What is the Corporate Insolvency Test for a limited company?

Updated: 2nd December 2021

A corporate insolvency test refers to a method of determining a company’s ability to meet its liabilities as and when they fall due, and whether the total value of its liabilities - or debts - exceeds its assets. If your company is experiencing signs of financial distress, it is imperative that you take steps to discover whether the business is indeed insolvent.

The three individual tests for insolvency should be viewed together to gain a reliable picture of the company’s financial position, and are designed to trigger the appropriate actions should insolvency be the result.

Maximising creditor interests must be the principle focus if results indicate insolvency. This is a legal requirement for directors of insolvent companies; you could face investigation as a director if you continue to put your own or shareholder interests first.

Begbies Traynor is available for advice and support in this regard, and operates from over all areas of the UK covered through our extensive office network.

Cash flow test

Increasingly squeezed cash flow is often the first sign a company director has that their business could indeed be insolvent. An inability to pay bills as they fall due is a clear sign of your company’s precarious financial situation. Furthermore, a requirement exists to consider whether you can pay bills ‘in the reasonably near future.’

It cannot be over-emphasised that maximising creditor interests is paramount, and takes precedence over company and shareholder interests in this situation. Directors will be expected to understand that if the company is paying its bills late each month, the effect on creditors needs to be managed.

A commercial insolvency test such as this looks ahead to future payments, and although in some industries payments are inherently later than in others, directors should be able to demonstrate that a clear payment procedure has been followed.

Balance sheet test for insolvency

A ‘fair and accurate’ view of the company’s current and future financial position should be reflected in the balance sheet, and must include all contingent liabilities. Items such as work-in-progress and levels of stock must not be overstated, nor should debts owed to the company that are unlikely, in reality, to be collectable.

Presenting a solvent ‘picture’ of the business does not exclude directors from allegations of wrongful trading if a different view emerges at a later date. It is incumbent on all directors to understand the ramifications of their company’s financial position at all times, and be aware of problems with cash flow and other trading issues.

Personal liability for company debts could result, in addition to director disqualification for a period of up to 15 years. The best way to avoid such a situation is to seek the services of a finance professional who can ensure the accuracy of all figures used within calculations.

Begbies Traynor is the leading corporate recovery firm in the UK, and provides advice and guidance on these matters to companies in distress.

Results of these insolvency tests should be viewed as a whole - passing one test does not guarantee a successful result with another. Even if you think the company has passed both of these checks, a third test exists that could dramatically change the outlook for your business.

Legal action test

The ‘legal action’ test looks at whether a company has outstanding Statutory Demands for non-payment of company debt, and/or any unanswered court orders or judgments.

If a County Court Judgment (CCJ) has been upheld against the company, or it has failed to pay a Statutory Demand for payment of a debt exceeding £750, it is likely that the company will be forcibly wound-up. This figure has increased to £10,000 as per the Government's temporary measures which will apply for the period 1 October 2021 to 31 March 2022.

The existence of these outstanding payments officially confirms the company’s inability to meet its liabilities, and is used by creditors as a precursor to winding up.

Failing the legal action test is a clear sign that trading should cease immediately, and creditor interests prioritised. You must also seek the guidance of a licensed IP.

What options are available?

Being insolvent is not an untenable situation. Various options remain that could rescue the business if it is deemed viable, or release cash through consolidation of debt.

A licensed Insolvency Practitioner would need to identify your options depending on the company’s current financial position, actions that creditors are likely to take, and whether there are any outstanding statutory payments.

These options might include:

  • Company Voluntary Arrangement: formal negotiations take place with your creditors – if successful, interest and charges on the outstanding debt are frozen, and a consolidated monthly payment is made for an extended period of time.
  • Company Administration: an administrator is appointed to restructure or reorganise the business, with the intention of returning it to profitability.

Begbies Traynor is the UK’s market leader in corporate recovery. We can present all the options available to you, and offer same day consultations free of charge.

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