Insolvent Liquidation?

August 25, 2020

What happens when a company goes into insolvent liquidation

It is a time of great uncertainty and confusion as a company heads towards the rocks of insolvency. Its directors and managers are firefighting with their dwindling cash flow and trying to placate angry and often aggressive creditors. The time for a business rescue procedure like Administration or a Company Voluntary Arrangement (CVA) has passed. There is no future for the company, so sadly it must be put into Liquidation. There are two ways in which a company can go into Liquidation. It can be a voluntary process initiated by the directors, through a procedure known as a Creditors’ Voluntary Liquidation (CVL). Alternatively, it can be an outcome forced onto the company when a creditor petitions for the company to be wound up by the courts, using another insolvency procedure called Compulsory Liquidation. Whichever way the Liquidation is triggered, the assets of the insolvent business are sold and the net proceeds after the costs of the liquidation are used to repay as much as possible to the creditors. The exact steps to be taken will vary depending on which of the two types of liquidation. The process will be overseen by either a licensed insolvency practitioner if it is a CVL or by the Official Receiver (who works for the Insolvency Service) if it is a Compulsory Liquidation. It will involve the sale of all of the business’s property, assets and anything else of value, followed by the complete dissolution and closure of the company. The directors play no part in the process, unless under exceptional circumstances they may be asked to assist in achieving a better outcome for the creditors. The bottom line is that whether the liquidation is voluntary or compulsory, the result will be the same; creditors are paid as much as possible and the company ceases to exist.

What Happens During a Compulsory Liquidation?

The Compulsory Liquidation of a company is usually started when a disgruntled creditor lodges a winding up petition (WUP) with the court. The motivation for doing this is simple; the creditor is hoping to recover all or at least some of the outstanding debt the insolvent company owes them and has lost patience with all other collection options. In some instances, the creditor may wish to stop the company from continuing to trade because they believe that this will increase the losses suffered by creditors in general. During the Covid-19 crisis, the government has temporarily banned the use of a WUP, unless the creditor can prove that the company is not paying its debts for some reason unconnected with the impact of the virus, which is likely to prove extremely difficult. Eventually, creditors will be able to issue WUPs once more. Although the petitioner is usually a creditor, this is not always the case. Shareholders or any other interested party can present a WUP to the court so long as they have a legitimate reason for doing so. Shareholders might believe that this route is their only option to prevent the directors from continuing recklessly to trade on, or sometimes to resolve a shareholder dispute. The directors of the insolvent company can also legally lodge a petition to have the company wound up, but this is usually handled through a CVL instead. After the court has issued a winding up order, the process of selling the company’s assets begins. All contracts, including employment contracts are automatically terminated and any legal actions taken by creditors are considered void because the company is in the process of being closed down and will soon cease to exist as a legal entity.

What happens during a CVL?

The CVL procedure is usually less stressful as the process can be planned in advance to minimise disruption. The company’s directors will have the benefit of the assistance and guidance of a licensed insolvency practitioner, who will manage the entire process. There is often little for the directors to do once proceedings have been initiated, but they will be involved to one degree or another in the preparations for putting the company in a CVL. Providing the directors can show that a CVL will provide the best outcome for the company’s creditors, then approaching a potential liquidator is surprisingly straightforward. But the insolvency practitioner will want to review the financial position in detail and discuss with the directors whether there may be other more suitable solutions, which may either allow the company to continue trading, or to maximise the return to creditors. This could involve negotiating with creditors and entering into a CVA to manage cash flow or restore the company’s solvency. Alternatively, it might mean placing the company into Pre-Pack Administration if the directors wish to purchase assets of the business and start up again or if there is potential third party buyer for the business and/or its assets.

Reasons to opt for a CVL

The directors of a company have a variety of fiduciary responsibilities, of which one of the most important is to recognise when there is no way out of their financial position and that the business is too indebted or too unprofitable to survive. They must then take quick and decisive action to prevent creditors from incurring any further losses than they have already suffered. This means seeking the assistance of a licensed insolvency practitioner to discuss the company’s financial problems. Delaying taking this step and continuing to trade will only lead to a further increase in creditor losses, which puts the directors at risk of being held personally liable for these increased losses under the Wrongful Trading provisions in the Insolvency Act. This is one of the areas where the normal rules of limited liability can be turned on their head. By taking advice from a licensed insolvency practitioner once the directors realise that their company is insolvent, they are demonstrating their commitment to placing the interests of your creditors above their own, which will help in refuting accusations of Wrongful Trading. As with the temporary ban on creditors issuing winding up petitions, Wrongful Trading prosecutions have been suspended for the duration of the pandemic; however, they will be re-applied in due course.

Directors Duties in a Liquidation

Although the appointment of Liquidators relieves the directors of all powers and their further involvement with the company may be limited, there are two specific duties which they must observe whether it is a CVL or a Compulsory Liquidation Statement of Affairs & Explanation for the Failure The Directors are required to prepare a statement of the company’s financial position as at the date that it went into Liquidation to prepare a brief history of its trading with an explanation of the reasons for its failure. Liquidators will generally be willing to assist if the directors do not have the knowledge or skills for these tasks, especially with regard to the Statement of Affairs. Duty to cooperate with the Liquidator Directors must assist the Liquidator as and when requested to do so. Failure to do so can lead to disqualification as a director for a period of up to fifteen years.

Directors Conduct Report

The Liquidator is obliged to prepare a report to the Insolvency Service on the conduct of the directors.  This will form the basis of a decision as to whether or not to start disqualification proceedings against a delinquent director or to take action under a number of provisions of the Insolvency Act, including Wrongful Trading and a number of other statutory offences. We are experienced in advising directors on all aspects of their company’s financial affairs, including insolvency and the need to take prompt action to place the company into Liquidation. If you’re facing the threat of a Compulsory Liquidation, or believe a CVL may be the only option left for your company, we will be pleased to assist.

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