Being unable to pay your employees is one of the most serious financial positions a company can reach. It’s also one of the clearest signals that the business may be insolvent.
If wages can’t be met from current cash flow, you need to understand your legal position as a director, what it means for your employees and what options are available.
What it means legally when you can’t pay wages
Wages are a legal obligation. Employees are creditors of the company and unpaid wages are a debt the company owes. Failing to pay wages on time can expose the company to employment tribunal claims and, in some cases, personal liability for directors if payments are withheld deliberately.
More significantly, being unable to pay wages is a strong indicator of cash-flow insolvency. Once insolvency is likely, your duties as a director shift. You’re expected to act in the interests of creditors as a whole, which includes your employees, rather than continuing to trade in a way that increases losses.
Taking on further obligations, such as hiring more staff or making new commitments you’re unlikely to be able to honour, carries real risk at this point.
Are employees prioritised in insolvency?
Employees are treated as preferential creditors in UK insolvency law. That means certain amounts owed to them are paid ahead of most other unsecured debts when a company’s assets are distributed.
The preferential amounts currently cover:
- Up to eight weeks of unpaid wages, subject to a weekly cap set by government
- Unpaid holiday pay accrued up to the date of insolvency
- Certain other payments linked to the employment relationship
Amounts above those caps become unsecured debts, which rank alongside supplier invoices and other general creditor claims.
What is the Redundancy Payments Service?
The most likely reason is that your company has unpaid liabilities that one or more creditors became If the company enters a formal insolvency process and can’t pay what it owes to employees, employees can make a claim to the government’s Redundancy Payments Service (RPS), administered by the Insolvency Service.
The RPS can pay out from the National Insurance Fund (NIF) on behalf of the insolvent company. This is a significant protection for employees and means that even where the business has no money, employees aren’t necessarily left with nothing.
Claims to the RPS can cover:
- Statutory redundancy pay
- Unpaid wages (up to eight weeks, subject to a weekly cap)
- Unpaid holiday pay (up to six weeks)
- Notice pay, where the employer failed to give proper statutory notice
- Unpaid pension contributions in some circumstances
The RPS pays these amounts directly to employees. The government then becomes a creditor of the insolvent company for those sums, ranking as a preferential creditor.
Does this only apply in formal insolvency?
RPS claims are available once a formal insolvency process has been opened, such as a Creditors’ Voluntary Liquidation (CVL) or Administration. Employees can’t access the NIF simply because the company is struggling. A formal appointment needs to be in place.
This is one reason why entering a formal insolvency process, rather than trying to wind down informally, often gives employees a better outcome. It opens the route to RPS claims and provides a proper framework for dealing with what’s owed.
What should you do as a director?
If you can’t pay wages, or can see that a payroll date is coming that the business won’t be able to meet, the priority is to take advice quickly.
The steps that matter most at this point are:
- Getting a clear picture of the company’s actual financial position
- Understanding whether the business is insolvent under UK law
- Knowing what your duties are as a director from this point
- Exploring whether the business can be stabilised or whether a formal route is needed
Trading through a payroll you can’t fund while hoping the situation improves is one of the riskier positions a director can be in. It can increase the losses owed to creditors, including employees, and continuing to trade in those circumstances may later be examined as potential wrongful trading.
Can the business still be saved?
Depending on the wider financial position, there may still be options that allow the business to continue.
If the inability to pay wages is being driven by a short-term cash-flow problem rather than fundamental insolvency, solutions such as emergency finance, restructuring or a Time to Pay arrangement with HMRC for tax debts may create enough breathing room to stabilise.
If the business isn’t viable, a Creditors’ Voluntary Liquidation gives employees access to RPS claims and brings the company to a proper, regulated close. That’s a better outcome for staff than an uncontrolled collapse and it reduces personal risk for directors who act promptly.
Key takeaways
- Unpaid wages are a company debt and a strong indicator of cash-flow insolvency
- Employees are preferential creditors under UK insolvency law
- The Redundancy Payments Service can pay employees directly where the company can’t
- RPS claims require a formal insolvency process to be in place
- Director duties shift once insolvency becomes likely
- Early advice gives you more control and gives employees a better outcome
Get advice before the next payroll date
If a payroll date is approaching and you’re uncertain whether the company can meet it, that’s the point to seek advice. A short conversation with a qualified insolvency practitioner can help you understand:
- Whether your company is insolvent and what that means for your duties
- What your employees would be entitled to claim through the RPS
- Whether the business can be stabilised or whether a formal process is the right step
- How to protect your own position as a director going forward
Acting early gives you more control over what happens next and gives your employees the best chance of recovering what they’re owed.
