When a limited company is insolvent – meaning either its debts are greater than its assets, or it is unable to pay its bills and other outgoings as and when they fall due – directors need to make a decision whether the company has a realistically possibility of being turned around, or whether it should be placed into liquidation.
What happens during liquidation?
When a company is liquidated, all its assets are sold with the proceeds being distributed amongst outstanding creditors. The company will eventually be dissolved and it will cease to exist as a legal entity. An insolvent company can be liquidated either through a compulsory court-order, or else through a voluntary process known as a Creditors’ Voluntary Liquidation (CVL).
Who can put a company into liquidation?
A CVL is a director-initiated liquidation process which must be administered by a licensed insolvency practitioner. Once the director – or directors – of a limited company know the business to be insolvent, they can take the decision to voluntarily shut down the company by placing it into a CVL. They will select an insolvency practitioner of their choosing who will work towards realising company assets, and ensuring the company is wound down in an orderly manner in accordance with the Insolvency Act 1986.
What happens to outstanding creditors in liquidation?
The appointed insolvency practitioner will be responsible for dealing with all outstanding creditors throughout the liquidation process, as well as distributing all available company assets as per a designated order of priority depending on the class each creditor falls into. Creditors will be paid in the following order:
- Secured creditors with a fixed charge – This include banks and asset-based lenders who are holding a fixed charge over a business asset such as property, machinery, or vehicles.
- Preferential creditors – Employees who are owed arrears of wages and holiday pay are classed as preferential creditors, and they will receive a distribution once fixed charge secured creditors have been paid.
- Secured creditors with a floating charge – Floating charge holders are those who hold security over moveable assets such as stock, raw materials, as well as fixtures and fittings in commercial premises.
- Unsecured creditors – Trade creditors comprise those who have lent to the business, or extended a line of credit, yet have not had this secured by an asset. A large number of creditors typically fall into this category including trade creditors, and unsecured finance agreements such as loans and credit cards. In many CVLs, unsecured creditors typically receive a minimal distribution, or may be left out of pocket altogether.
- Shareholders – Shareholders are the final group to get paid and will only receive a distribution if all other creditors have been paid in full. In the case of a CVL, there will not be surplus funds remaining at this stage to give shareholders a distribution.
Understanding director responsibilities in insolvency
Although a CVL is considered a voluntary process, the reality is that when it gets to this stage, often directors have no choice left but to place their company into liquidation. As the director of an insolvent company, you have a legal responsibility to protect the interests of your creditors and to refrain from any action which may worsen their position. Once you know your company to be insolvent, your creditors’ interests must be placed above your own and those of other shareholders. By being proactive and taking this step voluntarily, rather than being forced into compulsory liquidation, demonstrates your responsibility as a limited company director, as well as showing a duty of care to your creditors.
Company liquidation and director redundancy
The director will be responsible for paying the fees associated with the liquidation, but in many cases, this can be taken from the company’s assets. Many directors are also classed as employees of the company and receive a salary in payment for the work undertaken. In these instances, directors are often eligible for a redundancy payment following their company entering into an insolvent liquidation procedure such as a CVL. Redundancy for directors works in much the same way as redundancy for employees, and can be a vital lifeline for those struggling financially in the wake of their company becoming insolvent.