Understanding Insolvent Liquidation

March 19, 2021 / Business Insolvency

Since March 2020 thousands of businesses in the UK have been impacted by the COVID-19 pandemic and subsequent lockdown and social distancing restrictions.

Some of these companies will now find themselves to be insolvent. This means they can no longer cover their daily costs or debts. For some of these companies, business rescue is not a viable option and the best thing to do is to liquidate.

If this sounds familiar, Clarke Bell has put together this handy guide to insolvent liquidation in the UK, to help you know what steps you should take next.

Liquidating an insolvent company

A company that is insolvent is one that is no longer sustainable and can’t cover its daily costs, bills or debts.

There are two tests to determine whether a company in insolvent, these include:

  • The balance sheet test: this measures whether a company’s liabilities are greater than its assets. If this is the case, the company can be classified as insolvent.
  • The cash-flow test: this looks at whether a company can pay its bills and debts when they are owed. Again, if your company cannot, it can be deemed insolvent.

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What is liquidation?

Liquidating a company refers to the process under which a company is closed. This is a procedure that must be carried out by a licensed Insolvency Practitioner.

Any company assets are sold and any realisation of revenue is distributed to the company’s creditors.

Next, the business is dissolved, meaning it is struck-off the registrar of companies. This is the final stage of the insolvent liquidation process.  Find out more about dissolution vs liquidation in our useful guide.

There are two paths open to an insolvent company going into liquidation, Compulsory liquidation and Creditors’ Voluntary Liquidation.

Compulsory Liquidation

One form of insolvent liquidation is compulsory liquidation. This is when a company is forced to close by creditors who are unable to recover debts they are owed of more than £750.

In this case, the creditors can issue a statutory payment demand notice, giving your company 21 days to pay back the amount.

Alternatively, creditors can go directly to the courts to issue a winding-up petition by using a pre-winding up demand letter (as opposed to a formal statutory demand) to evidence inability to pay, and then proceed with the petition if the debt is not disputed.

What is a winding-up petition?

A winding-up petition asks for your company to be closed, meaning its assets will be sold to raise the funds to cover debts.

Once the winding-up petition has been issued, the company’s bank account may be frozen. Any other creditors will also have the opportunity to join in on the winding-up petition.

It then usually takes about 1 month after the winding-up petition has been issued for the court to decide whether the company should be wound up.

If it is decided that your company will be forced to close, it will enter into liquidation, meaning its assets will be sold in order to pay back creditors. The court will appoint a licensed Insolvency Practitioner to liquidate the company.

Following liquidation, an Insolvency Practitioner will conduct an investigation into the company to decide whether directors were guilty or wrongful or fraudulent trading.

To find out more about winding-up petitions and what to do if you have been issued one check out our handy guide.

What options do you have?

If you fail to act quickly, the winding-up petition will go ahead and your company will be forced to close via compulsory liquidation, the most serious of form of insolvent liquidation.

If you act quickly there are ways to stop the winding-up petition.

One of these options is a Creditors’ Voluntary Liquidation (CVL), another type of insolvent liquidation in the UK.

Creditors’ Voluntary Liquidation

Although a CVL occurs when a company is insolvent, unlike compulsory liquidation it is a completely voluntary form of liquidation.

So, why would you choose voluntary liquidation?

There are many benefits for both directors and creditors using a CVL.

This is a good option for businesses that believe they no longer have a sustainable future and the best option will be to close their doors. This is a way for company directors to take control of the situation and act before things get any worse.

By opting for Creditors’ Voluntary Liquidation, you can avoid being forced into compulsory liquidation.

As it is a voluntary process, directors who want to put their company into Creditors’ Voluntary Liquidation are free to choose which Insolvency Practitioner they appoint.

With this option, the director can close the company and always has the option to open another business in the future if they wish. What’s more, their personal finances won’t be impacted.

Options for solvent companies 

A solvent company can also enter into liquidation. This is known as Members’ Voluntary Liquidation (MVL.)

An MVL is a legal process that winds-up a solvent company, meaning one that is viable and usually has assets of over £25,000.

As the name suggests, this is a completely voluntary process that is initiated by company directors.

There are many benefits to an MVL. Firstly, it allows a director to quickly close their solvent business and free up funds. What’s more, as a voluntary process this will only ever occur when the time is right for the director.

However, perhaps the main advantage of an MVL is that it lets the company close in a tax efficient way.

By closing your company through a Members’ Voluntary Liquidation, any funds taken out are subject to Capital Gains Tax rather than Income Tax. What’s more, there are further tax advantages for companies that qualify for Business Asset Disposal Relief (which was known as Entrepreneur’s Relief before 6th April 2020).

This is a lot less than the level of income tax you would otherwise be charged which stands at 18% for the basic level and 28% for the higher rate.

Find out more about Members’ Voluntary Liquidation and when you would choose this option in our complete guide.

See how Clarke Bell can help you 

If you would like advice on any of the above, Clarke Bell are here to help you.

Our team of experts have years of experience working with thousands of companies to get the best solution for them.

Get in touch now to see how we can help you.