Insolvency refers to a situation where a company or an individual can’t pay their debts. Read this guide to learn about the options that individuals and companies can use to navigate insolvency and handle their debts.
Last reviewed on 24 October 2022.
Insolvency is when a company or a private individual is considered unable to pay their debts. Insolvency is usually identified when the company or individual has more liabilities (ie debts) than assets.
A company may also be considered insolvent if, for example, the courts decide that it is insolvent based on the evidence presented to them.
Where a company is insolvent, it’s usually the directors’ duty to identify this.
Insolvency is a term that can apply to both individuals and companies. Meanwhile, bankruptcy only applies to individuals and doesn’t apply to limited companies or partnerships.
There are other legal methods of managing personal insolvency, other than bankruptcy. These include individual voluntary agreements (IVAs) and debt relief orders (DROs).
Individual voluntary arrangements (IVAs) are legal agreements with creditors to repay debts over a period of time. IVAs and payments made under them are managed by insolvency practitioners.
Debt relief orders (DROs) are court orders that protect individuals from having to pay certain debts for a certain period (usually 12 months), whilst imposing restrictions on the individual (eg against running a business)
For information about other personal insolvency options, see the Government's guidance.
Sole traders, unlike company directors, are personally responsible for their business’ debts.
If a sole trader becomes insolvent, they should make use of personal insolvency options such as applying for bankruptcy or entering into an IVA.
Sole traders may be able to continue operating whilst paying debts via legal arrangements (eg an IVA). If you’re made bankrupt you may, for example, be allowed to keep reasonable assets that allow you to perform your job (eg trade tools and equipment).
Depending on the aim of the company and the severity and character of its insolvency, different options are available.
The cheapest way for an insolvent company to save its business is to negotiate payment terms with its major creditors to, for example, delay payment. This doesn’t involve any insolvency procedures. However, it may be difficult for all the necessary creditors to reach an agreement at the same time. Moreover, the creditors are unlikely to agree to payment plans if the company has no prospect of honouring its promises to make payments at a later date. If such voluntary payment plans cannot be reached with all necessary creditors, other options will need to be considered.
An alternative to reaching a consensual agreement (eg agreeing on a payment plan) is making formal arrangements with creditors. This option is efficient since it overcomes the hurdle posed by creditors not all agreeing on a repayment plan. Once a certain proportion of the company’s creditors (or a proportion of the creditors within a class of similar creditors) have voted in support of an arrangement, the arrangement binds all of them.
There are two possible arrangements: the Scheme of Arrangement and the Company Voluntary Arrangement (CVA).
A Scheme of Arrangement is a binding legal agreement between a company and its creditors that has been approved by the courts. Schemes of Arrangement can be used to implement a broad variety of restructuring measures (eg delaying repayment or exchanging debts for shares). Once approved by creditors and the court, a Scheme becomes binding on the relevant creditors, including secured creditors. They are flexible and can range in scope, and may be preferred as they are governed by the Companies Act 2006 rather than insolvency law, so using them helps companies avoid the stigma of using strict ‘insolvency’ practices.
A CVA is an agreement between a company and its creditors to put in place a timetable for the repayment of debts. This allows the company to attempt to trade itself out of financial difficulty. Where this isn’t possible, it’s used to achieve a better result for creditors than if the company was wound up. CVAs are usually less costly than Schemes of Arrangement because they don’t always involve the courts. However, they can be less effective as they’re often only binding on unsecured creditors.
Administration is a short-term insolvency mechanism that allows a business to continue trading whilst an appointed administrator attempts to pull the company out of insolvency so it doesn’t have to be wound up.
If a business can still be rescued but the company requires protection from creditors’ legal actions (ie claims to recover debt), administration is usually the appropriate option. Companies tend to enter administration first, followed by, if required, formal arrangements or liquidation.
Distinct features of administration include:
the suspension of creditors’ rights to take specific actions without the administrator’s or court’s consent (known as a ‘moratorium’)
the appointment of an administrator who takes over the management of the company
For more information, read Administration.
Liquidation is an insolvency process used for companies that cannot be saved (eg once administration has failed). Liquidation is usually the last resort for companies. Its primary function is to sell the company’s assets for cash to repay the debts owed to creditors. There are two types of liquidation: compulsory liquidation and voluntary liquidation.
For more information, read Liquidation and Closing a limited company, and see our Checklist for closing your company.
The main difference between administration and liquidation is their objectives.
Administration aims to help the company get out of debt to stay in business, while liquidation results in closing down the company.
If an administrator believes that a business can’t be rescued, they must ensure that the administration process achieves a better result for creditors than liquidation would. As such, their role is to maximise value for creditors by selling business assets. A liquidator’s role, on the other hand, is to generate cash quickly to repay creditors.
The CIGA reformed insolvency law, introducing new restructuring tools and protection for companies going through an insolvency or restructuring process.
This new moratorium procedure acts as a payment holiday for specific pre-moratorium debts that fall due during the moratorium period. This provides companies with breathing space to develop and start a business rescue plan, by temporarily relieving them from the pressure of creditors.
During this period, directors will remain in charge of the management of the company but will be supervised by a ‘monitor’ (a licensed insolvency practitioner). The monitor is responsible for ensuring that the creditors’ interests are protected. Certain transactions, for example the grant of new security, require the monitor’s approval.
The ‘Restructuring Plan’ is a new type of procedure that companies in financial difficulty can use to reach a compromise with their creditors. It is similar to a Scheme of Arrangement, with a notable difference being that it’s binding on all creditors including those within a class that’s overall vote was against the agreement. This is known as a ‘cross-class cram down’.
Suppliers aren’t allowed to end their contracts on the basis that the other party has entered into a formal insolvency procedure, the new moratorium, or the new Restructuring Plan process.
Furthermore, once a company has entered into an insolvency procedure, suppliers can’t exercise their termination rights that arose from events that took place before the start of the insolvency process.
Suppliers can only terminate a contract if they obtain the relevant one of:
consent from the company
consent from the court, or
consent from the administrator, liquidator, or administrative receiver
Some supply contracts are excluded from the prohibition. Ask a lawyer if you have any questions about insolvency and the different insolvency procedures.