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Company Insolvency: How do you know if any company is insolvent?

Insolvency is a state of financial distress in which a person or business is unable to pay its debts. Insolvency in a company can arise from various situations that lead to poor cash flow. When faced with insolvency, a business or individual can contact creditors directly and restructure debts to pay them off.
|| Ruchika Bhagat, Chartered Accountant

How do you know if your company is insolvent?

A company is insolvent when it can’t pay its debts. This could mean either that it can’t pay bills when they become due.

It can also be put as a situation in which it has more liabilities than assets on its balance sheet.

There are three tests you can do to check if your company is insolvent:

The cash-flow test

Poor cash-flow is usually one of the first signs of an insolvent business. It can be the result of a market downturn, poor credit control procedures or the loss of one or more customers. Poor cash-flow will affect the day-to-day running of your business and make it difficult to grow.

The test: Can you afford to pay debts that are due for payment now or that will become due in the reasonably near future?

If you are consistently making payments long after they’re due and there’s no sign of things changing anytime soon, your company is likely to be insolvent.

The balance sheet test

A balance sheet provides a snapshot of the business’s assets, liabilities and capital at a point in time. It’s important your assets are valued correctly and all of your contingent liabilities (a potential loss that may occur in the future) are taken into account.

The test: Do your company’s liabilities exceed its assets i.e. does it owe more than it owns?

If your company’s liabilities exceed its assets, you would not have sufficient funds to repay all of your creditors even if you sold all of the company’s assets. That means the company is insolvent. If the value of the company’s assets and liabilities are comparable then the business is on the verge of insolvency.

The legal action test

If you owe a creditor more than £750, they can take legal action to recover that debt. Initially, that will take the form of either a statutory demand or a county court judgement (CCJ) being issued against the business. If the debt remains unpaid, the creditor can issue a winding up petition to close your business down.

The test: Has any legal action been taken against the company that is still outstanding?
If there’s an outstanding statutory demand or county court judgement registered against your business that has not been paid, your company is insolvent. This is the case even if the debt is disputed.

What happens when a company is insolvent?

A company that is insolvent is in danger of being closed down.
However, company directors may be able to take action that allows the company to continue trading or a company may, after extinguishing all its liabilities, by a special resolution or consent of seventy-five per cent members in terms of paid-up share capital, file an application in the prescribed manner to the Registrar for removing the name of the company from the register of companies and the Registrar shall, on receipt of such application may remove its name from the Register of Companies.

Pre-requisites/conditions for applying for Striking off name of Company:

  • Extinguishment of all the assets and liabilities of the Company
  • Approval of members for applying for strike off of the Company by way of Special Resolution passed in a duly convened General Meeting or by obtaining consent of 75% of the shareholders in terms of paid up share capital.
  • Financial Statements (Form AOC-4/Form AOC-4 XBRL) and Annual Return (Form MGT-7) should be filed up to the end of the financial year in which the company ceased to carry its business operations
  • There must not be any pending litigations against the Company
  • The Company must not have received Notice from the Registrar under subsection 1 of Section 248.

PROCEDURE for applying for Strike off by the Company under Section 248

Convene a Board Meeting to approve closure of Bank Account, pay off all the pending liabilities, to prepare latest Financial statement of the Company after closure of Bank account and to convene an Extra Ordinary General Meeting of the members.

Send notice of EGM atleast 21 clear days before the EGM or obtain consent for shorter notice from atleast 90% of shareholders for notice period of less than 21 days.

Hold EGM and pass Special Resolution for approval of strike off of Company. Alternatively, instead of passing Special Resolution, consent of atleast 75% of the paid up capital holders can be obtained.

File E-form STK-2 with the respective Registrar of Companies.

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