money collected for VAT or PAYE to fund day-to-day trading.
- The directors are putting in personal funds, or extending personal guarantees, to keep the company running. There are safe ways of doing this so speak to us first.
None of these on its own proves the company is insolvent. Taken together, or left unaddressed, they tend to point the same way. The value of recognising them early is that early action keeps more options open, which we return to below.
How do a director's duties change when a company is insolvent?
While a company is solvent, directors act in the interests of its members, the shareholders. Once the company is insolvent, or insolvency is likely, that duty shifts: you must act in the interests of the company’s creditors as a whole. In practice this means protecting the money available to creditors and not making the position worse.
This shift matters because the decisions you take after it are judged against the creditors’ interests, not the shareholders’. The courts have confirmed that the duty to consider creditors arises when a director knows, or ought to conclude, that the company is insolvent or that insolvency is likely. From that point, the company is in effect being run for the people it owes money to.
In day-to-day terms, acting in the interests of creditors as a whole usually means:
- Stopping the company taking on new credit or orders it has no realistic prospect of paying for.
- Not paying one creditor ahead of others where doing so would unfairly improve that creditor’s position. Settling a debt that a director has personally guaranteed, for example, can later be challenged as a preference.
- Not selling or transferring company assets for less than they are worth.
- Not continuing to run up losses.
- Keeping clear, contemporaneous records of the decisions you take and why, including the advice you sought.
- Treating creditors even-handedly and being straight with them about the position.
A common worry at this stage is which creditors rank where, and HMRC is often misunderstood. Certain taxes the company collects on HMRC’s behalf, such as VAT, PAYE and employee National Insurance, rank as secondary preferential debts in an insolvency. Other amounts the company owes in its own right, such as corporation tax, are unsecured. The detail matters less than the principle: once insolvency is in view, you should not be making decisions that quietly improve one creditor’s position at the expense of the rest.
It is also worth being deliberate about your own paper trail. Board minutes, the figures you relied on, the advice you took and the dates you took it all help to show that you recognised the position and acted on it. If decisions are later reviewed, a contemporaneous record is usually more persuasive than anything reconstructed afterwards.
You do not have to work out the precise legal position yourself. The duty is to recognise when the company has reached this point and to take proper advice, which is where a licensed insolvency practitioner comes in.
What are the risks for directors of an insolvent company?
Most directors of an insolvent company are not at personal risk, provided they act reasonably and take advice once insolvency is in view. The risks arise from how you behave from that point: continuing to trade and run up creditors’ losses, putting your own interests first, or giving personal guarantees. The main areas to understand are wrongful trading, fraudulent trading, misfeasance, personal liability, disqualification and personal guarantees.
These are the situations that can turn a company’s debts into a director’s problem. They are worth understanding clearly, not because they are likely in every case, but because acting early is usually what keeps you out of them.
Wrongful trading. This is the risk of continuing to trade when you knew, or ought to have concluded, that there was no reasonable prospect of avoiding insolvent liquidation, and the company’s position got worse as a result. If that is found, a court can order the director to contribute personally to the company’s assets. The defence is to take every step to minimise loss to creditors once you realise the position, which again points to taking advice early. The Courts have recently extended an application of this to what is known as misfeasant trading.
Fraudulent trading. This is more serious and harder to establish. It applies where the business has been carried on with intent to defraud creditors or for any fraudulent purpose. It requires actual dishonesty, not just optimism or poor judgement, and it carries both civil and criminal consequences. Most directors in financial difficulty are nowhere near this, but it sits at the far end of the same spectrum.
Misfeasance. Misfeasance is a breach of duty in the way a director has handled the company’s money or property: paying themselves improperly, misapplying funds, or breaching their statutory duties. A liquidator can bring a misfeasance claim to recover what the company has lost. Keeping clean records and not treating company money as your own is the practical protection. Once a company is insolvent it is actually difficult for directors not to breach their duties unless you take and follow professional advice.
Personal liability for company debts. A limited company’s debts are usually the company’s, not yours. That separation can fall away in specific situations: an overdrawn director’s loan account that has to be repaid, debts covered by a personal guarantee, or where wrongful trading, fraudulent trading or misfeasance are established. Our overview of directors’ personal liabilities explains where the line sits.
Director disqualification. After an insolvency, the conduct of the directors is reviewed. Where a director is found to have acted in an unfit manner, they can be disqualified from acting as a director for a period of up to fifteen years. Disqualification is about conduct, not simply about having run a company that failed, and most directors of failed companies are never disqualified.
Personal guarantees. Many directors sign personal guarantees for company borrowing, leases or supplier credit, sometimes without realising it. A guarantee makes you personally responsible for that specific debt if the company cannot pay it. When a company becomes insolvent, guarantees are one of the first things to identify, because they shape which options protect you and which do not.
The thread running through all of these is timing and conduct. A director who recognises the position, stops making it worse, takes advice and keeps records is in a very different place from one who trades on in hope and pays connected parties first. The law is concerned with the second, not with the simple fact that a company has failed.
What are a director's options if the company is insolvent?
The right option depends on whether the underlying business is viable and what its creditors will support. The formal routes range from rescue procedures that aim to keep the business going to liquidation procedures that close it down in an orderly way. A licensed insolvency practitioner can set out which of these realistically apply to your company.
Each option below has its own process, costs and consequences, which we cover in full on the linked pages.
Choosing between them is not guesswork. A licensed insolvency practitioner weighs whether the business can trade profitably once its historic problems are dealt with, what secured and preferential creditors are owed, whether creditors are likely to support a proposal, and how much time the company realistically has. The same set of facts can point to rescue in one case and an orderly closure in another.
Business rescue
Business rescue covers the wider set of options aimed at turning a struggling but viable company around, which may combine restructuring, refinancing and a formal procedure. The starting question is always whether the underlying business can be saved, and on what terms, rather than assuming closure is the only route.
Company Voluntary Arrangement (CVA)
A Company Voluntary Arrangement is a formal, legally binding agreement with creditors to pay back some or all of what is owed over time, usually from future trading. The company keeps trading under the directors’ control. A CVA suits a viable business carrying historic debt it cannot clear under normal terms, provided enough creditors vote in favour.
Company administration
Company administration puts the company under the control of an administrator and creates a legal moratorium that holds off creditor action while a plan is worked out. It is used where there is a viable business or valuable assets worth protecting, whether the aim is to rescue the company, achieve a better result for creditors than liquidation, or sell the business as a going concern.
Creditors' Voluntary Liquidation (CVL)
A Creditors’ Voluntary Liquidation is the director-led process for closing an insolvent company in an orderly way. The directors resolve to liquidate, a licensed insolvency practitioner is appointed as liquidator, assets are realised and distributed to creditors, and the company is wound up. It is the appropriate route where the business cannot be rescued and continuing to trade would only add to creditors’ losses.
Members' Voluntary Liquidation (MVL): the solvent route
A Members’ Voluntary Liquidation is for solvent companies only, so it is not an insolvency procedure, but it is worth knowing where the line falls. An MVL is used to close a company that can pay all its debts in full, typically to release reserves tax-efficiently on retirement or restructuring. If your company is insolvent, this route is not open to it. Our Members’ Voluntary Liquidation guide explains how the solvent route works.
Starting again after liquidation
Directors often ask whether they can set up a new company after a liquidation. Yes they can, but there are rules, particularly around reusing the insolvent company’s name or a similar one, which exist to protect creditors. Our answer to what is a phoenix company? explains what is allowed and what is restricted.
What should a director do now?
If you think your company may be insolvent, the most useful step is to take advice from a licensed insolvency practitioner early. Acting early widens the options: the sooner the position is assessed, the more chance there is of a rescue or a managed outcome, and the lower the risk to you personally. Leaving it tends to close options off.
There are some practical things worth doing straight away, before and alongside taking advice:
- Stop the company incurring new debts or taking orders it has no realistic prospect of fulfilling or paying for.
- Do not make payments that favour one creditor over others, and do not move or sell assets at less than their value.
- Pull together up-to-date figures: management accounts, a list of creditors and what is owed, bank balances and any personal guarantees.
- Keep a clear written record of the decisions you take and the reasons for them.
- Get the company’s position assessed properly rather than relying on your own estimates.
The reason early advice widens the options is straightforward. A rescue, a CVA or an administration depends on there still being a viable business and enough headroom and time to put a plan in place. The longer an insolvent company trades on without a plan, the more creditors’ losses grow, the fewer of those routes remain realistic, and the more exposed the directors become.
Every company’s position is different, and a specific situation needs a conversation with a licensed insolvency practitioner rather than general guidance. We act through licensed insolvency practitioners regulated by the ICAEW, and we offer free initial advice so you can understand where your company stands and what the realistic options are. You can arrange a confidential, no-obligation conversation through our free initial advice page or by calling 0800 331 7417. Ask for Tony Harrison, Director.
Frequently asked questions
How do I know if my company is insolvent?
Test it two ways. Can the company pay its debts as they fall due? If not, it may be cash-flow insolvent. Are the company’s liabilities, including future and contingent liabilities, greater than its assets? If so, it may be balance-sheet insolvent. Failing either test can mean the company is insolvent, and it is worth having the position checked by a licensed insolvency practitioner if you are unsure.
Can I be personally liable for company debts?
Usually not. A limited company’s debts belong to the company, not its directors. The main exceptions are debts you have personally guaranteed, an overdrawn director’s loan account that has to be repaid, and situations where wrongful trading, fraudulent trading or misfeasance are established against you. Acting reasonably and taking advice once insolvency is likely is what keeps that separation intact.
What should a director do first if the company is insolvent?
Take advice from a licensed insolvency practitioner before making further decisions, and in the meantime stop the company taking on debts it cannot pay and avoid favouring one creditor over others. Gather your figures, keep records of your decisions, and do not dispose of company assets. Early advice gives you the clearest picture and the widest set of options.
Is it too late to rescue the business?
Not necessarily, but timing matters. Rescue options such as administration, a CVA or a wider turnaround depend on there still being a viable business and enough room to put a plan in place. The earlier you take advice, the more likely a rescue is, but even at a late stage there is usually a more or less managed way through, which a licensed insolvency practitioner can identify.
Does my company have to stop trading immediately if it is insolvent?
Not automatically. An insolvent company can sometimes keep trading, for example inside an administration or a CVA, where that is part of a proper plan. What changes is that you must act in the interests of creditors as a whole, and continuing to trade without a plan, while losses to creditors grow, is where the risk lies. This is a point to take advice on quickly rather than to decide alone.
Can I start a new company after my company is liquidated?
In most cases yes, but there are rules designed to protect creditors, particularly restrictions on reusing the insolvent company’s name or a closely similar one. There are limited exceptions to those name rules, and breaking them can carry personal liability and other consequences. Speak to a licensed insolvency practitioner before you act.