Compulsory vs Voluntary Liquidation ‐ What’s the Difference?
In 2014, HMRC applied to the courts to shut down 3,000 businesses due to unpaid tax bills. Of the 3,000 winding up petitions served, HMRC were successful in 1,887 cases. Many of these firms will have allowed the action to take place whilst others would have sought to deal with the petition by initiating their own insolvency solution such as a Company Voluntary Arrangement (CVA) or Creditors’ Voluntary Liquidation (CVL).
When it comes to a company entering into liquidation, there are some important differences between the compulsory and voluntary routes, not least for the directors of the company.
A compulsory liquidation is forced upon an insolvent company by one or more creditors, (owed £750 or more) seeking a winding up order from the Court. It is very important to note that under insolvency legislation, the winding up of a company is deemed to commence upon the presentation of the petition to the Court.
This could have very serious implications for any company, including:-
- The bank may freeze the company’s bank account on notification of the petition
- Any transactions entered into by the company after the presentation of the petition, may be considered void (and therefore repayable to the liquidator) unless the Court validates the transactions. This could potentially cause significant damage to any on-going trading relationships a director may have with the bank, suppliers, and other third parties. For example, Bridgewood (as liquidator) recently recovered nearly £40,000 for the benefit of creditors from two parties who had received payment from a company, after it had had a winding up petition presented.
Once the order is made, the company will almost certainly be required to cease trading and all employees made redundant. The directors will be required to complete a detailed questionnaire and attend a lengthy interview with the Official Receiver, who is responsible for investigating the background and circumstances leading up to the insolvency. A liquidator (an Insolvency Practitioner) made also be appointed if the company has assets to recover – such assets will be used firstly to pay the costs of the liquidation, with any remaining funds being distributed to the creditors of the company. The Official Receiver will report on the conduct of the directors to the Secretary of State which may also involve further lengthy interviews and Public Examinations in Court.
A voluntary liquidation, known formally as a Creditors’ Voluntary Liquidation (CVL) occurs when the directors/owners of a company, make a decision to close down the business. This process involves the calling of meetings of shareholders and calling a decision procedure to pass the appropriate resolutions and appoint an Insolvency Practitioner as Liquidator. The Official Receiver plays no part in a voluntary liquidation. It is the Insolvency Practitioner who reports on the conduct of the directors to the Secretary of State via an on-line form.
When Would a Creditor Seek a Compulsory Liquidation?
HMRC will pursue a compulsory liquidation where a company has not paid what is due to it. This is to ensure that the liability doesn’t increase further and to make sure that an investigation takes place – this is why HMRC will often oppose an application to strike-off a company at Companies House, since they will want to ensure that the company is properly wound up and investigated. Trade creditors and lenders will normally only consider winding up a company, if they believe that it has sufficient assets to cover the Official Receiver’s costs and the statutory fees of obtaining a winding up order (which now are over £10,000), as well as provide some level of repayment to creditors.
Before applying to the Court for a winding up order, a creditor needs first to make a demand which is served on the company at its registered address. If the company does not respond to the demand (usually within 21 days) or come to an agreed arrangement to pay, then the creditor can proceed to petition for a winding up order.
How Can a Compulsory Liquidation Be Stopped or Avoided?
There are a number of ways for a company to avoid being placed into compulsory liquidation:
- By paying the debt owed to the petitioning creditor in full before the court hearing
- By defending the petition at Court, on the basis that the debt isn’t actually owed or on a technicality such as inadequate service
- By successfully entering into a Company Voluntary Arrangement (CVA) or applying for Administration
- By placing the company in a Creditors’ Voluntary Liquidation (CVL) before the court hearing
If a Statutory Demand or winding up petition has been issued, then a company still has time to avoid compulsory liquidation, but it will need to act very quickly, and ideally before the winding up petition is advertised, which would alert the bank and other creditors to the company’s difficulties.
Why Choose a Voluntarily Liquidation Rather Than Wait For a Compulsory Liquidation?
On the face of it, if a company is insolvent with no prospect of turnaround or recovery, then it might be tempting to sit back and wait for HMRC or another creditor, to petition for the winding up of the company, as there would be no financial cost to the directors. However there are some good reasons why the company’s directors may wish to consider a voluntary liquidation as an alternative:
- By taking positive action, the directors are properly fulfilling their role and obligations as officers of the company – this will be to their credit when it comes to the Liquidator reporting on their conduct
- In a voluntary liquidation, the directors remain in control of the process and timings, and can ensure that the company is closed down in an orderly manner
- The directors can choose a Liquidator (although the appointment of any proposed Liquidator will need to be approved by a majority of creditors)
Bridgewood can help a company through the voluntary liquidation process and make it as simple as possible, based on the following four key steps:
- The directors of the company discuss matters with an Insolvency Practitioner – all options are considered so that they can make an informed choice
- The company provides to the proposed liquidator, details of its financial affairs including its assets and liabilities, so that the impact of liquidation can be properly assessed and a report prepared for creditors
- Meetings of shareholders are held and a creditors’ decision process commenced to pass resolutions to take the company into liquidation and to appoint a liquidator
- The liquidator takes control of the company as soon as the liquidation is approved. Any assets are realised into the liquidation, for the benefit of creditors. The affairs and circumstances of the company leading up to the liquidation are investigated and reported on to the Secretary of State (this is a legal requirement)
There may be the opportunity for the directors to purchase the assets from the liquidator at market value and continue to trade through a new company, subject to certain legal obligations being met.
You may also be interested in our article How to Identify an Insolvent Company.