Insolvency is, unfortunately, part of business; not all businesses will succeed, and many will become insolvent.
But what is insolvency, what process does a business follow during insolvency, and what happens if one of your clients/customers goes insolvent with unpaid debts to you?
We’ll answer these questions and more in this blog.
What is insolvency?
When a business becomes insolvent, it means that its financial liabilities exceed its assets, and it is unable to meet its debt obligations as they come due. Insolvency can result from various factors, including poor financial management, economic downturns, excessive debt, or declining revenue.
Essentially, when a business declares insolvency, it’s because they cannot pay off their debts and cannot continue functioning as a business.
At this stage, an insolvency practitioner (IP) is usually appointed. It’s their job to liquidate the business by selling off all assets, and settle any debts to the best of their ability. This might mean that, if someone owes you money, that you’ll not get the full amount back. This is why trade credit insurance is so important, but more on that a little later.
What Happens When a Business Becomes Insolvent?
1. Assessment of Insolvency
Business owners or management typically first assess the financial situation and determine whether the business is insolvent. This may involve consulting with financial experts or accountants to evaluate the company's financial statements.
2. Appointment of an Insolvency Practitioner
In many cases, when a business becomes insolvent, it will appoint an insolvency practitioner or a licensed insolvency trustee (in some jurisdictions) to oversee the insolvency proceedings. These professionals are responsible for ensuring that the process is carried out legally and fairly.
3. Communication with Creditors
The insolvency practitioner will communicate with creditors, informing them of the situation. Creditors may include suppliers, lenders, employees, and other parties to whom the business owes money.
4. Legal Options
Depending on the severity of the insolvency and the jurisdiction, the business may consider various legal options, including bankruptcy, insolvency proceedings, or restructuring. The specific course of action will depend on the company's circumstances and local laws.
If the insolvency is severe and there is no viable plan for recovery, the business may file for bankruptcy. In bankruptcy, the business's assets are liquidated, and the proceeds are used to pay off creditors in a specific order of priority established by the law (this often starts with HMRC). Once the process is complete, the business typically ceases operations.
6. Insolvency Proceedings or Restructuring
In less severe cases of insolvency, the business may pursue alternatives, such as entering into administration or restructuring its debts. These options aim to negotiate with creditors to reach agreements on repayment plans, debt reductions, or other arrangements that allow the business to continue operating.
7. Employee Concerns
Insolvent businesses must also address employee concerns, including wage arrears, termination, and potential layoffs. Depending on local labour laws and the circumstances of the insolvency, employees may be entitled to certain protections and claims.
8. Liquidation of Assets
In cases where assets are to be liquidated, an orderly process is followed to sell off the company's assets, with the proceeds distributed to creditors according to the established priority. The IP will lead this operation.
9. Closure and Dissolution
Once all obligations and liabilities have been addressed, and the assets have been distributed, the business is typically closed and dissolved. This may involve formal legal processes to officially wind down the company.
10. Creditors' Recovery
Creditors may not always recover the full amount owed to them, especially if the assets are insufficient to cover all debts. The distribution of proceeds is usually done based on a predetermined hierarchy, with secured creditors being paid first, followed by unsecured creditors.
What Happens If One of Your Clients Becomes Insolvent?
If your business becomes insolvent, that’s it, the Insolvency Practitioner (IP) will handle the rest.
If one of your clients becomes insolvent, however, you may be uncertain how much of your debt will be settled, if any. This will depend on the amount of outstanding debt, the nature of your business relationship with the client, and the legal and financial circumstances surrounding the client’s insolvency.
When one of your clients declares insolvency, and they have outstanding debts to your business, common steps that you should take as a creditor are as follows:
1. Assess the Situation
First, you should confirm and assess whether your client is indeed insolvent – it’s very easy to overreact at this point, so take your time and get all the information you need. This might involve reviewing their financial statements and communications, or consulting with financial experts or attorneys.
Maintain open communication with your client. It's essential to be aware of their intentions and actions regarding the insolvency process. They may be working on a restructuring plan or bankruptcy proceedings that could impact your relationship.
3. Protect Your Interests
Review any contracts, agreements, or outstanding invoices with the insolvent client. Assess your rights and obligations as well as any clauses related to defaults, termination, or payment terms.
4. Consult Legal and Financial Advisors
Seek advice from legal and financial professionals who specialise in insolvency matters. They can help you navigate the complexities of the situation and protect your interests.
5. Debt Recovery and Negotiation
Depending on the circumstances, you may need to negotiate with the insolvent client to recover any outstanding debts or assets owed to you. This could involve participating in insolvency proceedings, working with a court-appointed trustee, or negotiating directly with the client.
6. Meeting of Creditors
A meeting of creditors is a formal gathering or assembly convened during certain legal processes, primarily in insolvency and bankruptcy proceedings, where the creditors of a debtor or insolvent entity come together to discuss and make decisions about their claims, the assets of the debtor, and the proposed course of action.
7. Participation in Insolvency Proceedings
If the client files for bankruptcy or enters insolvency proceedings, you may need to submit a claim for the amount owed to you.
8. Contractual Agreements
Review any existing contracts or agreements to determine how they are affected by the client's insolvency. There may be provisions that allow for termination or modification of the contract under such circumstances.
9. Alternative Solutions
Explore alternative solutions, such as debt restructuring or settling for a partial payment if a full recovery is unlikely. These options can be negotiated through discussions with the client or their representatives.
10. Protection of Your Rights
Be vigilant in protecting your rights as a creditor. Ensure that you comply with any legal requirements and deadlines for filing claims or participating in insolvency proceedings.
11. Prepare for Losses
Depending on the severity of the client's insolvency and the available assets, you may not be able to recover the full amount owed to you. It's important to prepare for potential losses and consider how they will impact your own financial situation.
12. Review and Adjust Business Practices
Use the experience as an opportunity to review your credit policies, risk assessment procedures, and contract terms to minimise the risk of similar situations in the future. It’s also best practice at this point to invest in trade credit insurance. This ensures that, should another client go insolvent, you’ll be financially compensated on any bad debt.
What’s the Difference Between Insolvency and Administration?
‘Insolvency’ and ‘administration’ are two terms that are commonly mixed up.
Administration is a legal process by which an administrator will be appointed by the business and attempt to bring it back from the brink of insolvency. The administrator takes control of the company’s affairs, and will attempt to maximise the business’ chance of survival.
This is, of course, much better for creditors, as they’re more likely to get all of the money that they’re owed. Do bear in mind that many administrators will ask for help from creditors, often asking to establish payment plans or for you to help the insolvent business in other ways. It’s up to you, as a creditor, to decide whether you wish to continue doing business.
Commonly, administration leads to insolvency, so if any of your clients enter into administration, you need to choose whether to preserve the relationship and hope they recover, or exit from the relationship to avoid accruing any further debt.
What’s the Difference Between Administration and Liquidation?
While both liquidation and administration are part of general insolvency procedures, they are very different in approach.
Liquidation is the final part of any company’s life – here all assets are sold, and the company is dissolved entirely.
Administration, on the other hand, offers the business a chance to pull out of insolvency by appointing an administrator and restructuring the business.
How Can You Protect Your Business from Client Insolvency?
Client insolvency is not something many business owners want to think about – after all, an insolvent client can only lead to headaches for you and your business.
That’s why we recommend that any business offering credit to their customers should invest in trade credit insurance.
What is Trade Credit Insurance?
Trade credit insurance is a policy that businesses use to protect their trade debtors from loss due to credit risks such as protracted default, insolvency, or bankruptcy.
Any credit risk is usually caused by customers (buyers or debtors) who cannot fulfil payment obligations. In this instance, if you have trade credit insurance, any debts will be settled by the insurer, and your organisation doesn’t miss out should a client fail to pay.
Trade Credit Insurance is a great way to protect your business and prevent any financial setbacks that are out of your control.
Where Can You Get Trade Credit Insurance?
Fortunately, you’re in just the right place!
PIB Insurance are a market leader in brokering agile, bespoke trade credit insurance, designed to cover anywhere from 75-95% of your invoice sum.
You shouldn’t be penalised for another business’ faults. By insuring against non-payment, you can confidently invest in your growth strategy, safe in the knowledge that your cash flow is assured, and financing can be secured, even in the face of unpaid invoices or bad debts.
Our Trade Credit and Surety division is backed by PIB Group. Don’t take the risk – partner with PIB. Let’s have a conversation about your trade credit insurance needs. Get in touch with our trade credit experts today.