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Put simply, insolvency is the point at which a business becomes unable to pay its debts. In England and Wales, this is largely governed by the Insolvency Act 1986. The process which follows is closely regulated and appears regularly on law courses all over the UK (for example, making up a large part of the Company module on the PGDL law conversion course). It may be useful to consider what this looks like in practice through a preliminary overview.
There are four primary ways of determining insolvency, but the main two are the cash flow test (the business is unable to pay a debt as it falls due) and the balance sheet test (the business’ liabilities become greater than its assets). Which one needs to be satisfied depends on the insolvency procedure you are looking to pursue.
Ideally, directors of a company (with strict duties under the Companies Act 2006) will deal with financial hardship in the company before it gets to the final stage of collapse.
Options include applying for a pre-insolvency moratorium (allowing some breathing space on repayment of debts for a temporary period of time – introduced fairly recently by the Corporate Insolvency and Governance Act 2020) or attempting to reach an agreement with creditors (more detail on that to follow). There is also the option to appoint an administrator (where the situation is very serious but there might still be a last-ditch attempt to rescue or restructure), or, finally, putting the company into liquidation (ending its life as a business).
Attempting to ‘do a deal’ with creditors could include processes like CVAs or Restructuring Plans. The latter is the newer option being promoted heavily. This is particularly useful because it can bind all creditors, although limited in the sense it requires court involvement, which can be costly and time-consuming for companies in immediate distress.
Many companies will survive financial difficulties such as insolvency, but unfortunately a large number will also reach the point of liquidation eventually. Once the ‘winding up’ order is provided, the liquidator has to distribute company assets to its creditors (for example selling off its office space in order to pay back a bank loan). There is a detailed order of priority at this stage which must be followed in order to avoid legal action.
A huge number of businesses in England and Wales are now facing the very process outlined above. In fact, according to data from the government’s Insolvency Service, company insolvencies reached highs towards the tail end of 2023 which have not been seen since the financial crisis back in the late 2000s.
The official report notes that the 2023 number was 10% higher than in 2022, that creditors’ voluntary liquidations (a subcategory of liquidation above which sees the creditors demanding a company be shut down, rather than the directors or shareholders doing so independently) were at their highest since 1960, and that, staggeringly, 1 in 191 active companies went insolvent during the 12-month period concerned.
There are a number of reasons for businesses struggling in this way at the moment. First, high interest rates have made the repayment of debts increasingly difficult for many companies. Second, the actual amount of capital available has slowed in many areas, as financial institutions are increasingly hesitant to take large risks with suggestions of a recession looming.
Furthermore, there has been a slow-down in consumer spending in many areas amidst the cost-of-living crisis (naturally hitting retail and hospitality businesses the hardest). Finally, an increase in costs for many businesses (especially on energy bills such as gas and electric) has certainly contributed. As is probably clear, many of these issues are interlinked and form part of a vicious circle by dragging each other down even further.
Another more unique factor could be the fact that many companies were also supported by the government during COVID through numerous taxpayer-funded grants and schemes. Most of these systems have now been removed, leaving businesses who were reliant on those schemes (plus cheaper debt in the past) to face the prospect of continuing long term in a difficult economic climate.
Naturally, any aspiring lawyers (whether solicitors or barristers) should be aware of the latest trends in these areas when going through the application process for opportunities such as training contracts or pupillages.
Interviewers are often very interested in the commercial awareness that these candidates are able to demonstrate – as can be built upon by following news sources such as the Financial Times or Economist (or even blog pages such as this one from The Lawyer Portal).
Candidates should not only seek to understand the business story at hand, but also think about how they could apply it to the everyday functioning of law firms and chambers.
Particular practice areas will be especially interested in this story. Corporate lawyers in general will regularly have to deal with these issues, although with larger businesses instructing firms on a Magic Circle/elite US scale, for example, there will often be specialist insolvency and restructuring teams in place. If this is something which interests you, then following stories such as these is a pivotal step to securing work as a lawyer in these practice areas.
Some law firms even specialise specifically in insolvency procedures (if you were looking to take a more ‘boutique’ route) – for instance Keidan Harrison (though large law firms like Akin Gump and Clifford Chance are equally ranked in the top band on sites such as the Legal 500).
Finally, it is worth noting that not everyone interested in these topics will necessarily choose to become a lawyer. There are a huge number of legal-adjacent jobs available in this highly in-demand field – for example work as a liquidator or insolvency practitioner, which can be a highly fulfilling and lucrative career path.
In short, the recent increase in company insolvencies in England and Wales, while certainly concerning from a wider economic perspective, should act as a very useful learning opportunity for the lawyers of tomorrow interested in areas such as corporate law.
Check out our round-up of commercial awareness questions to challenge you to take a deeper look into the topic:
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