When a limited company is in financial difficulty, directors aren’t usually personally liable for the business’ debts. That’s because limited companies are separate legal entities, unlike sole traders, who can be pursued for payment through the courts.

Nonetheless, it’s a difficult situation when a company struggles financially, and if you’re a limited company director it’s important to understand your duties and obligations.

If the company is formally insolvent, you’re legally obliged to stop trading and prevent any unnecessary financial losses for your creditors.

If you don’t do this you could face allegations of wrongful trading, and potentially be held liable for business debts.

But how do you know if your company is insolvent?

How to test for insolvency

Cash flow test

If the company cannot pay its day-to-day bills when they become due, it’s likely to be insolvent. Maybe you’ve fallen behind with supplier payments or cannot pay your staff? If so, take great care in how you proceed.

Balance sheet test

The company can also be insolvent if the value of its liabilities is greater than its assets. You need to include contingent liabilities in this test, such as pending claims against the company, to get a true picture of the situation.

These tests should be carried out together, and if the company fails you must obtain professional insolvency help. But what if you’ve not yet reached that stage – is there anything you can do to prevent slipping into full insolvency?

Negotiate with creditors

If you can negotiate with each creditor individually on an informal basis, to repay the company’s debts over a longer period of time, you may be able to stave off insolvency and get back on track. If you’re successful, it’s advisable to have the details confirmed in writing.

Alternative finance

Alternative finance typically offers more flexibility than a standard bank loan. Also, eligibility doesn’t rely on a good credit score.

• A retailer taking high volumes of card payments, for example, might be eligible for a merchant cash advance, which provides regular cash payments based on future card sales.
• Credit based businesses could find invoice finance a good option. This provides a constant flow of cash into the business, as the financier pays a proportion of each invoice in advance, generally within 48 hours.

HMRC Time to Pay arrangement (TTP)

If your company cannot pay its tax liabilities, HMRC might be able to offer a Time to Pay arrangement, or TTP. These agreements typically offer between three and six months’ extra time to pay, but it can be longer in some cases.

A Time to Pay arrangement only covers arrears, though, so you’ll also need to keep up with your current tax payments. If HMRC believes your financial problems are temporary and your company has a good history of payment, a TTP could provide the financial ‘breathing space’ you need.

But what if it’s too late for any of these and your company is already insolvent? What options do you have?

Company Voluntary Arrangement (CVA)

A Company Voluntary Arrangement may be appropriate if your company’s financial difficulties are believed to be temporary – perhaps caused by the loss of a significant customer, for example, or due to a large unexpected bill.

A licensed insolvency practitioner negotiates with creditors to pay off the debt at an affordable rate over a longer period. Essentially, CVAs restructure the debt, and allow directors to trade their way out of difficulty over time.

CVA is a legally binding agreement that stops creditor legal action, and freezes all additional interest and charges. Any debt remaining at the end of the term, which is typically 2-5 years, is written off. Creditors must agree the terms of the arrangement, and this should provide them with a better return than if the company was liquidated.

Company administration

When a company goes into administration, an eight-week ‘moratorium’ on creditor action commences. During this time a licensed insolvency practitioner decides on the best way forward for the company.

There may be several options available depending on the circumstances of each case. The administrator’s first obligation is to attempt to rescue the business as a going concern, and a Company Voluntary Arrangement is one potential exit route.

The administrator might also decide to raise funds by selling off non-essential business assets, or perhaps making staff redundancies. When a plan is decided upon, the creditors receive a report detailing how the company arrived at the position they’re in, and the administrator’s proposals for exiting administration.

Pre pack administration may also be a suitable option. This involves selling underlying business assets quickly to a third party, or sometimes to the existing directors, prior to the administrator being officially appointed.

Creditors’ Voluntary Liquidation (CVL)

If there’s no chance of rescuing the company, it can be beneficial for directors to voluntarily place their business into liquidation. Creditors’ Voluntary Liquidation prioritises creditor interests, and can help directors avoid accusations of wrongful trading.

Control of the company is handed over to the liquidator, who collects in and sells all business assets to repay creditors. The liquidator also investigates the reasons behind the company’s poor financial situation and how insolvency occurred, and files a report with the Secretary of State.

As a director you may be able to claim statutory redundancy pay under a CVL, but this depends on whether you’ve worked as an employee for the company as well as being a director.

Taking positive action to deal with serious debt is essential to minimise creditor losses. Whether that means contacting HMRC when you know you cannot pay your tax bill on time, or quickly seeking professional insolvency help, being proactive can make a huge difference.