What does it mean when a company is in liquidation? The fact is, many company directors don’t completely understand the liquidation process or what it means for them. This can make it more alarming when a customer’s or supplier’s business is being liquidated—especially if they owe you money.
Liquidation is a process used to close a company and dissolve it. The business’ assets are sold off to pay creditors and it is removed from the Companies House register, meaning that it ceases to exist.
The liquidation process can be undertaken voluntarily, or it can be forced upon a company by creditors who want to get money back.
What is the difference between liquidation and insolvency?
Liquidation is not the same as insolvency. Insolvency is a state of being. It describes a company that has insufficient assets and cash flow to cover its debts.
Insolvent companies won’t necessarily be liquidated, and liquidated companies aren’t always insolvent. For example, an insolvent company could be rescued by being restructured or going into administration.
Reasons to liquidate a company
Directors may decide to liquidate their company if:
Market conditions mean that the company is no longer viable
Revenue has been decimated due to the loss of key customers
The company has been left with bad debt and cannot sustain the loss
The business is having cash flow difficulties
Customers are not paying their bills
How does the liquidation process work?
Generally, all liquidation types follow a similar process, but there are some variations.
Here’s what the liquidator does once their appointment has been confirmed:
The liquidator gathers as much information on the company as possible by reading company books, records, asset details, and debts. This gives them a thorough understanding of the company’s financial position.
2. Inform creditors
The directors provide the liquidator with a complete list of creditors, including their contact details and how much money they owe. The liquidator then issues a formal notice informing creditors of the liquidation.
The liquidator assesses all company assets that can be sold to pay the company’s debts.
4. Staff management
The liquidator is also responsible for:
- Making staff redundant
- Helping employees make claims
- Investigating company director's conduct
At the end of this process, the company is liquidated. It ceases to exist and cannot trade.
Types of liquidation
There are several different types of liquidation and this section describes each one in detail. Which one is used depends on the current state of the company and who triggered the liquidation.
Creditors’ voluntary liquidation (CVL)
This is when directors choose to wind up their business. It is usually done in the face of creditor pressure and/or financial distress that is likely to get worse.
If a business has no viable future, a creditors’ voluntary liquidation is a good way to close down the company. That’s because:
- It encourages a constructive discussion between creditors, directors and shareholders on how to pay off as much of the company’s debt as possible.
- Directors are protected from wrongful trading or other misconduct accusations that could leave them personally liable to pay fines and penalties.
- It avoids the process of being petitioned by a court, which can be bad for the directors’ reputations.
After a creditors’ voluntary liquidation, all debts that cannot be repaid will be written off by creditors, unless they are secured by a personal guarantee.
The CVL process
- A director must enter insolvency proceedings as soon as they realise their company is insolvent.
- They should then appoint a liquidator and hand over control of the company to them, and the company ceases trading.
- One month later, shareholders and creditors hold a general meeting and vote on whether to wind up the company and approve the appointment of the liquidator. Creditors can also object to the appointment of the liquidator.
Members' voluntary liquidation (MVL)
Sometimes known as solvent liquidation, this is a process for closing down a solvent company. It allows directors and shareholders to close down a business that is no longer needed or that they wish to extract profits from. A members’ voluntary liquidation is not the same as a company strike-off, which is a quicker and cheaper process, but limits the amount of funds that you can take out of the business.
The MVL process
The MVL process is similar to that of CVL.
- Directors agree to liquidate the company and sign a declaration of solvency.
- The directors then appoint a liquidator and schedule a shareholders’ meeting to discuss the liquidation.
- 75% of company shareholders need to agree to an MVL for it to go ahead and confirm the appointment of the liquidator.
This is when a creditor petitions the court to liquidate a company because it has not paid its debts to them.
Directors and shareholders can also place their own business into compulsory liquidation by submitting their own winding-up petition to the court, but this is rare.
If you are an unsecured creditor, forcing a customer company into liquidity is usually a last resort. There is very little chance that you will get back the money owed. We’ll explain why later in this article.
The compulsory liquidation process
- The creditor submits a winding-up petition which is heard by a judge.
- If the judge agrees with the petition they can serve a winding-up order on the company.
- The company ceases trading.
- An appointed liquidator then takes control of the company.
A company strike-off is an alternative to liquidation and is a quick, easy way to dissolve a business. Directors simply fill in a form, pay a small fee and the business is struck off the Companies House register. After this, it ceases to exist as a legal entity. A company strike-off is suitable for businesses with little or no assets. Directors can extract assets worth up to £25,000 but anything beyond this becomes property of the Crown.
🚨Don’t ignore creditors’ meetings
If you are a creditor of an insolvent company and you are invited to a creditors’ meeting it is a good idea to attend. You will be given details on the business’s financial position and liquidation process.
The role of a liquidator
Liquidators are licensed insolvency practitioners. When one is first appointed they help the directors understand if the insolvency route they have chosen is correct. It may be that the company is salvageable and company administration or restructuring may be a better option.
Liquidators also take responsibility for:
- Dealing with outstanding contracts
- Communicating with creditors during the insolvency process
- Removing the company from the Companies House register
- Investigating directors’ conduct relating to the insolvency
Company directors’ duties
Directors have to:
- Provide the liquidator with all the information they need about the company.
- Attend an interview with the liquidator when asked.
- Hand over all of the company’s assets.
- Give the liquidator access to all relevant documents relating to the company’s assets and liabilities.
How long does the liquidation process take?
Generally, insolvency takes one to three weeks to complete. However, it can take longer. Every liquidation is different and the length of time it takes depends on a number of factors, including:
- How organised the directors are in providing information to the licensed insolvency practitioner.
- How complex the company’s financial situation is.
- Whether any shareholders reject the appointment of insolvency or the licensed insolvency practitioner.
- Whether any creditors reject the appointment of the licensed insolvency practitioner appointment.
Can a company trade during liquidation?
No. Directors should stop trading as soon as they make a decision to liquidate the company.
Directors found to be trading while insolvent could be charged with wrongful trading. If this happens they will be personally liable for some or all of the company’s debts and could be banned from being a company director for up to 15 years.
Insolvent companies can continue to trade, as long as the directors act in the creditors’ interests — for example, by appointing licensed insolvency practitioners.
Should I continue doing business with a company in liquidation?
You should not trade with a company in liquidation. Businesses that are being liquidated should have ceased trading and had their bank accounts frozen.
If a company director is attempting to trade with you while their company is in liquidation then they are breaking the law. You risk losing any money that you pay them during this period.
You can continue to trade with an insolvent company. However, this is risky and you should take steps to get significant guarantees on any credit that you extend to the insolvent business.
Can liquidated companies start again?
Directors of liquidated companies can start a new legal entity and buy all of the previous company’s assets. This essentially allows them to continue the business as a different company.
The main rule is that business assets must be acquired from the liquidator at fair value.
Also, for five years directors cannot:
- Become a director of a business with a similar trading name.
- Set up a business with a trading name that is the same or similar to that of the liquidated company.
However, there are some exceptions to this:
- If a new company buys the liquidated company they can use a similar trading name as long as they inform stakeholders.
- You can apply to the court to use a registered trading name that is similar to the liquidated company.
- If the use of the liquidated company’s trading name had been prohibited prior to the liquidation it can be used for the new company.
What does it mean for my business if a customer is in liquidation?
If one of your customers becomes insolvent it is usually bad news.
At best, you’ll lose vital revenue. But if the customer owes you money through unpaid invoices then it will be much worse—especially if the money owed to you is a significant sum.
As mentioned above, when an insolvent company is liquidated, its assets are sold off to pay the outstanding debt.
Since the definition of insolvency is when a company’s debts outstrip its assets and cash flow, it stands to reason that there won’t be enough money from this process to pay off everyone in full.
The liquidator is legally obliged to pay creditors in the following order:
- The liquidator: this includes the liquidator’s fee, along with any costs and expenses accrued during the insolvency process.
- Secured creditors: those with a fixed charge over business assets, like a bank.
- Preferential creditors: usually employees seeking wage arrears or holiday money.
- Prescribed part creditors: a set amount put aside to be shared out amongst all unsecured creditors.
- Secured creditors: those with a floating charge.
- Unsecured creditors: suppliers, customers, contractors, trade creditors.
In other words, companies like yours are paid last and on average the returns are well under 10% of the total debt.
The outstanding debt is written off and you have to take on the loss as bad debt. Companies that experience this kind of loss are three times more likely to become insolvent themselves in the next twelve months.
How can I protect my business from customers in liquidation?
Liquidation is the last step of the insolvency process. Once a customer company has entered liquidation, there is nothing you can do.
The best way to avoid customers that go bust is to ensure you only work with financially healthy companies. There are two ways to do this:
- Credit checks
- Financial health monitoring
Both of these require a business credit scoring database, and this is where Red Flag Alert comes in.
We have data on every UK company and our detailed business financial health scores are the best in the industry—in fact, we often spot financial risk that our competitors miss.
Here’s how Red Flag Alert can protect your business:
Making sure that companies are financially sound by conducting company credit checks before you agree to work with them is a great way to avoid losing customers and experiencing bad debt.
We have over 100 data points on every UK company and this information is updated in real time.
Our machine learning algorithm uses this data to calculate an accurate credit rating for every UK business. Using our insolvency risk score, healthy companies are rated gold, silver and bronze, while businesses at risk of insolvency are rated one, two or three red flags.
This allows you to set your risk tolerance when onboarding new customers. Better yet, your sales team can use our credit scores when prospecting to ensure they only approach healthy businesses.
Financial health monitoring
Even if your customers are financially healthy during onboarding, it doesn’t mean that things won’t change in the future.
That’s why we provide financial health monitoring tools.
You can use Red Flag Alert to set up monitoring alerts that inform you as soon as something changes in each customer’s financial health.
This allows you to take proactive measures to protect your business. This could be further monitoring, or even withdrawing credit and calling in invoices.
How Red Flag Alert can help
Red Flag Alert is the perfect tool to protect your business from financial risk. It provides:
- Financial health ratings for every business in the UK.
- Detailed ratings that incorporate all real-time information.
- Ratings developed over 25 years by expert credit analysts.
- Ratings that give quantifiable predictions on insolvency in the next 12 months.
- Key updates sent every day.
- Information integrated into your CRM.
To find out how Red Flag Alert can help your business, request a demo.
Or for more information on how to protect your business, read our article on managing risk in the post-pandemic economy.