Published on 21 December 2010 by Tony Groom

Creditors’ Voluntary Liquidation is a process by which the directors of an insolvent company can close it down without involving a court procedure.

There are four tests of insolvency laid down in the Insolvency Act 1986 and any one of the four tests can be used to determine whether the company is insolvent.

The tests are that the company has failed to pay a judgement debt, or deal with a statutory demand, the cash flow test and the balance sheet test. The most common is the cash flow test defined by whether or not the company can pay its liabilities on time.

Insolvency does not necessarily mean that a company should be closed down, but depends crucially on whether or not continuing to trade will enable the company to emerge from insolvency and will improve the position for creditors. In addition to trading out of the insolvency, there are a number of options, using formal and informal restructuring procedures, for avoiding liquidation. These would normally be incorporated in a rescue plan that would be developed by an insolvency practitioner or rescue adviser.

If the company does continue to trade, the directors should seek professional advice as they have a legal obligation to act in the best interests of the company’s creditors and if it should turn out that the company eventually does have to be closed down they will need documented proof of this. Failure to follow strict guidelines for trading while insolvent can lead to the directors becoming personally liable for the company’s debts if it does have to be closed down.

In the event that the directors conclude, with or without advice, that the company should be closed, they can then use the formal process called Creditors Voluntary Liquidation to wind up the company in an orderly fashion.

The CVL procedure is defined by the Insolvency Act 1986. It involves a board meeting at which the directors formally agree that the company should cease to trade. The next step is to seek shareholder consent. While this might be straightforward for a very small company with shareholders consenting to a short notice meeting, larger ones can be more complicated. At least 75% of the shareholders must approve the directors’ proposal that the company be placed into liquidation and at least 50% must approve the nominated liquidator. The shareholders may however disagree and wish to appoint new directors to save the company. In practice the directors normally sound out shareholders before convening the meeting.

Documents must be prepared including Statutory Information on the company, a history of the business, historical financial information of the company, deficiency account, a statement of affairs and a list of creditors.

The directors must first have members’ (shareholders’) support for the closure so a meeting has to be called in accordance with the company’s Memorandum and Articles, which define the length of notice they must be given, usually 14 days.

At the meeting the members (shareholders) are asked to pass a resolution to close the company by a vote of more than 75% and to appoint a properly licensed liquidator to manage the process and ensure it is all carried out correctly.

A meeting of creditors is also convened under section 98 of the Insolvency Act 1986 – this requires giving them at least seven days’ notice (excluding time for postage). The creditors meeting involves confirmation of the nominated liquidator or appointing the creditors’ own nominee who will need approval by at least 50% of the creditors. All nominated liquidators must be licensed insolvency practitioners who have provided consent to act. This consent must be available for inspection at the meeting. In practice, 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 them to assist the liquidator and to represent them by overseeing the conduct of the liquidation.

Preparation for meeting involves the directors producing a statement of affairs which is a prescribed format document that shows asset realisations and any creditors who have a claim over them. It makes assumptions about the value of realisations from the sale of assets and includes all creditors, trade, HMRC, finance, employees and contingent creditors that will crystallise due to termination of contracts. The directors must also produce a history of events to explain the circumstances that led to the company becoming insolvent.

Normally the directors would engage an insolvency practitioner or solicitor to help guide them through the above process and administer the sending out of notices so that the procedure is done correctly.

Following appointment the liquidator has a number of duties to perform. They must deal with assets which are normally sold, they must access creditors’ claims and then they must distribute surplus cash to creditors following a strict order of legal priority. They also have a duty to investigate the accounts and activities of the company and in particular look at the transactions prior to the company be placed into liquidation. Having done this they report to the Insolvency Service on the conduct of the directors with a view to pursuing them in the event of personal liabilities and disqualifying them in the event of a failure to discharge their duties correctly.

The advantage of a CVL is that it is a very efficient procedure with the liquidator taking over responsibility for dealing with creditors and closing down the company. It also has the benefit of demonstrating that the directors were responsible in carrying out their duties by them taking steps to close down the company in an orderly manner when they believed it should cease to trade.