Business insolvency can be a confusing area to navigate. Not only is there a myriad of technical terms to know about, but there is a constantly evolving array of procedures and solutions to be aware of.
Company Watch provides a range of in-depth business solutions that accurately predict, identify, and analyse business insolvency indicators.
This guide provides an overview of the key terms you need to know, as well as the procedures associated with business insolvency and business liquidation.
This blog covers the following:
- What is insolvency in business?
- Key insolvency procedures in the UK
- Winding Up Petitions
- The Insolvency Act 1986
What is insolvency in business?
Business insolvency occurs when a company is unable to meet its financial obligations. This can happen due to various internal and external factors. Internally, poor financial management and taking on excessive debt can be a significant financial risk to a company’s solvency.
Externally, economic downturns and sudden changes to regulations can negatively affect cash flow.
When a company becomes insolvent, it can no longer pay its debts as they fall due. This can lead to severe consequences, such as liquidation.
Key insolvency procedures in the UK
1. Administration
This administration process involves appointing an insolvency practitioner to manage the company and explore options to rescue it. The aim is to achieve a better outcome for creditors than liquidation.
Recently, the Company Watch database predicted the collapse of retail company Homebase, which fell into administration in November 2024. Homebase fell into the Company Watch Warning Area in January 2023, with an H-Score® of 6, significantly trailing an industry average score of 66.
Our H-Score® measures a company’s financial health using published financial results, and analyses a company’s financial position from a number of angles including profit management, working capital management, liquidity and how assets are funded.
At the same time, the company’s TextScore®, derived from the text contained in its published financial reports, had been deep in the Company Watch Warning Area since October 2020 with a score of just 11, and was a key indicator of future distress.
The H-Score® and TextScore®, along with other metrics available on the Company Watch dashboard, are some of the most accurate predictors of administration available.
2. Business liquidation
Business liquidation is the formal process of closing down a company and selling its assets to repay creditors. It's a final step in the insolvency process when a company is unable to recover financially.
There are two main types of liquidation:
- Voluntary liquidation: This is initiated by the company's directors. They may choose this route if the company is insolvent but has no outstanding debts or if it has sufficient assets to pay off all its debts.
In a voluntary liquidation, the company's assets are sold, and the proceeds are distributed to creditors according to a specific order of priority.
- Compulsory liquidation: This is initiated by creditors through a court order. Creditors may present a winding-up petition to the court if the company fails to pay its debts or breaches other legal obligations. Once a compulsory winding-up petition is accepted, a liquidator is appointed to take control of the company's affairs and sell its assets.
What happens when a company goes into liquidation?
In essence, when a company goes into liquidation, the following steps typically occur:
- Appointment of a liquidator
- Cessation of business
- Asset realisation i.e. the liquidator identifies and sells the company's assets to generate funds. This may include property, equipment, inventory, and intellectual property
- Creditor claims - this is usually when creditors, such as suppliers, lenders, and employees, submit claims for outstanding debts.
- Distribution of funds
- Dissolution i.e. removal from the Companies House register.
3. Company Voluntary Arrangements (CVAs)
A CVA is a formal agreement between a company and its creditors to reschedule or reduce its debts. It's a way for struggling companies to restructure their finances and avoid liquidation.
Creditors vote on the CVA proposal, and if it's approved, the company can continue trading under agreed terms.
The Insolvency Act 1986
The way insolvency procedures are currently structured in the UK are primarily down to The Insolvency Act, which was established in 1986. It provides a framework for dealing with the financial difficulties of companies and individuals.
Along with guidelines for companies falling into administration, business liquidation, or CVAs, the Insolvency Act regulates the conduct of insolvency practitioners and sets out their duties and responsibilities. The Act also introduced provisions to hold directors personally liable for fraudulent and wrongful trading, which can occur when directors continue to trade a company knowing it is insolvent.
Key takeaways
- Business insolvency arises when a company cannot fulfil its financial obligations, often due to a mix of internal and external factors.
- The 3 key insolvency procedures in the UK are administration, business liquidation, and Company Voluntary Arrangements or CVAs.
- The Insolvency Act 1986 provides a framework for dealing with the financial difficulties of companies and individuals.
