Stuart Evans, commercial litigation partner and specialist in business disputes at law firm BLM, discusses in this blog how a business should deal with the threat of insolvency, whether this affects a customer, supplier or (worse still) the business itself, and how early decisions can often avert a crisis.

Figures indicate that approximately one in four start-ups will fail within a year, half of them within four years. The reasons for failure are many and varied; they include the wrong business model, lack of planning, lack of execution, disagreements over direction, inadequate demand, heavy initial expenditure, even loss of energy or motivation. But failure is not the sole preserve of new market entrants; as we have seen in recent years, a declining trend in the high street retail sector has seen the demise of established businesses that have traded for decades, and in some cases, centuries. In the world of business today, things change, often at a frightening speed.

Whilst business failures are not always based on finances, bottom lines are usually the core issue. The spectre of insolvency for a business is therefore real and for most businesses, never that far away. Insolvency normally arises in two situations, either a cash-flow test, namely an inability to pay debts as they fall due or, on a balance-sheet test, where liabilities exceed assets. These are enshrined as tests under the Insolvency Act, as developed in case law.

If your business does go into a formal insolvency process (for example liquidation, administration, or bankruptcy for sole traders), this can have serious consequences. Where there is a large deficiency in a liquidation, directors can face personal liability for wrongful or (worse still) fraudulent trading and misfeasance, the calling in of personal guarantees and the additional threat of directors’ disqualification for a lengthy period of time. If you are a partner in an unlimited liability partnership or a sole trader, this might lead to personal financial ruin. It is therefore essential that the warning signs for insolvency are spotted as early as possible and remedial action is taken, so that these egregious consequences can be avoided.

These difficulties can often start from the outside. It may be that a key customer starts to wobble, and suddenly a “safe” receivable becomes a bad debt. That doesn’t stop the staff needing to be paid salaries, the landlord getting rent, the council seeking business rates and HMRC looking for tax payments. In no time at all, the cash-flow position has worsened. Don’t disregard the insolvent supplier, either; if they fail, then core services that your business needs may disappear overnight.

In a previous blog, we have looked at “zombie” companies. They often get through by paying interest due on their debts, but not the underlying debts. Absent parental company or third party support, the business may only be surviving courtesy of the continuing low interest rates in the UK. Its viability in the future may therefore be questionable. Business zombies may present themselves as entirely normal. Left unchecked, they may damage your business, potentially fatally.

Finding the tell-tale signs of a business in distress is therefore a vital skill for the protection of your own business. Keep an eye on longer delays in getting your invoices paid, credit terms being negotiated, future orders dropping or news of redundancies. Focus also on the supplier negotiating payments up front or on delivery when the course of dealing was not previously the case. Never assume that the company you have been dealing with as a customer or supplier, without previous controversy, may not suddenly be putting your business in danger.

But if there are signs that your own business is under financial stress, be this through customer or supplier failures, or significant claims, rising costs and below projected income, don’t let it fester. Seeking advice on the state of your business at an early stage may turn it around. With independent professional input you can focus on profitable areas of the business, discontinue unprofitable areas, make sensible cost cutting measures, arrangements with creditors and a general steer on restructuring your business. From the threat of collapse may come the opportunity to thrive, with your business in a better shape.

If, having taken advice, there is no prospect of saving the business, you can wind up its affairs with the benefit of professional advice, mitigating your risk of personal liability. If the advice is that with a few tweaks, all is well, then you have shown common sense and been given a professional steer for comparatively little cost.

So never be complacent, recognise the spectre of insolvency, control your customers and suppliers and watch the financial performance of your own business at all times. If you have any concerns, seek early advice; better to have worried unnecessarily at an early stage than realise the game is up when it’s too late.

Disclaimer: This document does not present a complete or comprehensive statement of the law, nor does it constitute legal advice. It is intended only to highlight issues that may be of interest to customers of BLM. Specialist legal advice should always be sought in any particular case.

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