The difference between Liquidation and Administration
We’re often asked about the difference between Liquidation and Administration and when one should be used over the other. They’re both formal insolvency procedures to help address a company that is insolvent, but there are significant differences between the two.
The primary difference between them is that a Liquidation is the process of selling/realising assets before dissolving the company completely, whereas an Administration provides an alternative to winding up, so where possible, the company or at least its business, can be rescued.
There are three types of liquidation;
Creditors Voluntary Liquidation (CVL) – Company is insolvent and the directors choose to close it down.
Compulsory Liquidation – Creditor action forces the company into closure.
Members’ Voluntary liquidation (MVL) – Company is solvent, Directors choose to close it down and redistribute funds back to shareholders.
In the first two instances, where a company is technically insolvent, the company’s assets (if any) are realised and distributed to satisfy its liabilities and to repay its shareholders (if surplus funds realised). The company is then closed and dissolved at Companies House.
If Directors are in a position to purchase back assets and goodwill at market value, they can start trading again under a different company. This can be a lifeline for the business and would effectively allow the business to carry on operations under a new company name, whilst keeping the same employees, assets and contracts.
Administration is a formal insolvency process which places a company under the control of a licensed Insolvency Practitioner (IP) and the protection of the court.
A ‘Notice of Intention to Appoint’ or ‘Notice of Appointment’ can be filed at court by the Director, qualifying floating charge holder, a company or creditor to commence the process of Administration.
The Administration process is used to rescue and recover a business, if that is not possible; it is used to achieve a better outcome for creditors than in liquidation. If both of these are not possible, then it is used to realise property, to enable funds to be distributed to secured or preferential creditors.
It is important to note the distinction between rescuing a company and rescuing a business. Rescuing a company entity is usually done through a Company Voluntary Arrangement (CVA) while rescuing the business is usually done through an Administration, as it is usually only the trade and assets which are sold in an Administration.
A CVA is often preceded by an administration, as an order of administration will protect the company with a moratorium period while it is being rescued by a CVA. The main purpose of the moratorium is to free an administrator’s rescue attempts from the distractions of enforcement action from creditors.
There is also another form of administration called a Pre-pack. This involves the valuation of assets and negotiating a sale of the business as a going concern, prior to the appointment of the administrator. Once the administrator is appointed, the business is sold and sometimes purchased by the existing Directors at the same time; who will usually continue trade without the loss of jobs.
Main differences between Liquidation and Administration
Although Liquidation and Administration are fundamentally different in their approach, both processes are used to limit the damage for companies and their creditors.
In both circumstances, a company will be technically insolvent, in that its liabilities will outweigh assets or it’s unable to make day to day payments.
Identifying which process is suited and most relevant to the situation, is governed by the desired fate of the company. If a company’s trading position is affected by cash flow problems and creditor pressure, but the underlying business is viable, then rescuing it through administration would be more appropriate. However, if there is no hope for the future, the company would benefit from being wound up and assets realised for the benefit of creditors.
A company administration could result in Liquidation, but also be used to avoid Liquidation or receivership. An advantage of entering into administration is that all legal actions against the company are stayed, allowing the appointed administrator (insolvency practitioner) time to develop a recovery plan.
The insolvency practitioner is legally obligated to act in the best interest of creditors and their main concern in liquidation and administration will be to maximise creditor returns. In a company administration, the rescue and recovery of the business will also be paramount.
Whenever a company is insolvent and being threatened by creditors, it is imperative to consult a licensed Insolvency Practitioner (IP).
Establishing the correct path to take can be daunting, but being pro-active at the first sign of trouble will minimise the likelihood of wrongful trading accusations. It will also leave more options for the Director and IP to devise a rescue strategy.
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