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Who Decides When a Limited Company Is Insolvent?

Imagine being a director of a limited company, and suddenly you find yourself unable to pay your company’s debts.

You’re not alone, as every year, countless businesses face the harsh reality of insolvency. But who decides when a limited company is insolvent, and what is the process that follows?

In this insightful blog post, we will unravel the complexities of insolvency, the role of licensed insolvency practitioners, and the legal obligations of company directors, all while shedding light on the various insolvency solutions available for limited companies.

Embark on this journey with us to gain a fresh perspective on this critical topic and learn how to navigate the turbulent waters of insolvency, safeguarding your business and your reputation in the process.

Identifying Insolvency in Limited Companies

Insolvency is an unfortunate reality for many limited companies, with the inability to pay debts as they become due being a critical indicator of financial distress.

Identifying insolvency is of utmost importance, as it allows company directors to take the necessary steps to minimize losses and protect their business.

There are two tests commonly used to determine whether a company is insolvent: the cash flow test and the balance sheet test.

Directors should be vigilant of warning signs, such as the inability to pay salaries or meet payroll obligations.

Prompt and decisive action is crucial, as expert intervention can help prevent a situation from deteriorating further.

Cash Flow Test

The cash flow test is a critical tool in assessing insolvency, as it determines whether a company can fulfil its financial obligations when they become due.

Inadequate cash flow is often one of the first red flags that a company is in trouble, manifesting in delayed payments to suppliers, the inability to acquire additional lines of credit, or failure to pay employees on time.

By utilising the cash flow test, directors can gain a clear picture of their company’s financial health and take appropriate action to prevent further damage or legal action from creditors.

Balance Sheet Test

The balance sheet test, another valuable assessment tool, evaluates whether a company’s assets exceed its liabilities or vice versa.

In simpler terms, this test helps determine if a company has sufficient funds to pay its debts. When liabilities surpass assets, the company is deemed insolvent, and directors must take action to protect creditors and prevent wrongful trading.

By conducting both the cash flow test and the balance sheet test, directors can obtain a comprehensive understanding of their company’s financial position, allowing them to make well-informed decisions moving forward.

The Role of Licensed Insolvency Practitioners

When faced with insolvency or nearing insolvency, it is essential to seek professional advice from a licensed insolvency practitioner.

These professionals possess the expertise and knowledge to assess a company’s financial health and advise on formal insolvency processes.

Licensed insolvency practitioners act on behalf of limited companies and their directors, evaluating the most suitable course of action for the company and communicating with creditors to ensure the best possible outcome.

Assessing Company Financial Health

Licensed insolvency practitioners employ methods such as the cash flow test and the balance sheet test to evaluate a company’s financial condition.

By seeking assistance from these professionals, directors can confirm their company’s financial status and ensure that the necessary steps are being taken to protect the business from insolvency.

With their guidance, directors can make well-informed decisions and take appropriate action to minimize losses, safeguard their company’s future, and maintain their reputation.

Assisting with Formal Insolvency Processes

In the event of a formal insolvency process, licensed insolvency practitioners play a vital role in providing professional advice, negotiating with creditors, investigating the conduct of the company, realizing company assets, and distributing proceeds among creditors and shareholders.

Their expertise is crucial in navigating the complexities of insolvency and ensuring a fair and orderly resolution for all parties involved.

If your company is facing unmanageable debts or an uncertain future, seeking help and advice from a licensed insolvency practitioner is the best course of action.

Legal Obligations of Company Directors

When a limited company becomes insolvent, company directors have a legal obligation to act in the best interests of creditors and minimize their losses.

This may involve ceasing trading, producing management accounts and financial projections, and obtaining consent from creditors to avoid insolvency and save the company.

Directors must prioritize the interests of creditors over their own and those of their fellow directors and shareholders, abstaining from any action that could potentially worsen their position or further exacerbate their losses.

Duty to Cease Trading

Directors have a responsibility to cease trading when a limited company is insolvent, preventing the company from incurring additional debt.

If directors continue to trade while the company is insolvent, they may be held personally liable for any new debts the company accumulates.

By stopping trading, directors can protect themselves from allegations of wrongful trading and ensure the best possible outcome for their creditors.

Seeking Professional Advice

Directors have a legal obligation to seek professional advice from a licensed insolvency practitioner when their company is insolvent.

Failure to do so could result in allegations of wrongful or fraudulent trading, with severe consequences such as being mandated to personally contribute to the company’s debts and disqualification from acting as the director of any limited company in the UK for up to 15 years.

Seeking expert advice is crucial in determining the best course of action for the company, whether that involves ceasing trading immediately, continuing operations in the short term, or exploring insolvency solutions.

Insolvency Solutions for Limited Companies

There are a variety of insolvency solutions available for limited companies, including informal arrangements with creditors, Company Voluntary Arrangements (CVAs), administration, and liquidation.

Each solution serves a specific purpose, and the choice of which route to take largely depends on the company’s financial situation and the objectives of its directors.

By understanding these options and seeking the guidance of a licensed insolvency practitioner, directors can make informed decisions and choose the most appropriate solution for their company.

Informal Arrangements with Creditors

Informal arrangements with creditors involve negotiating directly with them to arrive at a mutually beneficial agreement regarding the repayment of debts, without resorting to a formal legal agreement or court order.

This method can be a viable option for debt repayment when a company is facing temporary financial hardship and none of the creditors have initiated formal action.

However, it is important to remember that informal agreements are not legally binding and should be used with caution as a temporary solution to financial difficulties.

Company Voluntary Arrangement (CVA)

A Company Voluntary Arrangement (CVA) is a legally binding agreement between a financially distressed company and its creditors for the repayment of all or a portion of the company’s debts over a predetermined period.

The company’s directors are the entity that can propose a CVA, while shareholders and creditors are not able to do so.

A CVA allows a company to remain in operation during the agreement and following its completion, providing a lifeline for businesses that may otherwise face closure.


The administration is a formal insolvency process that allows a company to restructure its debts and continue trading.

The process involves transferring the company to an insolvency practitioner who prepares proposals for the company’s creditors, giving them the opportunity to decide whether to accept the proposals or not.

Administration can provide a company with the breathing room it needs to recover and return to profitability while protecting it from legal action by creditors.


Liquidation is the process of concluding a company’s operations and divesting its assets to satisfy its creditors.

This can be conducted through a creditor’s voluntary liquidation or compulsory liquidation. A liquidator, either the official receiver or an insolvency practitioner, is responsible for overseeing the liquidation process.

Their purpose is to ensure that the creditors are treated fairly during the liquidation process.

In the case of a Creditors Voluntary Liquidation (CVL), company directors may be able to avoid allegations of wrongful trading and may be eligible for redundancy pay and other statutory entitlements if they have been employed by the company.


In summary, insolvency is a complex issue that requires the expertise of licensed insolvency practitioners to guide directors through the process.

By understanding the cash flow test and balance sheet test, directors can identify insolvency and take appropriate action.

Furthermore, they must ensure they fulfil their legal obligations, including ceasing trading and seeking professional advice when necessary.

With various insolvency solutions available, such as informal arrangements with creditors, CVAs, administration, and liquidation, directors have options at their disposal to address their company’s financial difficulties and secure its future.

Navigating the complexities of insolvency can be daunting, but armed with the knowledge presented in this blog post, directors can make well-informed decisions to protect their business, their reputation, and the interests of their creditors.

Remember, seeking the guidance of a licensed insolvency practitioner is key to ensuring the best possible outcome for all parties involved.

The fate of your company may hang in the balance, but with the right guidance and decisive action, you can weather the storm and emerge stronger on the other side.

Frequently Asked Questions

What happens to the director if a limited company goes bust?

If a limited company goes bust, the director’s role is terminated and they may be required to contribute their own funds to help pay off the company’s debts.

The director will also be banned for 5 years from forming, managing or promoting any business with the same or similar name as the liquidated company.

This can have lasting implications for their career.

Are directors liable for insolvency?

Generally speaking, directors can be held liable for insolvency if they have breached their duties to the company or its creditors.

This includes failure to act in the best interests of the company, trading while knowing the company was insolvent and failing to take steps to minimise losses when a company is in financial difficulty.

In such cases, directors are likely to face serious legal consequences.

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