Insolvency is a complex topic. A deeper understanding of insolvency is crucial for accountants and other professionals who ‘touch’ insolvency and those directors of companies who have to decide which insolvency route to take. In this blog I will summarise the intricacies of liquidation and administration…
Liquidation: Bringing an End to a Company
Liquidation is a formal process that marks the conclusion of a company’s existence. Unlike sole traders or partnerships, which can simply cease trading, companies must follow specific proceedings to wind up their operations. There are two main types of liquidation: voluntary and compulsory.
Voluntary Liquidation: Members’ and Creditors’ Voluntary Liquidation
Voluntary liquidation can be further divided into members’ voluntary liquidation (‘MVL’) and creditors’ voluntary liquidation (‘CVL’). MVL is pursued when a company is solvent and in good financial health. In this case, shareholders agree, by passing either a special or ordinary resolution, to wind up the company. A declaration of solvency by the directors, affirming the company’s ability to pay its debts within 12 months, is a vital requirement for a MVL. Appointed by the shareholders, a liquidator takes charge of realising the company’s assets and distributing the proceeds to creditors. The entire process typically takes around 12 months.
On the other hand, a CVL is opted for when a company is insolvent, meaning it is unable to pay its debts within the specified timeframe. A special resolution is passed by the shareholders, and a liquidator is appointed. In this case, there is no declaration of solvency. Creditors have a say in approving the choice of liquidator, and a statement of the company’s affairs is provided to them. The liquidation process follows a similar timeline as a MVL, with the assets realised, costs paid any any surplus after costs distributed to creditors in an order set out in the law. Any shortfall to the creditors is written off.
Compulsory Liquidation: Ordered by the Court
Compulsory liquidation, as the name suggests, is ordered by the court. This process occurs when a company cannot pay its debts. A winding-up order application is filed by a ‘petitioner’ – who is normally a creditor, this can be a director or associated company that is owed money – and a judge decides whether to make the order to wind up the company. Compulsory liquidation means the cessation of business operations, the end of directors’ powers, and the certainty of employee redundancies. An official receiver, acting as the liquidator, oversees the process and sometimes appoints a licensed insolvency practitioner in his place to handle the liquidation proceedings.
Debt Repayment Hierarchy in Liquidation
One crucial aspect of liquidation is the order in which debts are repaid. The hierarchy typically starts with fixed charge holders, who possess security over specific assets. They are followed by liquidators’ fees and preferential creditors, including employees owed wages or entitlements. In 2020, legislation introduced the concept of secondary preferential creditors, elevating HMRC’s position in the hierarchy. Floating charge holders, unsecured creditors, and shareholders follow in the order of debt repayment, with ordinary shareholders being the least likely to receive any funds.
Administration: Rescuing a Company in Financial Difficulty
Administration differs significantly from liquidation in its objective and approach. Rather than bringing an end to a company, administration normally aims to rescue financially distressed businesses and can enable them to continue trading on during the administration. An insolvency practitioner, known as an administrator, is appointed to manage the company’s affairs and assets during the administration process.
The administrator’s primary goal is to achieve better outcomes for creditors than what would likely be achieved through liquidation. They have the power to sell assets, restructure the business, and attract new investments. Administration provides a moratorium period that suspends creditor enforcement and legal proceedings against the company, allowing the administrator to focus on the rescue efforts. The process must usually be completed within 12 months, with the potential for extensions.
Real-Life Examples and Benefits of Administration
Several real-life examples highlight the potential benefits of administration. Football clubs such as Southampton and Leeds United have successfully emerged from administration and achieved long-term success. Retail businesses like Clinton Cards also utilised administration to secure new investment and rescue their operations. Administration offers a chance for restructuring, safeguarding jobs, and achieving better outcomes for both creditors and employees. However administration is an expensive process, so often only undertaken for larger companies.
Conclusion
Insolvency is a vast and intricate field, with liquidation and administration playing vital roles in the rescue / recovery landscape. By comprehending these concepts and their associated procedures, you can navigate the complex world of insolvency and make informed decisions to protect the interests of all the stakeholders involved in a distressed company.