Insolvency: Company liquidation

The Insolvency Act 1986 sets out that a company is legally insolvent when it does not have enough assets to meet all its debts, or is unable to pay its debts when they fall due. Company directors are responsible for recognising when their company becomes insolvent, and they can be held legally responsible for continuing to trade whilst insolvent.

When a company becomes insolvent, it must follow an insolvency procedure. The insolvency procedure in its modern form exists to offer resolution to both the insolvent party and its creditors. The process aims to discharge an insolvent company’s liabilities (such as debts or contractual obligations), and to settle creditors’ claims.

Sometimes, companies will enter an insolvency procedure which gives an opportunity to rescue the company, such as administration. The other option is liquidation, after which the company ceases to exist. A company can enter insolvent liquidation in two ways, through either:

• the compulsory liquidation procedure, where the court orders the insolvent company’s liquidation, or
• the creditors voluntary liquidation procedure, where 75% of shareholders must vote to liquidate the insolvent company.

Compulsory liquidation

Compulsory liquidation is the procedure through which an insolvent company is forcibly wound up by the court.

Appointment of a liquidator

All compulsory liquidations start with the presentation of a winding-up petition (application) at court, usually from a creditor who hasn’t been paid. When making a winding-up order in England and Wales, the court initially appoints an Official Receiver (a civil servant) as the liquidator.

Subsequently, creditors and contributories (anybody liable to contribute to the assets of the company upon winding up) can choose to replace the Official Receiver with a licensed insolvency practitioner, who acts as the liquidator. In Scotland, there is no Official Receiver, so a private liquidator must be appointed.

Director obligations

Once a compulsory liquidation order has been made by the court, the Official Receiver (or the appointed liquidator) takes control of the company from the directors. The directors must co-operate with the liquidator and must identify all company assets and liabilities, and provide details of its affairs.

The Official Receiver (in England and Wales) and the liquidator (in Scotland) have an obligation to investigate and report on the conduct of directors. The Official Receiver or liquidator must submit a director conduct report to the Secretary of State (via the Insolvency Service). The Insolvency Service can then apply to the court to have an unfit director disqualified from acting as a director again for between 2 and 15 years.

Liquidator’s duties

Once an appointed liquidator has taken control of the company, they are under a statutory duty to act in the interests of all the creditors and to ensure an orderly winding-up of the company. Part of this duty is to dispose of the company’s assets for the best possible price. The liquidator’s aim is for creditors to receive as large a return as possible (after the costs and expenses of the liquidation have been paid).

The liquidator has wide powers over the company to achieve their legal objective. Their main objective is to realise (sell off) the insolvent company’s assets, and to distribute the proceeds to the company’s creditors according to the statutory order of payments.

The liquidator may only charge fees:

• on a time-cost basis,
• as a percentage of realisations, or
• as a fixed remuneration

The liquidator’s fees must be agreed by creditors and can be challenged in court.

Payments

Once the court has made a compulsory liquidation order, all creditors must formally register their claim (known as a “proof of debt”) before a deadline specified by the liquidator. The liquidator may require supporting evidence.

After selling the company’s assets, the liquidator must make payments to creditors in the statutory order of priority. The statutory order ensures that secured and preferential creditors, such as banks with mortgages and HMRC, get paid before unsecured creditors, such as suppliers and customers owed refunds or payments.

The compulsory liquidation process is complete when all the assets have been distributed and all creditors’ claims have been dealt with.

Creditors Voluntary Liquidation (CVL)

Like a compulsory liquidation, the CVL process can only be carried out by a licensed insolvency practitioner (the liquidator). The process is broadly identical to the compulsory liquidation process, in that the liquidator must sell all assets (realisations) and distribute the proceeds according to the statutory order.

However, CVLs are not ordered by the court. They are proposed by the directors and must be approved by 75% of shareholders through the passing of a special resolution.