Understand liquidation – solvent and insolvent

Many people hear the word liquidation and automatically think it is a negative process for businesses that are in trouble and suffering from insolvency.

Richard Simms, Managing Director and Insolvency Practitioner at F A Simms & Partners, explains why you would choose a liquidation process and the difference between a solvent and insolvent liquidation situation.

Why choose a liquidation process?

A liquidation process could be an appropriate solution for  a company struggling with insolvency or just looking for a way to close down their solvent business effectively.

For an insolvent company many directors may think that they can trade out of their troubles or just stop trading with the hope of no one noticing; this hardly ever works out. Choosing a liquidation process will ensure all loose ends connected to the company are tied up and will ensure a clean break is provided for all directors and shareholders.

What is a solvent liquidation?

The term “solvent” means that a company’s assets exceed their liabilities and that the company are able to pay all of their creditors in full within 12 months, including statutory interest.

A Members’ Voluntary Liquidation (MVL) is the formal liquidation process which is used to close down the affairs of a solvent company. The alternative process to this is an informal option called Strike Off.

Since the changes to the ESC C16 legislation in 2012, in order for final shareholder distribution of funds that exceed £25,000 to receive automatic capital tax treatment (this is where distributions are classed as capital receipts rather than income) an MVL process will need to be used. This system replaces the former HMRC concession which would have previously been used in order to receive the tax benefits.

These tax benefits are the main reason companies use an MVL process. There is also the possibility of receiving the personal tax relief known as Entrepreneurs’ Relief against the funds. If this relief is available, the tax rate can be reduced down to a low 10%. This tax saving therefore usually outweighs the cost of the liquidation process itself.

The process of an MVL is also deemed to be a huge benefit to the directors as it provides the chance to dissolve a company in the correct way and not leave any unattended issues behind. The process can also be seen as a benefit to the accountant as it would provide further chargeable hours of work for them in order to prepare the accounts needed in this process.

What is an insolvent liquidation?

The term “insolvent” means that a company cannot pay their creditors as and when payments are due, and their liabilities exceed their assets.

A Creditors’ Voluntary Liquidation (CVL) is a formal liquidation process used to close down the affairs of an insolvent company.

A CVL is the voluntary liquidation process initiated by the shareholders of the company. It is the process of closing down the insolvent company and selling its assets in order to pay back a pence in the £ distribution to its creditors (if there are funds available for this). This process will require an Insolvency Practitioner to be appointed as liquidator in order to manage and oversee the process accordingly.

This process compared to a court-led liquidation gives the director the flexibility of deciding on whom the Insolvency Practitioner will be. It also offers them the chance to purchase the assets and goodwill of the business at a fair value if they wish to start afresh in a new trading company. This insolvent process is that the director can choose to re-start their business if they so wish by using a CVL as a business rescue process; alternatively they can go ahead with full closure of their company.

The court-led liquidation process is called a Compulsory Liquidation. This process is usually initiated by a disgruntled creditor who is tired of waiting for their payments and so begins legal proceedings to try and obtain the funds they are owed.

AAT helpline

For professional free advice with regards to the liquidation procedures mentioned in this article please use the AAT helpline: 01455 555 615. All advice given is free, confidential and offered by one of our 4 Insolvency Practitioners.

Richard Simms is an Insolvency Practitioner at FA Simms.