As the COVID-19 era ends and we move towards a new era of record levels of inflation and a recession, it’s possible that you will encounter insolvency in some form, whether it is because your own business is struggling, or because you are owed money from a business that has entered an insolvency process. A key question being asked is: “What exactly is insolvency and what happens when a company is insolvent?”

Lisa Cooke, our award-winning Insolvency Solicitor, takes a look at the following areas:

  • The Insolvency Test
  • What happens if a company is insolvent?
  • What is Creditor’s Voluntary Liquidation?
  • What is Compulsory Liquidation?
  • What is Administration?
  • What happens if one of my debtors is insolvent?

The Insolvency Test

There are two tests to determine whether a company is insolvent; the balance sheet test and the cash-flow test.

A company is considered “cash-flow” insolvent if it is unable to pay its debts as they fall due. This test is set out in section 123(1) of the Insolvency Act 1986.

A company is deemed insolvent on a balance sheet basis if the value of the company’s assets is less than the amount of its liabilities, considering its contingent and prospective liabilities. This test is set out in section 123(2) of the Insolvency Act 1986.

Satisfying either test means that the company is technically insolvent. Whilst a company may continue to trade when insolvent in some circumstances, if a company meets the threshold of either the cash flow insolvency test or the balance sheet test for insolvency, the directors should seek professional insolvency advice immediately.

What happens if a Company is insolvent?

If a company is no longer financially viable and is not in a position to continue to trade, there are a number of insolvency processes it could consider, determined by the company’s financial circumstances.

The individual or entity seeking to place a company into an insolvency process may also determine the appropriate process. In the case of both administration and liquidation, from the point that the Company enters either process, directors no longer have authority over the company or control of its assets.

What is Liquidation?

Liquidation is an insolvency process that provides for the winding down of a company’s business and the sale of any assets of value for the benefit of the company’s creditors. When a liquidation is complete, the company is dissolved and no longer continues to exist.

The process after a company has entered liquidation is the same in both a Creditor’s Voluntary Liquidation (CVL) and a compulsory liquidation. The difference between a CVL and compulsory liquidation is the way in which the company enters liquidation:

On entering liquidation, a liquidator is appointed to have control over all company assets and affairs. The liquidator is not ‘employed’ by the company, but is an independent officer of the court and has a duty to the creditors of the company, not the company directors.

The liquidator is required to investigate the affairs of the company and pursue any actions that may benefit the liquidation estate. A failure to thoroughly investigate the affairs of the company and pursue any potential assets of the company would be a breach of the liquidator’s duty for which he/she could be personally liable. Ultimately, the liquidator’s role is not to try and rescue any part of the company but, as the name implies, liquidate it in it its entirety by extracting any value for the benefit of creditors as a whole.

Creditor’s Voluntary Liquidation (CVL)

A CVL is a formal insolvency procedure which involves the directors of an insolvent company voluntarily choosing to wind the company up. A company is placed into CVL by special resolution (passed by the Company’s shareholders). The creditors of the company are called to a meeting to vote on the appointment of the liquidator proposed by the directors. 50 per cent of creditors need to approve the appointment of the proposed liquidator (which is obtained in the majority of cases). When the liquidator is approved, the company thereafter enters liquidation.

While ‘choosing’ liquidation does not seem like a particularly attractive option, there are a number of benefits over a compulsory liquidation. A CVL is likely to be the most financially beneficial (for creditors) way of liquidating a company and the process into liquidation is ordinarily much faster than the court process.

Many directors also feel that taking autonomous steps to place a company into a CVL gives them more control over the process. This, together with the fact that the directors (usually) obtain professional assistance at an early stage of the liquidation process, helps to alleviate some of the stress associated with a failing business. Instigating a CVL also shows that directors are actively dealing with the company’s insolvency rather than continuing to trade unlawfully and/or waiting for a creditor to force action through a compulsory winding up. A director’s conduct will be considered (by both the liquidator investigating the affairs of the company and potentially the Official Receiver if disqualification proceedings are anticipated) and proactive steps to protect the creditors from further exposure by entering a CVL promptly will benefit the director’s position.

Compulsory Liquidation

Compulsory liquidation is a court-based procedure started by the filing (or “presenting”) of a petition at court. The petition can be filed by the Company itself, but the process is more typically instigated by a creditor of the Company.

After a winding up petition has been issued, the petitioner is required to ‘advertise’ the petition. The purpose of the advertisement is to notify any other creditors of the company of the petition and the hearing date to allow them the opportunity to attend. The practical implication for the company of the advertisement is that the company bank accounts are usually frozen, and customers may become aware of the company’s precarious financial position, both of which can have a direct effect to any continuing trade.

At the winding up petition hearing, a judge will decide whether it is appropriate to make a winding-up order. If the winding up order is made, the Company is placed into liquidation immediately and the Official Receiver is appointed as the liquidator of the company. A private Insolvency Practitioner may replace the Official Receiver as the liquidator later, if appropriate.


The scope of administration is much wider than that of liquidation. The Insolvency Act 1986 explicitly sets out the statutory purpose of administration as having the objective of:

1) rescuing the company as a going concern;

2) achieving a better result for the company’s creditors than would be likely if the company were wound up; or

3) realising property in order to make a distribution to one or more secured or preferential creditors.

The objectives are not inter-dependent, and the administrator can choose to pursue any one of the objectives having considered the specific circumstances of the company’s financial position.

There are two ways in which a company can enter administration; “out of court” or by way of an application to court for an Administration Order (“the court route”). The out of court method is more commonly used as it tends to be quicker and cheaper. It is referred to as out of court because a judge is not required to review the application or make an order (as is the case with the court route). The requisite documents do, however, still need to be completed and stamped by the court clerk. Upon which, the administration appointment becomes effective. The company can gain the benefit of an interim moratorium which is effective from the filing of the initial documents at court (to commence either the out of court or court route) up until the appointment of an administrator, when the statutory moratorium comes into effect.

During the moratorium, creditors are prevented from taking most enforcement action against the company including issuing a winding up petition, giving the breathing space required to restructure the business to reach one of the statutory objectives.

What happens if one of my debtors is insolvent?

As an unsecured creditor of a company in liquidation or administration, you should receive notification that the company has entered an insolvency process. You will be asked to submit a proof of debt setting out the extent of any monies due to you which you should return promptly. The liquidator/administrator may ask you to provide supporting evidence of the debt claimed in due course. Any repayment of your debt will be entirely dependent on the outcome of the administration or the amount that can be realised in the estate (i.e. from the sale of the company’s assets).

The timescales for receiving a dividend payment are entirely dependent on each and every liquidation/administration. Some processes can be completed very quickly but others may take years to administer (for various reasons). Secured creditors will be repaid directly from the sale of the asset that they hold their security against. After paying secured creditors, the residual monies will first be used to pay the costs of the liquidation and the remainder will go into the “pot” for unsecured creditors. Preferential creditors will be paid from the “pot” first. This includes creditors such as employees of the company and, from 1 December 2020, HMRC in respect of some taxes.

Any monies available thereafter, will be distributed to unsecured creditors. If there are insufficient funds to pay all creditors in full, you will receive a percentage based on the value of your debt compared to the overall body of unsecured creditors. The extent of other company creditors may therefore influence the amount that you ultimately receive.

Our goal at RHL Solicitors is to secure an accurate settlement of the client’s losses in accordance with their best interests. This means pursuing these claims expeditiously and accurately so that clients are fully compensated.

If you are concerned about the result of yours or your company’s financial position, contact our specialist insolvency team here and we will be more than happy to discuss the matter further. 

RHL Solicitors will have no delays or waiting times in advising you on your situation and will be quick to get you the support and care you deserve.