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What is the difference between liquidation and insolvency?

The simple and honest answer is – not much! Most companies that go into liquidation are insolvent, apart from those that are placed into Members’ Voluntary Liquidation. It’s probably easiest if we start by looking at the definition of insolvency and then we can look at how this impacts companies with financial difficulties, tells Richard Saville of Corporate Financial Solutions.

The definition of insolvency is:

  • “the inability to discharge your liabilities as and when they fall due for payment”.

The key point in determining whether an entity is insolvent or not, is whether that entity can pay its debts when they fall due for payment. This is determined by the dates that your debts are due for payment according to the terms imposed upon you by your suppliers. Not everything that you owe, will be due all at once – the dates by which you must pay will be set out as follows:

  • Trade suppliers – the date for payment will be set out in their terms and conditions which are usually sent to you when you open a credit account.
  • PAYE/NI – under the Real Time system, all monthly deductions have to be paid to HMRC by the 19th of each month following deduction.
  • Utility suppliers – these are a combination of monthly and quarterly payments, with the dates being set up when the accounts are opened.
  • Bank/lenders – overdrafts are repayable upon demand and are therefore capable of being recalled at any time. Other loans though will have the monthly payment dates specified in the agreement. The total amount of the loan is only repayable in the event that monthly payments are not made.

It is therefore important, when assessing whether a business is insolvent or not, to look, not so much at the aggregate debt, but at the dates on which debts are payable. In the event that you cannot discharge your debts on the due date, then, strictly speaking you or your company are insolvent.

If you are a director of a limited liability company, then determining whether the company is insolvent or not is a significant issue. If, as a director, you conclude that the company is insolvent, and if you then continue to trade without a reasonable belief that the position will improve, you could become personally liable for all future credit that the company incurs – that is not a good thing!

If at this stage, you have any concerns at all about your company’s financial position, then you should really speak to a reputable Insolvency Practitioner, who will be able to offer clear and impartial advice about what to do about your position.

Looking now at liquidation, there are various types of liquidation dealing with both solvent and insolvent situations. It may seem odd to be looking at solvent liquidations, but the legislation effectively uses the word “liquidation” for both solvent and insolvent processes. A summary of the various types of liquidation are as follows:

  • Creditors’ Voluntary Liquidation (CVL) – this is perhaps the most common form of liquidation. A CVL is instigated where the directors have concluded that, because of its debts, the company can no longer continue to trade, and they need to take the steps to place the company into liquidation. An Insolvency Practitioner will be appointed as Liquidator, and it is his responsibility to realise the assets and, where possible if the funds allow, to pay a dividend to the creditors.
  • Compulsory Liquidation – this is where a company is wound up by the court. This usually happens where one of the company’s creditors loses patience with the company not paying and applies to court for a winding up order to be issued. Once the winding up order is made, the company is then placed into compulsory liquidation, with the Official Receiver, usually being appointed as Liquidator. It is often the case that asset realisations in compulsory liquidations are minimal with little or no return to the creditors.
  • Members’ Voluntary Liquidation (MVL) – this is a solvent form of liquidation, where the assets of a company are greater than the total of all its liabilities. This process is usually used where shareholders decide simply to cease trading and convert the assets into cash for distribution to them or in some cases for obtaining tax relief for shareholders on capital distributions.

If you have any concerns at all about your position or your company’s position, or how debts can impact your position, then please seek the advice of a reputable Insolvency Practitioner. Your accountant or solicitor will usually know of one locally. Failing that, you can log onto R3, The Association of Business Recovery Professionals website, where you will find a list of their members – www.r3.org.uk.

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