Background
1st August 2019

What Is The Difference Between Solvent And Insolvent Liquidation?

Occasionally, some companies may find themselves not being able to make ends meet when it comes to their bills and creditors. When long-term financial obligations become impossible to meet, it may be time to register your business as insolvent. Doing so will force your company into insolvent liquidation; striking it from the Companies House register. […]

Scroll
Article Image Circle Circle


What Is The Difference Between Solvent And Insolvent Liquidation?

Occasionally, some companies may find themselves not being able to make ends meet when it comes to their bills and creditors.

When long-term financial obligations become impossible to meet, it may be time to register your business as insolvent.

Doing so will force your company into insolvent liquidation; striking it from the Companies House register.

But what about solvent liquidation?

Solvency vs insolvency

There are many reasons why a company may enter into liquidation – whether it be voluntary or not – but it all depends on its debts.

If a company remains able to meet its long-term financial obligations, but serves no further useful purpose as a business, it can be classed as solvent.

This also applies for closure processes caused by something other than finances, for example the company director’s retirement.

If you’re unsure whether your business would be classified as solvent or insolvent, there are three different ways of finding out:

● The Cash Flow Test – Under the Insolvency Act 1986 a business is rendered insolvent if it is ‘unable to pay its debts as they fall due’. This cashflow test highlights that if you are unable to meet your PAYE and VAT requirements, you may well be insolvent.

● The Balance Sheet Test – if the outstanding debts of your company outweigh your assets (e.g. property, cash, stocks, equipment), the company will be considered insolvent. This will prove problematic when the company’s assets are liquidised as this deficit will make it impossible to repay all creditors.

● The Legal Action Test – if a creditor is owed over £750 they are entitled to put forward a formal demand for the sum, or a County Court Judgement (CCJ), which must be paid within three weeks. If it is not paid the law will deem the company insolvent.

The ‘winding up’ procedure

Whether your business is solvent or insolvent, the process for winding up is quite similar.

A company winds up when it decides to close down, by ending all business affairs.

This covers every aspect of the business, including everything from customer/client relationships to obligations with employees.

If these business affairs are settled by the company director, this is classed as a voluntary winding up.

However, it doesn’t always go this smoothly.

Creditors who are owed more than £750 from a business are entitled to submit a winding up petition (WUP) to the court, which forces the company to be investigated and liquidated by the Official Receiver.

This involves an intrusive investigation into the company’s debts and trading history, and is not to be confused with the conventional winding-up procedure.

What is liquidation?

Liquidation is the process of bringing a business to a close by distributing its assets to pay off its debts, once all relationships have been severed.

The cause of liquidation often lies in the hands of the director(s), but other factors may also affect cash flow, such as:

● Late customer payments

● Customers/suppliers entering insolvency

● Market fluctuations

● Increased competition

● Mistakes in pricing of goods/services

Due to the complex nature of the process, the only person qualified to liquidate a company’s assets is a professional Insolvency Practitioner (IP).

This can be done in different ways depending on the company’s position:

● Members’ voluntary liquidation (MVL)

A members’ voluntary liquidation is the formal process whereby a solvent company is closed down.

This method divides the company’s assets in the most tax efficient way between creditors and directors.

As this is a solvent liquidation process, all creditors are repaid in full and the directors must each sign a declaration of solvency.

This declaration provides evidence that the company is able to settle its outstanding debts within 12 months of beginning the liquidation process.

● Creditors’ voluntary liquidation (CVL)

When a creditor is threatening to take legal action against an insolvent company (e.g. through a WUP) the safest and most harmonious option is to enter a creditors’ voluntary liquidation (CVL).

This means the appointed IP works on behalf of the creditors as opposed to the company directors, with a main priority of ensuring all debts are settled.

This option provides the best chance for creditors to receive a return, as well as helping directors to avoid being investigated for wrongful trading.

CVL and MVL procedures are very similar but because CVL companies are insolvent and unable to settle their debts, a meeting with the creditors is a fundamental step in the process.

As this procedure is voluntary as opposed to court led, the company directors can decide who their IP will be.

The directors will also have the option to purchase any assets as part of the company rescue process.

● Compulsory liquidation

Compulsory liquidation may be considered the final resort for an insolvent company to be forcefully liquidated.

Although compulsory liquidation can be proposed by its directors, it is more often a forceful procedure brought forward to a court by a company creditor owed over £750.

This can be done so by submitting a WUP.

If the courts grant this, business assets are settled using an IP and directors face a rigorous investigation – much more severe than those following a CVL.

The investigation aims to uncover the cause of insolvency and reveal any evidence of misconduct or illegal, wrongful trading.

Any evidence found could result in directors facing disqualification for 2-15 years, and criminal charges if necessary.

 

Company dissolution

Dissolution takes place at the final stage of closing a business, whereby the company’s existence is officially withdrawn by the law.

This is recorded and registered by the Registrar of Companies.

Dissolution may seem like an easy and cheap way to strike off a company, with just a £10 admin fee to submit an application.

But be sure to seek advice from a professional before proceeding.

 

Why you should act quickly

If you are headed towards insolvency, it is your legal responsibility to act fast in order to protect the interests of your creditors.

To avoid personal consequences for continuing to trade while insolvent, seek advice from an IP and register your company as insolvent when the time is right.

Hudson Weir are licensed insolvency practitioners with vast experience in all industries, and are available for liquidation services.


Categories: Articles



Other Articles You Might Like
Arrow

Wealth & Finance International is part of AI Global Media

Discover our 10+ brands covering different sectors
APAC InsiderBUILD MagazineCorporate VisionEU Business NewsGHP NewsAcquisition InternationalNew World ReportMEA MarketsCEO MonthlySME NewsLUXlife MagazineInnovation in BusinessThe Business Concept