Generally speaking, insolvency can occur when the liabilities of an individual or company are greater than the value of its assets and as a result, the individual or company are unable to pay their debts.
Personal insolvency
There are a number of insolvency mechanisms which can be applied to individuals. These mechanisms are governed by the Insolvency Act 1986, with the three main forms being as follows:
1. Individual Voluntary Arrangements (IVA)
IVAs are essentially contractual arrangements between an insolvent individual and their creditors. They allow a debtor to settle some or all of their debts at a discount and are tailorable to the situation to which they are applied.
The individual will propose terms to their creditors and the creditors simply vote whether they are in favour or otherwise. If creditors holding 75% of the total sum owed agree to the terms, the IVA will be approved. Interestingly, it binds all creditors who were entitled to vote, irrespective of whether they took part or sought to reject the proposal.
There are means of challenging an IVA but speed is of the essence and those wishing to challenge should contact a solicitor as quickly as they can.
2. Debt Relief Orders
Debt Relief Orders are used when an individual is insolvent, but the assets and income are minimal. This mechanism can be used when the individual is unable to pay their debts, such debts are less than £50,000, and the total assets are less than £2,000, with disposal monthly income at £75.00 or less.
If approved, the individual will be placed into a moratorium, which stops any creditors from taking action in respect of qualifying debts; essentially it is an attempt to provide relief. At the end of the moratorium, the individual will no longer be required to pay the sums that were owed.
3. Bankruptcy
Bankruptcy is the most well-known mechanism of insolvency and certainly the oldest, with the first laws passed by King Henry VIII in 1542. Additionally, it is the only mechanism that can be initiated by a third party.
In order to declare an individual bankrupt, the court must be satisfied that the debt is over £5,000, that the sums are immediately due and owing, and the debtor appears to be unable to pay said debts once they fall due.
Of the mechanisms referred to above, bankruptcy has the most severe consequences for the individual. The bankruptcy order is made public and financial institutions will freeze any and all bank accounts related to the individual. As at the date of the order, all assets owned by the bankrupt are vested in a Trustee. The Trustee will liquidate all assets and distribute the sums to the creditors on an equal basis (e.g. pence in the pound )
That being said, as with IVAs and debt relief orders, the bankrupt is given a financial ‘clean slate’ and can rebuild their lives without debt once the relevant process is concluded.
The Insolvency Service is the government agency that is responsible for processing and recording events of insolvency. In 2023, there were 103,454 individual insolvencies which was 13% lower than those registered in 2022, of those 62% were individual voluntary arrangements, 30% were debt relief orders and 7.5% were bankruptcies.
Corporate insolvency
In 2023, one in 186 active companies entered insolvent liquidation, with the Insolvency Service recording 25,158 company insolvencies. This was the highest number since 1993 and 14% higher than in 2022. 82% related to Creditors Voluntary Liquidations, 11% were Compulsory Liquidations and 2% related to Company voluntary arrangements.
The highest increase has been seen with Creditors Voluntary Liquidations (CVL) as the figures show that the amount of CVLs is the highest since 1960. A CVL is a procedure which is instigated by the shareholders of an insolvent company, usually upon advice of its directors who have concluded that the business is no longer feasible and is unable to pay its debts.
Whereas, a Compulsory Liquidation is a court supervised procedure that tends to be instigated by a creditor. The creditor will provide a petition to the court that states that a company is unable to pay its debts and requests that the court review and order the winding up of the company.
The ability of a company to pay its debts is tested in two ways:
- The first is by way of cashflow, which is a commercial test that assesses whether the company can pay any expenses/invoices as they fall due. It may be that the company has assets but if they are unable to access the funds to pay liabilities, it may well be that they are cashflow insolvent.
- The remaining test is an assessment of the company balance sheet. The company would be deemed insolvent if there is a shortfall when comparing assets owed by the company with the amount of its liabilities.
Once the resolution (in the case of a CVL) or a winding up order (as per the compulsory liquidation) is made, a liquidator is appointed and has control of the company’s assets and affairs. Depending on the company in liquidation, the liquidator may choose to enter into further contracts on behalf of the company if appropriate. The main aim of the liquidator will be to realise and distribute the assets of the company to its creditors (usually as pence in the pound.).
In addition, the liquidator has a duty to investigate the reason for the failure of the company and report on its directors, which may lead to proceedings against said directors if it is found that they misused company money or did not act in the best interest of the company, now in liquidation.
Finally, Company Voluntary Arrangements is essentially the company version of an IVA.
Insolvency and what you should do
The initial position should always be to seek advice from relevant experts, such as solicitors, insolvency practitioners, and accountants, whether an individual or company. That being said, those seeking such advice should bear in mind that each of the named specialities has boundaries of advice to provide, and a combination of advice is recommended.
The information provided above is ‘surface level’ and there are many ways of avoiding insolvency if that is the best course of action in your circumstances.
If you have any queries with regard to protecting your personal or company interests, or seek to take steps against a third party, and would like to speak to a member of our Insolvency team, please email or call us today on 0113 207 0000.
