Liquidation – an overview
Liquidation is a procedure by which a company can be wound up, its assets distributed to creditors and members, and then dissolved. Unlike administration, it is not a rescue mechanism that can be used in order to effect a restructuring or structure a sale of the business.
Liquidation can be used as an exit route from administration, however, if for example it becomes clear that the company’s fortunes cannot be turned around, or if a buyer for the business cannot be found.
There are two types of liquidation:
Compulsory – By order of the court. This is commenced by petition, often by a creditor on the grounds that the company is unable to pay its debts.
Voluntary – By resolution of the company.
What is compulsory liquidation?
Compulsory liquidation or “winding-up” is a court-based procedure under which the assets of a company are realised and distributed to the company’s creditors. The procedure is started by the filing (or “presenting”) of a petition at court. A judge then decides at a court hearing whether it is appropriate to make a winding up order. The most common reason for a winding up order is that the company is insolvent. Whether a company is insolvent can be determined by using the cash flow test (a commercial test where the courts look to see if on the evidence the company is paying its debts as they fall due) or the balance sheet test (a shortfall in the value of its assets in relation to the amount of its liabilities, taking into account its contingent and prospective liabilities).
In most cases, a court will dismiss a winding up petition if there is a genuine dispute between the debtor and the petitioning creditor about whether the debt is due.
Briefly, the petitioner presents the winding up at court, and then serves it on the company. The court fixes a date for a hearing. The petitioner advertises details of the petition and the hearing date in the London Gazette. The company and other creditors may be represented at the hearing, whether to oppose or support the petition.
On the hearing of a winding-up petition, the judge may dismiss the petition, adjourn the hearing (conditionally or unconditionally), make an interim order, or make any other order that he thinks fit. When exercising his discretion, the judge will have regard to the wishes of the creditors. If a majority of the creditors in value support a petition to wind up the company, the judge will normally make the order.
Effect of compulsory liquidation order
Once a winding-up order is made, the Official Receiver becomes the liquidator. The Official Receiver is a civil servant and an officer of the court. Upon the making of a compulsory liquidation order, the powers of the company’s directors cease and the liquidator takes control of the company’s assets. Any disposition of the company’s property by anyone other than the liquidator is void.
There is no freeze on enforcement of security but there is a stay on commencing or continuing with proceedings by or against the company without the leave of the court. All company papers (whether in hard copy, electronic or any other form) and websites must state that the company is in liquidation. All employees are automatically dismissed.
There are two types of voluntary liquidation dependent upon whether the directors are willing to swear a statutory declaration of solvency: a members’ voluntary liquidation (MVL) and a creditors’ voluntary liquidation (CVL).
A MVL is commenced by a special resolution passed by the members within five weeks of a statutory declaration made by the majority of the directors, which usually also appoints a liquidator for the purpose of winding up the company and distributing its assets.
A CVL is commenced by a special resolution to the effect that it cannot by reason of its liabilities continue its business and that it is advisable to wind up. A meeting of creditors is then held within 14 days of the general meeting passing the resolution to wind up the company. Both the creditors and the members at their respective meetings can nominate a person to be liquidator for the purpose of winding up the company’s affairs and distributing its assets. The creditors then vote to appoint a liquidator, and should the creditors’ choice of liquidator be different from that of the shareholders, the creditors’ nomination takes precedence.
In a MVL, the company is solvent and the creditors should be paid back in full.
The role of the liquidator
In either a compulsory or voluntary liquidation, a liquidator is appointed to collect in the assets and distribute them in a prescribed order and has certain powers for this purpose. A liquidator acts primarily in the interests of unsecured creditors and members.
Liquidators also have powers to review past transactions and challenge them in order to increase the company’s assets.
A liquidator appointed in a compulsory liquidation will be an authorised insolvency practitioner or the Official Receiver, and is an officer of the court. Once appointed to a company, a liquidator has control of its assets and affairs. A liquidator can enter into contracts and other documents in the name of and on behalf of the company.
The liquidator has a duty to assess the proofs of debt and may accept, reject or seek to compromise the debt. When the assets of the company have been realised and the liquidation is otherwise complete, the liquidator will distribute the fund in accordance with the statutory order of priority (see below). Unsecured creditors will receive a dividend which will usually be expressed as “Xp in the £”. In a lengthy liquidation, the liquidator may be able to pay interim dividends.
A liquidator also has a duty to investigate the reasons for the failure of the company and to report on its directors. The liquidator’s costs of fulfilling his duties will be met from the company’s assets, according to the statutory order of priorities.
Order of payment of creditors
During the course of the liquidation (whether voluntary or compulsory), the liquidator will ask the creditors to send him a proof of debt. To make a claim the creditor must complete a proof of debt form which is sent to all creditors with the notice of liquidation. The liquidator will then approve or reject the proof of debt and will rank it in the liquidation.
The liquidator collects in all the assets and where he has funds available, declares a dividend and distributes this to the creditors who have proved their debts in the following order (the liquidator will first reserve a fund for payment of his own fees):
1 Fixed charges.
2 Expenses of winding up.
3 Preferential debts.
4 Floating charges.
5 Ordinary unsecured creditors (pro rata).
6 Members receive surplus (if any).
What are the differences between a voluntary and a compulsory liquidation?
Court involvement – A creditors’ voluntary liquidation is a procedure that enables an insolvent company to be wound up without a court order and the liquidation is primarily under the control of the creditors.
Director’s powers – In a voluntary liquidation, the powers of the directors come to an end upon the appointment of the liquidator. In a compulsory liquidation, the winding up order terminates the directors’ powers and dismisses them from office.
Liquidator’s powers – In a voluntary liquidation, the liquidation is primarily under the control of the creditors and the liquidator can exercise without sanction certain powers which in a compulsory liquidation would require the sanction of the court or the liquidation committee.
Moratorium on proceedings against the company – Unlike a compulsory liquidation, when a creditors’ voluntary liquidation is commenced there is no automatic moratorium on proceedings against the company. The liquidator or any creditor or shareholder may, however, apply to the court for a stay of any proceedings although this will not be granted automatically. Usually a stay is granted if the creditor’s claim is admitted but not if it is disputed.
Commencement of liquidation – In a voluntary liquidation, the liquidation commences on the passing of the resolution to wind up whereas in a compulsory liquidation it commences from the date of presentation of the petition.
Tips for creditors
Whilst petitioning for the winding-up of a company can be a powerful tool in the hands of a creditor, a creditor must not issue a statutory demand and subsequent winding up petition as a means of debt collection as it will be considered an abuse of process. This includes claiming too much as a debt in the hope of extracting more money.
It is unusual in a compulsory or creditors voluntary winding up for the creditors to receive more than a few pence in the pound in relation to their debts. It is therefore sensible for creditors to protect themselves if at all possible by taking security or retaining title in any goods.
If a loan is unsecured and the borrower defaults and becomes insolvent, the lender will rank alongside all the other creditors of the borrower and may lose some or all of its money. If, however, the lender has taken security for a loan then, provided there is some value in the security, it has been properly registered or otherwise perfected and is not capable of being set aside, the lender will (subject to any rules of priority) be protected on the borrower’s insolvency to the extent of the value of the asset and may be able to be repaid in full and ahead of the other creditors.
The object of a retention of title clause is to give the seller of goods priority over secured and unsecured creditors of the buyer if the buyer fails to pay for the goods because it is insolvent, or for some other reason which may be specified in the clause. The basic clause provides that title to the goods is retained by the seller until it has received full payment for the goods.
The rules and procedure for liquidation (whether compulsory or voluntary) are lengthy and complex. This note merely gives an overview of the process and specific specialist advice should be sought by any creditor wishing to petition to wind-up a company, or by a company threatened with winding-up or against which a winding-up petition has been presented.