What Is a Set off In the Liquidation Process?

September 5, 2023 / Business Insolvency

Directors may, at some point, consider using a liquidation process for their company. This could be for a number of reasons, including:

  • The directors have voluntarily decided to close their (solvent) company and extract the assets / cash, via liquidation to take up a PAYE-role, move abroad or retire. (This would be with a Members’ Voluntary Liquidation, enabling the company owners to save thousands of pounds due to its tax effectiveness.)
  • The (insolvent) company has severe cashflow problems and is not able to pay its debts, so the directors decide to voluntarily liquidate the company. (This would be with a Creditors’ Voluntary Liquidation.)
  • The (insolvent) company is involuntarily liquidated, by means of compulsory liquidation, as it has not paid its creditors what they are owed, and those creditors have taken action against the company. 

These scenarios are relatively common. However, many parts of the liquidation process are not widely known, for example, the various rights of both creditors and directors involved in the liquidation. Directors should be aware of these rights beforehand, so that they can determine the best course of action. One such right held by creditors is the ability to submit a claim against a company for an outstanding debt. If successful, this can compel a company to pay a creditor the claimed sum before it is completely liquidated. However, creditors are not the only party who can submit such a claim. Directors of a company also can, submitting a claim against one or more of their company’s outstanding creditors for monies owed. This claim is known as a set-off.

In this article, Clarke Bell will discuss the set-off process, how it relates to the liquidation process, and how it can affect you.

What is a set-off in liquidation?

The set-off process is a right held by directors of a company entering liquidation. Essentially, it acts as a means for directors to recover a sum of money owed to their company, which can offset a portion of their debt, hence the name. In some instances, a set-off can reduce a creditor’s claim to nothing, completely removing that part of a company’s debt. In cases of insolvency, or for companies with very little in the way of retained profits, this can be incredibly useful.

However, creditors also have the right to make a set-off claim. This works in much the same fashion as it does for directors; the creditor can submit a claim to recover a debt owed by the company. If the claim is recognised as legitimate, the company will be required to pay it. If the company cannot make the payment once the order is given, then they have the right to seize assets detailed in the set-off clause. This functions much the same way as any other secured loan.

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How does a set-off work in cases of insolvency?

The set-off process for an insolvent company works quite similarly to how it does for a solvent one, though it has one major difference. Specifically, once an insolvent company enters liquidation, a set-off clause will take effect immediately as of the date of the liquidation. This entitles a creditor to what is essentially the first pass at repayment. If this repayment cannot be made in cash, then either a transfer of assets will take place, or assets will be disposed of with the proceeds immediately going to the creditors attached to the set-off clause. However, this is not true for company administration. If a company is entered into administration, the set-off clause can be triggered only if the administrator notifies the relevant creditors.

With the differences present in cases of insolvency covered, let’s consider a practical example. Suppose a company owes a creditor £30,000, but the creditor in question owes the company £10,000 for reasons of faulty merchandise sales or otherwise; triggering a set-off will reduce the total owed by the company to £20,000. This reduction can help a struggling company repay most or all of its debt, and possibly have some left over for shareholders at the end of its liquidation.

Also Read: Standalone Moratorium – How Can It Help Your Company?

When is a company eligible for a set-off?

Not every liquidation will allow for a set-off to occur. Companies must first meet a set of criteria in order to be eligible, as outlined in the Insolvency (England and Wales) Rules 2016. Assuming the necessary criteria are met, the statutory right to a set-off clause will take effect, allowing companies and creditors to apply for a set-off. These criteria include the following:

  • There have been mutual dealings between the insolvent company and the creditor
  • The creditor’s claim must be provable and quantifiable
  • The debt must have been incurred before the date the company entered into an insolvency procedure, including liquidation and administration.

If the above criteria are met prior to a company entering liquidation, the set-off clause will be triggered immediately and without any input from either party.

Is there a difference between a set-off and a counterclaim?

Set-offs and counterclaims are two very different legal processes. The foremost difference is that a set-off can only be used as a “defensive” legal option, one that can work only to reduce the value of an outstanding debt. Counterclaims, on the other hand, can be used aggressively in the event of the sale of faulty goods or a poor installation of machinery. While set-offs act only as what is essentially a refund, a counterclaim can result in the claimant walking away with more money than they started a transaction with.

That said, a set-off can be used as a viable defence against a counterclaim. As set-offs are a defensive measure, the reverse cannot happen. This will cause the defendant to incur a legal fee in order to submit their set-off claim, however, and is occasionally not worthwhile.

Clarke Bell can help you

If you are considering the liquidation process for your company, let Clarke Bell help. 

Whether you are considering a solvent liquidation (MVL) or an insolvent liquidation (CVL), we can help you.

We have more than 28 years of experience in helping directors to liquidate their companies.

Our team of experts can help you to identify the best procedure for your situation, and ensure it is implemented efficiently.

Contact us today for your free advice, and get your problem sorted out.