Published on 17 December 2010 by Tony Groom

Insolvent Liquidation involves a formal process to close a company. It happens when a company is insolvent, which means it does not have enough cash or liquid assets to pay its debts and the directors have concluded that continuing to trade will be detrimental to creditors.

There are four tests (set out in the Insolvency Act 1986) any of which can be used to establish whether a company is insolvent.

They are:

• Failure to deal with a statutory demand

• Failure to pay a judgement debt

• Cashflow test, when the company is unable to pay its debts on time

• The balance sheet test, when a company’s liabilities are greater than its assets

The tests don’t necessarily mean that the company will have to close down, although often directors assume that it must. However, there are remedies that could save the company if at this stage it calls on a licensed insolvency practitioner or business turnaround adviser, who would carry out a review of the accounts, the assets including property, stock and debts and the liabilities. With help from the adviser, the company can develop realistic plans for it to survive and trade out of insolvency.

However, once it is decided that the company is insolvent, and cannot be rescued, it should be closed down in an orderly fashion which means via a liquidation process.

This involves the company’s assets, such as the buildings, vehicles and equipment it owns, being turned into cash, which is used to pay off its debts to creditors. In some cases it is necessary to work out the company by continuing to trade for a period to realise trading assets such as selling fresh produce or completing work in progress but this should be done with advice if the directors are to avoid potential for personal liability that can accrue when trading while insolvent.

There are two types of liquidation, one compulsory and one voluntary and both are legal processes.

Voluntary liquidation through a Creditors’ Voluntary Liquidation (CVL) is when the directors of the company themselves conclude that the company can no longer go on trading and should be wound up.

Normally they would engage an insolvency practitioner to help guide the directors through the formal procedure, which involves a board meeting to convene shareholder and creditor meetings.

In order to convene the shareholder and creditors meeting, the nominated liquidator normally sends out notices to shareholders and creditors having obtained their details from the directors. Preparation for meeting will involve the directors preparing a statement of affairs. This is essentially a prescribed format liquidated balance sheet that shows asset realisations by class of asset and creditor. It makes assumptions about the value of realisations from sale of assets and shows all creditors including contingent creditors that will crystallise due to termination of contracts e.g. employees, leases and term agreements. Before the meetings, the directors will also be expected to prepare a short history of events to explain the circumstances that led to the company being placed into liquidation. The company’s advisers or possibly the nominated liquidator may provide some assistance with these but he/she will make it clear that these are prepared by the directors.

The shareholders meeting takes place before the creditors meeting to obtain consent from at least 75% of the shareholders to approve the directors’ proposal that the company be placed into liquidation. It will also consider and approve a nominated liquidator. Given the notice period, in practice the directors normally sound out shareholders before convening the meeting as they may seek a short notice meeting providing they can obtain appropriate consent.

The creditors meeting only requires seven days notice (excluding postage normally at least two days). The creditors must at the meeting either confirm the nominated liquidator or obtain 50% support for another nomination. The nominated liquidator must be a licensed insolvency practitioner who provides his consent to act which must be available for inspection at the meeting. Such consent is normally only provided once the nominated liquidator is satisfied about his/her fees. The creditors, at the meeting, may also nominate a creditors committee that must comprise of three or five creditors appointed by the creditors to assist the liquidator and to represent them by overseeing the conduct of the liquidation.

If the directors have left consulting too late they can then find themselves facing the court winding up procedure rather than having the option of a CVL.

Compulsory liquidation is triggered by a creditor formally asking the courts to have a company closed down by submitting a Winding Up Petition (WUP). In this case the court decides whether or not to support the petition by ordering that the company be wound up (compulsorily liquidated).

Upon a winding up order being made, an officer called the official receiver is automatically appointed to take control of the company to oversee the process of closing it down. The official receiver may, if he/she wishes, appoint a liquidator to assist in dealing with recovering and selling any assets.

Whether the winding up is compulsory or voluntary the liquidator’s job is to write to all creditors asking them to put in claims for the debt they are owed, to investigate the directors and produce a directors conduct report, to convert assets into cash, establish the legitimacy of creditors’ claims and finally make payments to creditors following a strictly laid down legal priority.