This checklist outlines how bankruptcy and insolvency are commonly approached and managed.
An insolvent company is one that cannot pay its debts. Cash flow insolvency is the inability to pay debts as they fall due, while balance sheet insolvency occurs when a company has negative net assets and its liabilities exceed the assets. A company can be cash flow insolvent but balance sheet solvent if its assets are illiquid, particularly against short-term debt. Conversely, a company could have negative net assets on the balance sheet but still be cash flow solvent if income can meet debt obligations. Bankruptcy (liquidation in the United Kingdom) occurs when a court rules that a company is unable to pay its creditors. Creditors can force bankruptcy by filing a suit in court against the company in debt, but more usually a company will initiate bankruptcy proceedings itself.
Insolvency law around the world varies, but is generally aimed at protecting creditors’ interests and keeping a business afloat. As companies generally want to avoid bankruptcy, the usual practice today is for an insolvent company to file for “bankruptcy protection” (in the United Kingdom, the equivalent is for the company to go into what is called “administration”). An administrator can be appointed by the company directors, or creditors can ask a court to appoint one (without petitioning for bankruptcy). The administrator’s job is rescue the business and maintain it as a going concern. To this end, administrators work to restructure the business and its debts in order to pay off creditors and ensure the company emerges in good financial health for the future.
Bankruptcy may follow insolvency, but can also be initiated without going into administration. Bankruptcy laws vary enormously around the world, but all legislation has the aim of winding up the company and paying off creditors. Receivers are appointed by the court to manage this process. The largest creditors will have priority as the debts, or portions of them, are cleared. Some—particularly customers who bought goods but never received them—may never see their money again.
Appointing administrators is often the smartest option for an insolvent company, as it keeps the company trading and encourages managers to face up to the challenges of learning from their previous errors.
Bankruptcy may be the best option for a smaller company if its debts are too big to be managed by administration, although there are downsides (see below).
Public knowledge of financial problems can cause reputational damage to an insolvent company, possibly hampering the restructuring process and causing customers to decline to do business.
In many jurisdictions, company directors are banned from running a business for a set period of time if they are involved in a bankruptcy. In some jurisdictions, company directors may be forced to surrender personal assets to clear company debts.
In some jurisdictions, being made bankrupt can make it very difficult for a company owner to start a new business in the future.
If you need to appoint administrators, choose a firm that has a strong track record in turning ailing businesses around.
It may be worth asking a different firm of accountants to give a second opinion on the company’s books to see if there is any other way forward.
Dos and Don’ts
Weigh up all the options before embarking on any course of action.
Take appropriate advice, including consulting your bank and other financial advisers.
Don’t rush into making a decision to go bankrupt as other options may be better.
Don’t forget that bankruptcy fraud (concealment of assets, concealment or destruction of documents, making false statements, etc) is a crime.