Posted on Jul 15, 2013 by Lawrence King| Comments (1)
There are two tests for insolvency within the Insolvency Act 1986. Firstly, the Balance Sheet Test, i.e. the value of assets is outweighed by the level of liabilities. Secondly, the Cashflow Test, when a company is unable to discharge its liabilities as and when they fall due.
When faced with an insolvent position many directors, based upon the advice of their accountants and insolvency practitioners, believe that they have little alternative other than to liquidate.
It is all too easy to default to looking at (in)solvency at an isolated date and conclude trading must cease either in order to facilitate an orderly wind down or to enact the often much maligned pre-packaged sale.
But there are always mitigating factors to consider.
We were recently approached by directors who had also consulted another Insolvency Practitioner. The advice they had previously received was that they ought to cease trading, enter into administration or liquidation and then purchase the business as a going concern. This in itself is not always poor advice. However, in this instance it would have served little purpose other than to reduce the return to creditors, leave the directors with a sizable liability and generate largely unjustified professional fees.
The company in question had one pressing creditor but robust future cashflow because of a substantial order book and relatively loyal customer base. The company’s assets were limited to cash at bank and a minor debtor ledger. The company had traded successfully for a number of years but had allowed rapid expansion which had led to an increase in overheads with no real benefit in terms of turnover.
The business was able to restructure so that overheads were reined back to previous levels and this allowed the debts to be discharged over a 9 month period. Not only was liquidation avoided but so was a Company Voluntary Arrangement.
An informal repayment plan was negotiated with the creditors whereby they received 100 pence in the £. In the event of a liquidation the creditors would have received less than 50 pence in the £.
The lesson is to look at each matter on its merits and devise a pragmatic solution avoiding formal insolvency where possible.