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If you are a director or shareholder of a company facing insolvency, you may wonder what your options are. The most drastic insolvency proceedings available to distressed companies are liquidation proceedings, also known as winding up. Nevertheless, in practice, liquidation is reserved for companies with little chance of being rescued. This article will explain the liquidation process and what you can expect if your business faces insolvency.
Liquidation and Insolvency Proceedings
Like administrations, voluntary arrangements, and court-sanctioned restructuring plans, liquidation is a form of formal insolvency proceedings. However, liquidation is the most drastic of all proceedings because they are the equivalent of a death sentence for a company.
In a liquidation, a court appoints an insolvency professional known as a liquidator. The liquidator then takes control of the company from the directors and proceeds to sell off the company’s assets on a piecemeal basis to recover as much money as possible. Finally, the liquidator uses the proceeds of these sales to pay back the company’s creditors in the legal order of priority (see below).
If you are a director or a shareholder, this may sound unfair. However, insolvency law exists to maximise creditors’ rights over shareholders when a company has insufficient assets.
Forms of Liquidation Proceedings
Liquidation comes in two forms, including:
- voluntary liquidation; and
- compulsory liquidation.
Voluntary Liquidation
Voluntary liquidations come in two forms, including:
- members’ voluntary liquidation (i.e., a shareholder-led liquidation); and
- creditors’ voluntary liquidation.
Since members’ voluntary liquidation is only available for solvent companies, we will only examine creditors’ voluntary liquidations (CVL). In a CVL, the insolvent company’s shareholders (i.e., its members) formally initiate the proceedings by approving a special resolution requiring at least 75% of the shareholders’ approval to wind the company up.
In practice, the directors typically propose the resolution. Likewise, the shareholders must also appoint a liquidator. When the resolution is approved, the directors usually have a week to notify the company’s creditors. The creditors have a right to overrule the liquidator’s appointment and substitute their preference.
The liquidator then takes control of the company when the creditors either:
- approve the shareholder-nominated liquidator; or
- appoint their own.
Compulsory Liquidation
Compulsory liquidation refers to liquidation proceedings commenced by certain parties, which apply to the court for a winding-up petition. The law permits several different parties to apply for a winding-up petition. This includes the company itself (via its shareholders) and insolvency practitioners already managing its affairs. However, in practice, unsecured creditors are the most common applicant.
When the applicant lodges the petition, the court will convene a hearing if there are sufficient grounds to do so. Usually, the applicant must prove that the company cannot pay its debts, which the court typically assesses on four separate grounds.
If the applicant successfully obtains the court’s approval, it must notify the company. At this point, one or more creditors may appoint a liquidator of their choosing, provided they obtain the necessary consent from other creditors. Absent any creditor appointment, the law automatically appoints the Official Receiver, a court officer, as the liquidator unless the court intervenes and appoints a liquidator.
Regardless of the liquidator’s identity, the liquidator controls the company’s affairs at this point. The liquidator can order the directors to assist it in the liquidation process.
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The Liquidation
Regardless of the form of liquidation, once a liquidator is appointed over an insolvent company, it has a single goal. This is to manage the company’s affairs to maximise the interests of the company’s creditors. The law gives liquidators broad powers in exercising this power.
Typically, the liquidator will review the company’s assets and liabilities to sell the valuable assets to pay back the creditors. The liquidator can also pursue any person for engaging in fraudulent trading.
Similarly, the liquidator can pursue directors for wrongful trading. To do so, it must apply to the court. If they are successful, the court can order the liable party to pay into the insolvent company’s assets. This increases the value of the assets the liquidator can use to repay the creditors.
Repaying the Creditors and the Order of Priority
The law obligates the liquidator to maximise the interests of the creditors. But it must repay individual creditors according to the order of priority. This means that the liquidator cannot favour one creditor over another unless the favoured creditor ranks ahead of the other creditor according to the order of priority. The order of priority goes as follows:
| Secured Creditors With Fixed Charges Over the Company’s Assets | Secured creditors with fixed charges typically refer to banks that have security over the bulk of the insolvent company’s assets. Most fixed charges are contained in a debenture, which describes a security agreement that grants the secured lender security over most of the company’s assets. In practice, secured creditors typically exercise their security rights over the secured assets separately from the liquidation proceedings. This is because the nature of security means that the secured creditor does not need to participate in the liquidation proceedings to recover its debt. It can simply take possession of the secured assets and sell them, provided it repays any surplus to the company. |
| The Liquidator’s Fees and Expenses | If there are any remaining assets after the secured lender has exercised its security rights, the liquidator uses them to repay itself. |
| Preferred Creditors | The law treats certain creditors preferentially. These include employees with unpaid wages, beneficiaries of employee pension schemes, and HMRC. In most cases, the amount preferred creditors can recover is fixed. |
| Secured Creditors With Floating Charges of the Company’s Assets | A floating charge is another form of security. In practice, the fixed charge holder under a debenture also has a floating charge over all the assets not secured by the fixed charge. The liquidator must set aside some of the assets available to the floating charge holder for the unsecured creditors. |
| Unsecured Creditors | Anything remaining after the liquidator repays the floating charge holder goes to unsecured creditors. This includes customers, trade suppliers, and unsecured lenders. |
| Shareholders | In practice, shareholders receive nothing in a liquidation. |
Key Takeaways
A liquidation is one kind of insolvency proceeding. Under liquidation, the law appoints a liquidator to manage the company’s affairs to repay the creditors. In practice, an insolvent company does not usually have enough assets the liquidator can sell to repay all the creditors in full. Therefore, the liquidator repays the creditors with the liquidated assets’ proceeds according to the priority order. Once all the assets are sold, the liquidator shuts the company down. The law gives the liquidator broad powers throughout the proceedings, which it can use to pursue directors and other parties liable for the company’s insolvency.
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Frequently Asked Questions
Liquidation is a form of insolvency proceeding where an insolvency practitioner (a liquidator) takes control of the company. It then sells off the company’s assets and uses the proceeds to repay the creditors according to the order of priority. Once all the assets are sold, it shuts the company down.
The order of priority is how the law ranks which creditors should get first dibs on the company’s assets. Secured creditors are at the top of the list. Shareholders are at the bottom. Unsecured creditors, which include trade suppliers and customers, sit in between.
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