Insolvency and liquidation are two states that often go hand in hand. Many insolvent companies enter a state of liquidation due to their financial distress, as a means of handling their debt. Given the close connection, the line between the two is easily seen as blurred, which causes some understandable confusion. However, although they are often combined, insolvency and liquidation are not the same thing. In this article, Clarke Bell will discuss both insolvency and liquidation, break down how they impact companies, and outline how they are different.
What is insolvency?
Insolvency is a term that refers to a company in a state of acute financial distress. The term is given to companies that have more liabilities than assets, meaning they cannot fully repay their debts once they come due. Although insolvency is a financial state, and not a procedure, insolvent companies will often pursue procedures that specialise in assisting such companies. These procedures are known as insolvency procedures.
Company administration is one example of an insolvency procedure. It aims to essentially restore a company to profitability, and is primarily used for companies that have a viable business plan. The procedure is headed by an administrator, which the company directors appoint.
Administration may take several different approaches, depending on the scenario. For some, restructuring will aim to refine the business plan and bring the company in question back into profitability. For others, the company in question will be partially or fully sold off. This could be restricted only to the sale of company assets, or extend to less profitable departments of the company. Others still may be placed into liquidation, though this is typically reserved for companies that cannot be assisted using the latter methods. We will discuss liquidation in detail later.
Company voluntary arrangement
Another common procedure for insolvent companies is a Company Voluntary Arrangement (CVA). Similar to administration, it requires a company to have a viable business model underneath its financial distress, and cannot be done on a whim. The objective of a CVA is to lessen a struggling company’s financial burden by arriving at a new set of repayment terms with its outstanding creditors. It is hoped that in doing so, the company in question would be able to return to profitability and repay its creditors in full, if at a later date than first intended. This would be a win-win for creditors and directors alike.
This procedure is carried out by an insolvency practitioner that fills the role of negotiator. While in this role, an insolvency practitioner will negotiate with a company’s creditors on its behalf, with the aim of reaching a new set of repayment terms that creditors can agree to. It is for this reason that the company must have a viable business model, as creditors are not likely to be convinced otherwise, and will instead pursue other action.
What is liquidation?
If insolvency is a financial state that a company can be in, liquidation is a procedure that companies can pursue as a remedy. Many directors will liquidate their insolvent company to free up the funds necessary to repay their outstanding creditors and uphold their obligations. However, as we discussed previously, liquidation is not the only procedure insolvent companies can take.
There are several different types of liquidation that a company can be placed into. Although each type of liquidation is very similar, there are certain key differences to be aware of before taking action.
Creditors’ Voluntary Liquidation
Creditors’ Voluntary Liquidation (CVL) is a voluntary form of liquidation that directors can place their insolvent companies into. They may appoint an insolvency practitioner of their choosing to the role of liquidator to carry out the procedure. In this role, the liquidator will essentially take control of the company, identifying its assets and accounts, then obtaining an accurate valuation. These assets will then be liquidated, with the proceeds going to repay as many outstanding creditors as possible. Once all possible distributions have been made, the company will be closed, ceasing to exist as a commercial entity.
The CVL procedure offers a range of strong benefits. First, it allows directors to appoint a liquidator of their choosing, as we mentioned. Second, all debts that remain after the company has been closed will be written off, unless secured by a personal guarantee. Third, the company in question is protected from legal action upon entering a CVL. This effectively eliminates the risk of being served a winding-up petition, which typically precedes compulsory liquidation. If you would like to know more about CVLs, read our complete guide to the process.
Compulsory liquidation is another form of liquidation intended for insolvent companies. Whereas a CVL is voluntary, compulsory liquidation is not. This means that, while they may be incredibly similar in terms of practical application, compulsory liquidation does not offer the same benefits as a CVL. In fact, it can often be a negative for directors. As it is an involuntary form of liquidation, it shows that directors were slow to act in the interests of their company’s creditors, and had to have their hands forced. This could open directors up to valid accusations of misconduct, which can carry significant penalties.
If a director is charged with misconduct, the Insolvency Service could apply any of a series of penalties. This includes the following:
- Disqualification of a director’s license for up to 15 years
- Personal liability for company debt
- An order to repay money to the company
- Prison sentence
While directors are certainly not guaranteed to face the above penalties, it is often best to avoid compulsory liquidation if at all possible.
Members’ Voluntary Liquidation
Although the previous two types of liquidation were for insolvent companies, liquidation as a whole has a broader audience. A Members’ Voluntary Liquidation (MVL) specialises in helping solvent companies close, while keeping as much of their retained profits as possible.
The MVL process is incredibly tax efficient. It aims to ensure large companies with vast reserves of retained profits don’t have to pay an exorbitant tax bill. This is accomplished in two ways. Firstly, gains realised under the MVL procedure will be taxed under Capital Gains Tax rates, rather than Income Tax rates. CGT rates are much lower than Income Tax rates, so companies can retain more of their money. Secondly, the MVL procedure allows directors to apply for Business Asset Disposal Relief (BADR), which was previously known as Entrepreneurs’ Relief. BADR allows eligible directors to claim a significant tax break, up to a lifetime limit of £1 million. These two factors combined result in significant tax savings for companies undergoing an MVL.
Clarke Bell can help
If you are considering placing your company into liquidation, don’t go it alone; let Clarke Bell help. We have more than 28 years of experience in helping companies close down in the best way possible, and we can do the same for you. Don’t hesitate to contact us today for a free, no-obligation consultation and find out exactly what we can do for you.