What is balance sheet insolvency?
There are many different types of insolvency, all of which refer to when a company is unable to pay its liabilities when they are due. A common, and perhaps less serious type of insolvency, is balance sheet insolvency. If a company shows signs of balance sheet insolvency, it can indicate that it is in financial difficulty, and further review of its finances should be made.
In this article, we explore what balance sheet insolvency means, the warning signs, how to test for it, the legal implications and the options that may be available to a struggling company and its directors. First, let’s begin with understanding balance sheet insolvency.
Explaining balance sheet insolvency
Balance sheet insolvency is a financial condition that occurs when a company’s liabilities exceed its assets. This means that even if they sold all their assets, they would still be financially unable to repay all of their creditors. Recognising the warning signs can help the company achieve a better outcome and avoid severe consequences such as liquidations or legal proceedings.
When a company is having financial difficulty, it can be hard to know what to do for the best. However, early action is always the best path to take in the long run. Thinking things will improve with time can lead to more dire consequences for the company. Instead, it is far better to recognise the early signs and seek professional advice.
Warning signs of balance sheet insolvency
The early warning signs of balance sheet insolvency include:
- Negative net assets: This is when the company’s liabilities exceed the value of assets on the balance sheet.
- Increase and reliance on short-term borrowing: When a company needs to use loans or overdrafts to cover day-to-day expenses.
- Decreasing asset value: Significant declines in the value of assets, stock and property.
- Unable to pay creditors: Missing or delaying payments could be an early indicator of balance sheet insolvency which can lead to cash flow insolvency (being when debts cannot be paid when they fall due).
How to test for balance sheet insolvency
If a company has concerns about its financial position, it can voluntarily test for balance sheet insolvency to determine if it is insolvent. Testing for balance sheet insolvency simple and can be done by anyone who has the asset and liability details of the company.
The purpose of a balance sheet insolvency test is to provide directors with an exact and non-biased assessment of the financial position of the company. Once complete, if the liabilities are of greater value than the assets, the company is deemed to be balance sheet insolvent. Directors can then take action to stabilise their company finances or begin the liquidation process if turnaround is not achievable.
However, if creditors complete their own balance sheet insolvency test and find that the company is balance sheet insolvent, this can result in the creditor considering that legal action is required in order to recover their debt.
Legal implications of balance sheet insolvency
Under UK insolvency law and the Insolvency Act 1986, once a company is deemed to be balance sheet insolvent, it must act in the best interests of its creditors. If the company continues to operate and trade, the directors could face personal liability for the company’s debts.
Failure to adhere to these laws can have dire consequences for company directors. Continuing to trade, or making decisions which are not in the interests of creditors, can result in wrongful trading and/or fraudulent trading charges, which carry large fines and can even lead to disqualification from acting as a director in the future or imprisonment.
Balance sheet insolvency: what are the options?
If a company finds itself insolvent on its balance sheet, there are a few options available to them to try and save the business.
Some of the key insolvency processes that can help to save a company from liquidation or achieve the best outcomes include:
- Compulsory Liquidation – A Court liquidation process where typically the creditor pays the costs of getting the company into Liquidation by way of a winding up petition, then this is administered by a government liquidator and handed out to an independent liquidator if assets remain.
- Creditors Voluntary Liquidation – An out of court process voluntarily sought by directors to close their Company. This is administered by an independent insolvency practitioner.
- Company Voluntary Arrangement (CVA): This involves a legal contract between the insolvent company and its creditors. Typically, the company will agree to pay 25-100% of its debts to creditors over a 3-5 year period.
- Administration: The struggling company is placed under the control of an insolvency practitioner for the purpose of selling all or part of the company to repay debts or turn the company around and save it. If saved, the company can continue to trade or find a new owner.
- Administrative Receivership: Similar to administration, an administrative receiver is appointed by a single creditor. Therefore, they act in the best interests of that one creditor to sell assets to help the company settle its liabilities with that creditor. This approach often ends in liquidation.
Looking for balance sheet insolvency advice?
If your company is showing early signs of balance sheet insolvency or you think it may already be insolvent, we can help at Bridge Newland. For affordable and professional advice, please contact our friendly team on 0800 612 6197.
Categorised in: Insolvency Reviews & Advice
