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Liquidations

Money down the drain

Liquidations - Creditors Voluntary, Solvent & Compulsory

Liquidation is an insolvency procedure used to deal with the winding up of companies or partnerships. It involves the realisation and distribution of the assets and usually the cessation of a business.

Liquidation proceedings can be commenced by:

The liquidation proceedings are similar regardless of which type of liquidation. A liquidator, who can be the Official Receiver or an Insolvency Practitioner appointed to administer the liquidation of a company or partnership is appointed to realise the company's or partnership's assets and the proceeds of the realisations are distributed according to the regulations set down in the insolvency act 1986.

Liquidation usually results in a lower return to creditors and shareholders (members) than a corporate recovery or turnaround procedure as assets are generally dealt with on a "break up" basis.

There are four types of liquidation:

Creditors Voluntary Liquidation

The decision to commence a Creditors' Voluntary Liquidation (CVL) is one made by the directors/shareholders of a company. As a director/shareholder you control the timing of the CVL and also, you decide on the Insolvency Practitioner who is to assist the company to go into CVL and who is to be nominated as Liquidator by the shareholders. Whilst the shareholders' nomination for Liquidation is subject to the agreement of creditors at the Creditors' Meeting, in the vast majority of cases the creditors accept the shareholders' nomination.

CVL is, however, terminal for the company. It ceases to trade and the liquidator is left to dispose of the assets. The liquidator's objective is to maximise realisations from the sale of assets, collection of debts etc. in order to pay a dividend to creditors, if at all possible.

In many cases directors/shareholders are interested in trading again. Generally there is nothing to prevent this, they can bid for and purchase the assets, subject to the liquidators agreement. They can set up and control a new limited company. Directors are not liable for the debts of the old company unless they have signed personal guarantees to that effect.

The liquidator will also review the company's affairs with a view to reporting to the DTI on the conduct of the directors. This happens in every case. In instances where the insolvency is genuine and due to little or no fault of the management, then this report will do no more than indicate to the DTI who the directors are. At the other end of the scale, it can highlight offences which may lead to directors being disqualified from acting in that capacity in the future.

There are strict rules of priority as regards the order in which the creditors are paid. In the event that a bank or other party holds a fixed and floating charge over the assets of the company (a debenture) then they will be entitled to realisations from "fixed charge assets" first. These might be freehold property, fixed plant and machinery, goodwill and realisations from investments, for example. Book debts used to fall into this category but the decision in Brumark Investments Ltd, which has been upheld recently in a test case has thrown this into doubt. Whilst the decision in the test case is likely to be appealed, directors can no longer rely on book debts being caught in this manner.

On 15th September 2003 the corporate provisions of the Enterprise Act 2002 came into effect. They abolished the rights of the Inland Revenue and HM Customs and Excise to establish preferential claims. They rank with trade creditors for any dividends. The only preferential claims are now those from employees or the Redundancy Payments Office acting in their place, in respect of arrears of wages and holiday pay. To a large extent this makes the Brumark decision irrelevant in the majority of new cases as book debt realisations will work their way down to the holders of floating charges without first having to satisfy large preferential debts. However, for floating charges created after 15th September 2003 the holders will have to give up a percentage of realisations to unsecured, non-preferential creditors. Therefore, these provisions should mean that creditors as a whole are more likely to receive a dividend in insolvencies than was previously the case.

In all cases of insolvency, personal and corporate, employees, and in certain instances directors, can claim arrears of wages, holiday pay, redundancy and monies in lieu of notice from the government, subject to statutory limits. The Redundancy Payments Office then takes the employees' place as a creditor. The Insolvency Practitioner concerned will be able to advise directly on these claims in specific circumstances.

Creditors Voluntary Liquidation (CVL) - Centrebind

In the event that the company is insolvent and has assets that are perishable or require immediate protection to preserve the value of the business, a specific procedure can be implemented which significantly reduces the time required to put the company into liquidation. This is achieved by holding shareholders and creditors meetings on a "back to back" basis. The procedure is rarely used and is therefore not covered here in great detail.

Compulsory Liquidation

A creditor has pursued the debts due to it for a significant period and has exhausted all other avenues to recover. Often deals to repay will have been agreed but the debtor company has not stuck to the deal, has demonstrated intractability or simply does not want to communicate with the creditor. In this situation the creditor will instruct a solicitor or debt collector to collect the debt, if all avenues of collection subsequently fail then the agent can proceed with an action to wind the company up.

The costs of this action are not insubstantial and a creditor has to decide whether the debtor is likely to pay up. A debt of over £750 must be undisputed and the creditor must have notified the debtor of its intent to collect the debt. Often this will involve the issuing of a statutory demand first. If the debtor fails to pay the statutory demand in 21 days and does not dispute the debt, then the creditor may issue a winding up petition.

From solicitor to solicitor the costs vary but a typical cost of the action will be £250-£500 for a statutory demand, £1,000-£2,000 for a winding up petition (includes court costs). Despite this, for larger debts it is a very effective way of collecting money when the creditor believes that there is sufficient resource to pay it. Many larger companies use established debt collection law firms to collect their debts this way.

The application for a petition will be granted where it can be proven to the court's satisfaction that the debt is undisputed, attempts to recover have been undertaken and the debtor is not compliant. A petition will be issued and court hearing date granted, usually the date is well in the future because of court pressures. Once the petition is correctly served upon the company it has a period to pay the debt or to defend the action. This is costly as the action is usually in the High Court. This requires a barrister to attend and the costs of such defence are high. If the case is found the company is wound up by the court.

Substitution of Service

Even if the debt is paid (always with full costs), the fact that a petition is issued means that a winding up hearing (in the High Court) MUST be held. Between the date of the payment and the hearing it is possible (and often happens) that another creditor learns of the petition and "substitutes" their debt for the settled debt. Thus, they piggy back the action in order to get ahead of other creditors and get paid.

15 days, (or sometimes more) before the hearing the petition is "advertised" in the London Gazette. All high street banks and lenders monitor this very carefully because if a customer is involved in such an action they MUST freeze the bank account immediately - thus stopping any trading. The purpose of this is to stop assets being sold or other transactions that may worsen the creditors position.

This mechanism is used most by the Inland Revenue and HM Customs and Excise. Over 50% of all petitions are issued by the crown agencies as the revenue and the VAT are "involuntary" creditors. The action of trading and employing people means that the debt to the crown ticks up. If a company tries to make arrangements to repay outstanding PAYE and/or VAT and still fails to make payments the crown debt will be rising. For these reasons they decide to wind the company up. This way, either the company will pay, enter a CVA or Administration or simply cease trading.

If the Crown winds up the company remember that the liquidator is court appointed and will investigate very carefully the actions of the officers of the company. If it can be proved that these individuals traded wrongfully, took credit without reasonable prospect of repaying the debts, failed to submit accounts or a number of other offences then it is possible they will face action.

Company Director Disqualification

Remember that the DTI or liquidator can press for the Directors to be disqualified and, in some cases, fined.

Compulsory Liquidation should always be the last option and generally, should be avoided at all reasonable cost.

Administration Order

Administration is a court driven procedure which, since the introduction of the corporate provisions of the Enterprise Act 2002 on 15th December 2003, has become a cost effective way to preserve even small businesses. Interested parties, including directors and creditors, can petition the Court for a company to proceed into Administration. The petition will include reports from the petitioner and an Insolvency Practitioner indicating the purposes for which the Administration is required. This could involve the survival of the company as a going concern but could also be simply to maximise the realisation of assets. Once an Administration Order is in place it freezes creditors' rights and means that they cannot pursue old debts. In the right circumstances the company will continue to trade although the Administration rather than the directors controls it.

It is important to realise that in these circumstances the Administration controls the direction of the company. Until the Administration Order is discharged the directors only have the powers that have been delegated to them. However, in practice the Administrator and the directors will work together to preserve the business. Most often, an Administration Order is issued to protect the company in the short term whilst a Company Voluntary Arrangement (CVA) is discussed and proposed to creditors.

Administrative Receivership

An Administrative Receiver is appointed to the company by a debenture holder, who holds a fixed and floating charge over the company's assets. On appointment, the directors no longer control the company and it is run by the Administrative Receiver. He has the ability to continue to trade although he may decide not to do so depending on the circumstances. If trading takes place, it will only be to preserve the business with a view to sale. The objective of the Administrative Receiver is generally to realise the assets for the best possible price with a view to repaying the debenture holder in particular. The priority of payments to creditors though is the same as in a Creditors' Voluntary Liquidation.

Since the decision in Brumark Investments Limited, which has been upheld in a recent test case, the classification of book debts fixed charge assets has been thrown into doubt. The enterprise Act 2002 has also made administrative receivership less attractive. It promotes Administration as a more acceptable recovery route.

Brumark Investments Ltd suggests that realisations from book debts will no longer be paid to the debenture holder and at the moment Insolvency Practitioners are retaining funds from this source pending a likely appeal of the test case on this subject. This is of particular relevance where directors/shareholders have given personal guarantees to the debenture holder.

Members Voluntary Liquidation

The members/shareholders of the company decide to put the company into liquidation. The difference between this procedure and other insolvency procedures is that the company is solvent.

A members voluntary liquidation can happen for a number of reasons. If the business and assets of the company have been sold then a members voluntary liquidation is a way of distributing funds to the shareholders based on the number of shares that they hold.

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