What is insolvency?
There are two types of insolvency in UK law, as set out in the Insolvency Act 1986:
- Balance-sheet insolvency – is when a balance sheet has more liabilities than assets. This does not necessarily mean that the organisation must close. As long as it is possible to pay debts as they fall due and that the trading performance is likely to improve, the organisation can usually continue to operate, but special care should be taken to protect creditors.
- Cash-flow insolvency – is when creditors cannot be paid as they fall due. This position often leads to an organisation going into liquidation.
Boards must ensure that they closely monitor solvency and take immediate advice and action if they become insolvent. If an organisation continues to trade while insolvent, then individual board members can be held to be personally liable for the debts incurred during the insolvency.
For more information see the Charity Commission’s guide on understanding reserves and the need for a reserves policy.
