What is the Difference Between Liquidation and Insolvency?
Posted on 29th October 2021 at 12:45
When a company reaches the end of its life, the view from outside can be unclear. That is to say that public perception of the circumstances of a company closure can be skewed by assumptions based on technical language. Specifically, the terms ‘liquidation’ and ‘insolvency’ are often used interchangeably by people unfamiliar with the processes involved, and so both can have negative connotations. These connotations are not strictly true, however, as there is a clear difference between liquidation and insolvency.
In the broadest of terms, all companies that are closed down are ‘liquidated,’ because this is the process of turning assets into money that is distributed to shareholders and creditors. Liquidation, then, is the term used to describe the process required to end a company. Insolvency, by contrast, is one type of circumstance that can prompt the end of a company. It is one of a number of possible reasons for ceasing to trade and closing down the business.
Circumstances of insolvency
Insolvency is a very specific financial situation defined by two sets of criteria. To be deemed insolvent, the accounts of a company will show that:
It is unable to pay its debts when they fall due
The value of its assets is less than the value of its liabilities
Where both these criteria apply, a company is insolvent and action must be taken to ensure that everyone is eventually paid what they are owed. These actions are the processes that lead to liquidation. There are, essentially, two types of process that follow the realisation of an insolvency situation.
Creditors Voluntary Liquidation (CVL) – This is a process initiated by the directors of an insolvent company, having agreed between them that there is no reasonable prospect of the company regaining solvent status. This is a common procedure that allows company leadership to take a proactive approach to managing financial difficulty – allowing a higher degree of control to be retained while working with professional Insolvency Practitioners to ensure creditor needs are met.
Compulsory Liquidation – This is a court-ordered process that usually follows the issue of a Winding Up Petition by a creditor. This is the worst-case scenario of all formal insolvency processes because directors are entirely stripped of control.
The liquidation process
Reasons for closing a solvent company can include retirement, career change, or diversification, and it is essentially a formal exit strategy for commercially viable operations. When the directors of a company decide to close the business – to cease trading, end existing employment contracts and stop recruitment of new employees – then all of the company assets need to be used to pay off debts. These debts include all outstanding third party bill payments, along with financial obligations to employees. The remaining money is then distributed among shareholders in the most tax efficient way possible.
The final part of closing down a company is its removal from the companies register held by Companies House. During liquidation, the distribution of remaining money must be complete before the company is ‘struck off’ from the register. If it is not, then the remaining money is collected by the state and can only be claimed back by restoring the company to the register.
In addition to the two types of liquidation that are options in circumstances of insolvency – namely, Creditors Voluntary Liquidation (CVL) and Compulsory Liquidation, as discussed earlier – the process of Members Voluntary Liquidation (MVL) provides the means to liquidate a company that is solvent. In other words, where a company is still able to pay its debts when they fall due and has assets that are of a higher value than its liabilities, then Members Voluntary Liquidation can be put in motion
The MVL process needs to be overseen by a professional Liquidator but is relatively straightforward. Once solvency of the company has been established, then four steps are followed:
The company directors make a sworn statutory declaration of solvency that includes a closing financial statement.
A shareholder meeting is held within five weeks of the declaration being sworn and a resolution is agreed and passed, placing the company into liquidation. It is at this point that the move to appoint a professional Liquidator is also agreed.
The appointment of the Liquidator is announced in The London Gazette.
The Liquidator realises the assets, pays off debts and liabilities, and distributes remaining funds to shareholders and board members.
Expertise is essential
The confusion that often arises around the difference between liquidation and insolvency demonstrates the fact that expertise is essential. While directors and shareholders are experts in the operation and finances of the company with which they are involved, professional Insolvency Practitioners are needed to navigate the intricacies of company law, regulatory requirements, and tax liabilities. Indeed, the technical term ‘Insolvency Practitioner’ may seem to limit work to the worst-case scenario end of the spectrum but, in fact, the most reputable, licenced practitioners – such as Smith & Barnes – can facilitate solvent liquidation as well as the liquidation of insolvent companies.
The Smith & Barnes Insolvency team provides expertise to businesses around the U.K from Yorkshire-based offices. The need for guidance around debt management, insolvency and liquidation can arise at any time, for a wide variety of reasons, and Smith & Barnes understand the need for down-to-earth, affordable, straightforward advice. With a wealth of experience to draw upon, the team offers a free consultation process that is specifically designed to determine financial circumstances along with current and future needs.
Smith & Barnes use the information gathered through this consultation to identify bespoke solutions, tailored to deliver the outcome required – whether that is to continue trading, or to close the business completely. This emphasis on customer-focused service means that the team strives for efficiency and accuracy while ensuring that solvent and insolvent situations receive the utmost professionalism for a low cost, fixed fee.
Call Smith & Barnes Insolvency Practitioners Ltd today to discuss your financial situation and get the expertise you need.
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