Liquidation – ss.73 – 229 of IA 1986

TheLawStudent

What is liquidation (otherwise known as winding up)?

Liquidation is the most basic and oldest of the corporate insolvency procedures. The liquidator’s function is to realise the company’s assets for cash, determine the identity of the company’s creditors and the amount owed to each of them and then pay a dividend to the creditors on a proportionate basis relative to the size of their determined claims (creditors of the same rank are said to rank ‘pari passu’). The ranking of creditors’ claims (that is, the order in which they must be repaid) is set out in the IA 1986, the IR 2016 and by general law.

Liquidation is not a rescue mechanism and a liquidator has only very limited powers to carry on the business of a company. He will usually close a company’s business and dismiss employees very soon after his appointment. He will usually sell assets on a piece-meal basis rather than selling the assets and business as a going concern. The statutory moratorium which applies in a liquidation is very limited. For these reasons, it is common for companies to enter into liquidation after having been through a different insolvency procedure (e.g. administration) first. In particular, the ability of an administrator to maximise value for creditors by selling a business as a going concern is an important advantage of administrations over liquidations. However, administrators do not generally have the power to pay a dividend to unsecured creditors (other than the prescribed part dividend out of the ring-fenced fund) and where there is a dividend to be paid to them, companies in administration may later enter into liquidation after the objective of the administration has been achieved and the administration comes to an end. In such a case, the main purpose of the liquidation will be to provide the mechanism for agreeing creditors’ claims and payment of a dividend to them.

Types of liquidation

There are two types of liquidation: compulsory and voluntary.

Voluntary liquidations are further divided into:

  • members’ voluntary liquidations (which are solvent liquidations); and
  • creditors’ voluntary liquidations (which are insolvent liquidations).

What follows liquidation?

The company’s life is generally brought to an end automatically by dissolution. In the case of a compulsory liquidation, this will be three months after notice by the liquidator to the Registrar of Companies that the winding up of the company has been completed. In the case of voluntary liquidation, dissolution will occur three months from the filing by the liquidator of the final accounts and return. On dissolution, the company ceases to exist.

Going into compulsory liquidation

Compulsory liquidation is a court based process for placing a company into
liquidation. To begin the process, an applicant presents a winding up petition to
the court under which the applicant requests the court to make a winding up
order against the company on a number of statutory grounds. The court issues
the petition and fixes a date for the hearing of the petition. The applicant then
serves the petition on the company.

The following can apply to the court for the issue of a winding up petition:

  1. a creditor;
  2. the company (acting by the shareholders; this would happen where there are insufficient assets in the company to fund a voluntary liquidator);
  3. the directors (by board resolution); again, this would happen where there are insufficient assets to fund a voluntary liquidator;
  4. an administrator;
  5. an administrative receiver;
  6. the supervisor of a CVA; and
  7. the Secretary of State for Business, Energy & Industrial Strategy (on public policy grounds).

Given the ability of a QFCH to appoint an administrator out-of-court following the occurrence of an event of default under the relevant loan agreement, it is usually an unsecured creditor who will apply to the court for a winding up order. A secured creditor which holds only fixed charges (and so is not a QFCH) will usually enforce against the assets subject to its fixed charges by appointing a fixed charge receiver and will not usually resort to issuing a winding up petition.

Grounds of petition for liquidation

The usual grounds are:

  1. insolvency, that is the company’s inability to pay its debts (s.122(1)(f) of IA 1986); or
  2. the court being of the opinion that it is just and equitable that the company be wound up (s.122(1)(g) of IA 1986).

Technically, the just and equitable ground to wind up a company is not an insolvency situation.

Proof of inability to pay debts – s.123 of IA 1986

Methods

  1. Failure by the company to comply with a creditor’s statutory demand. A statutory demand is a written demand in a prescribed form requiring the company to pay a specific debt. The statutory demand can only be used if the debt exceeds £750 and is not disputed on substantial grounds. The company has 21 days in which to pay the debt, failing which the creditor has the right to petition the court to wind up the company.
  2. The creditor sues the company, obtains judgment and fails in an attempt to execute the judgment debt.
  3. Proof to the satisfaction of the court that the company is unable to pay its debts as they fall due (the “cash-flow test”). The cash flow test is usually satisfied by going through the statutory demand process in 1 above but that is not essential.
  4. Proof to the satisfaction of the court that the value of the company’s assets is less than the amount of its liabilities, taking into account contingent and prospective liabilities (the “balance sheet test”).

Note that some of the limbs of s.123 are very wide and borrowers will usually seek to restrict which limbs are deemed to be an insolvency event of default in their loan agreement with lenders.

Going into voluntary liquidation

Members’ voluntary liquidation (‘MVL’)

The MVL procedure is utilised only if the company is solvent. The procedure (set out in s.89(1)) is that the directors make a statutory declaration that the company will be able to pay its debts in full within a period specified in the declaration (not exceeding 12 months from the commencement of the winding up). The statutory declaration must attach a simplified form of balance sheet listing and giving values for the company’s assets and liabilities and showing that the assets exceed the liabilities.

The shareholders pass:

  • a special resolution to place the company into an MVL; and
  • an ordinary resolution appointing a liquidator.

Notice of intention to put a resolution for voluntary liquidation to the shareholders must be given in advance to any QFCH. Note that the MVL will be converted into a creditors’ voluntary liquidation (see below) if the company becomes unable to pay its debts within the period (invariably one year) specified in the statutory declaration.

Creditors’ voluntary liquidation (‘CVL’)

This is a form of insolvent liquidation commenced by resolution of the shareholders but under the effective control of the creditors who can choose the liquidator.

The procedure is for the shareholders to pass a special resolution to place the company into a CVL. The shareholders may also nominate a person to be liquidator, but in any event within 14 days of the special resolution being passed the directors of the company must ask the company’s creditors to either approve the nominated liquidator or put forward their own choice of liquidator. Where the creditors’ choice of liquidator differs from that of the company’s shareholders, the creditors’ nomination will take precedence. The directors must also draw up a statement of the company’s affairs (setting out the company’s assets and liabilities) and send it to the company’s creditors.

Effect of the pre-insolvency moratorium

A company cannot be placed into type of liquidation while a pre-insolvency moratorium subsists.

Liquidator’s powers and duties

The liquidator is the de facto agent of the company and has extensive statutory powers. The directors lose their powers upon the liquidator’s appointment. The liquidator’s powers include:

  • To collect in and realise the company’s assets and to distribute them in the order of priority set out in IA 1986.
  • To make any compromise or arrangement with creditors.
  • To bring in or defend any action or legal proceeding in the name of and on behalf of the company.
  • To maximise the assets available for distribution to the company’s creditors by:
    • challenging voidable antecedent transactions or to sue one or more of the directors for wrongful or fraudulent trading. It is of interest to note that liquidators (and administrators) also have the power to assign the right to wrongful and fraudulent claims as well as preference and transactions at an undervalue causes of action. This allows them to realise some money for the benefit of the estate without assuming the risk of litigating the claims; and
    • disclaiming onerous property (s.178) e.g. onerous, unsaleable or unprofitable contracts – this is available equally in both solvent and insolvent liquidations. The most important example of onerous property is a lease of land. When notice of disclaimer is given by the liquidator, all rights, interests and liabilities of the company in respect of the property cease. A person who suffers any loss resulting from a disclaimer is entitled to prove in the liquidation as an unsecured creditor, or in certain circumstances, to apply to the court for an order to have disclaimed assets vested in him.

Proceedings against the company

After presentation of a petition and before a winding up order is made, the company, or any creditor or contributory, can apply to the court to request it to make a provisional order to stay any action or proceedings then current against the company.

The effect of a winding up order will be automatically to stay any action or proceedings against the company, unless the court otherwise determines.