Suzanne Brooker and Stacey Jones explain what happens when it’s the end of the line for a business.
What is liquidation?
Insolvent liquidation (or winding up) is when a company stops trading and its assets and property are realised (ie turned into cash) and distributed to creditors in satisfaction of the debts that they are owed. Following the end of liquidation, the company is dissolved.
The insolvent liquidation process can either be compulsory or voluntary. There are two types:
- Creditors’ voluntary liquidation (CVL): when the directors and shareholders of the business voluntarily decide to close the company because it is insolvent and does not have sufficient assets to cover the company’s debts as and when they fall due.
- Compulsory liquidation: when a creditor applies to the high court to wind up a business due to non-payment of a debt. The company is then liquidated, its assets sold, and the proceeds (if any) distributed amongst the company’s creditors.
Solvent liquidation via a members’ voluntary liquidation (MVL) is the process used for winding up a solvent company, where the company's shareholders have decided to wind up the company in order to distribute the assets after the payment of any debts, and then close the company. In an MVL, the directors must make a declaration that the company will be able to pay its debts in full within 12 months.
An administration process is used where there is a going concern business to be realised – the assets and business can be sold to another, and jobs can be saved. A liquidation process is used where there is no business to be realised, and therefore where the assets will be sold off on a ‘break up’ basis, and the business of the company ceases.
In both solvent and insolvent liquidations, a liquidator (qualified insolvency practitioner) is appointed to facilitate the liquidation process. The liquidator’s role is to collect and apply the company’s property in order to discharge the company’s liabilities and make distributions to the creditors (in the case of a compulsory liquidation or CVL) or shareholders (in a MVL).
Why choose a liquidation process?
An insolvent liquidation is a last resort – it occurs where there is no prospect of trading on. Directors of insolvent companies often think they can trade out of financial difficulty, or cease trading outside of a formal process. However, directors have to adhere to strict fiduciary and statutory duties, so once they have formed the view that the company is insolvent, they have duties to act primarily in the interests of the company’s creditors.
All liquidators (whether appointed by the directors, the court, HMRC, or another creditor) are required to perform a post-liquidation investigation, and they have a duty to thoroughly investigate the directors’ conduct, the decisions they took with regard to the management of the company’s affairs, and the transactions entered into by the company in the lead up to its insolvency.
By taking steps to ensure that the company is placed into liquidation at an early stage, the directors are minimising their exposure to an investigation by the liquidator for, inter alia, wrongful trading, fraudulent trading, a misfeasance action, or transactions at an undervalue, all of which leave them personally financially exposed, as well as risking an adverse finding and disqualification under the Company Directors Disqualification Act 1986.
All insolvent liquidations are a matter of public record. However, compulsory liquidations are advertised in The Gazette prior to the court hearing, and once the petition has been served, the company’s assets cannot be transferred or sold, and the company bank account will be frozen. Other creditors will also be made aware of the winding up petition, and can use the same petition to pursue money owed to them.
If, instead, directors take the initiative to voluntary wind up the company through a CVL, before a creditor invokes the court procedure, there is no court hearing, and it will be apparent to the outside world that it was a voluntary decision by the directors, and not a hostile action taken by the company’s creditors.
If, therefore, the demise of the company seems imminent, choosing a voluntary liquidation process is far more advantageous than waiting for a creditor to force the company into liquidation. It minimises the risk to creditors, helps to ensure that the directors involved get a clean break, and that loose ends are tied up.
The liquidation process is also beneficial to directors and shareholders of solvent companies. Tax benefits are typically the main reason that companies use an MVL process (as opposed to allowing the company to be informally struck off), and the process is often considered the most tax-efficient method of extracting cash and assets from a company (although the rules on the taxation of company distributions are due to change with effect from 6 April 2016). Furthermore, the process has a huge benefit to the directors, as it allows them to dissolve a company in the correct way and not leave any unattended issues behind.