Solvent vs Insolvent Company Liquidation

Two different types of liquidation, solvent and insolvent, represent distinct approaches to closing a limited company.

Solvent liquidation occurs when a company has enough assets to pay off all of its debts and obligations. In this case, the company can choose to go through a voluntary liquidation process, where the company’s directors decide to close the business and sell off its assets in order to pay off creditors.

On the other hand, insolvent liquidation occurs when a company does not have enough assets to pay off its debts. In this case, the company may be forced into involuntary liquidation, where a court orders the company to sell off its assets in order to pay off creditors.

Insolvent liquidation can also occur through a bankruptcy process, where the company’s assets are sold off and the proceeds are used to pay off creditors according to the priority of their claims.

Liquidation is a process which works for both solvent and insolvent companies, with the principle difference being that the proceeds of insolvent liquidation go to creditors.

In this article, we’re going to explore the essential definitions of solvent and insolvent liquidations and take a look at a few of the reasons why a company might decide that either a creditors’ voluntary liquidation (voluntary insolvent liquidation) or a members’ voluntary liquidation (solvent liquidation) is the right option for them.

Difference between a Solvent and Insolvent Company Liquidation

A Solvent company liquidation occurs when a company has enough assets to pay off all its debts and liabilities and still have some assets left over. The process involves selling the assets to pay off creditors and distribute any remaining assets to shareholders. On the other hand, an Insolvent company liquidation occurs when a company does not have enough assets to pay off all its debts and liabilities.

The process involves selling any assets that are available to pay off creditors, but often not all debts can be fully satisfied, and the company may have to be dissolved. In insolvent liquidation, the creditors, rather than the shareholders, become the primary focus and priority for the distribution of assets.

Solvent liquidation definition

Directors may wish to close the company for personal reasons. They maybe retiring, or perhaps the market has changed and the business is no longer viable. In these circumstances, and where the business has assets, solvent liquidation may be the most appropriate solution.

Solvent liquidations are known as a Members Voluntary Liquidation and require the services of a licensed insolvency practitioner to complete.

Insolvent liquidation definition

Insolvent means that a company is unable to meet its liabilities as and when they fall due, or that its debts exceed its assets.

A Creditors’ Voluntary Liquidation (CVL) is a formal liquidation procedure that is used to close down an insolvent company. This is a voluntary process, which is initiated by the company’s directors/shareholders and it involves realising or selling the assets of the company to pay back creditors. This procedure requires the appointment of a licensed Insolvency Practitioner (IP) to manage the process.

Common causes of liquidation

Companies can become insolvent for a number of reasons. In certain cases, the blame for insolvency could be levelled at a company director, in which case they could face a misconduct charge and a directorship ban. They could also be made personally liable for some of the company’s debts.

there are also a number of ways a company can become insolvent without any fault on the part of the company directors. This includes:

• Late payments from customers
• A major customer or supplier enters a formal insolvency
• A significant dip in the market
• An increase in competition
• The incorrect pricing of goods

All of these events can impact negatively on a company, and may ultimately result in it having to enter a liquidation process if no other alternatives, like a company voluntary arrangement (agreed payment plan with creditors), are available.

How do I know if my company is insolvent?

If your company fails any one of the three tests set out in the Insolvency Act 1986, then it is likely to be insolvent. In addition, the company also needs to consider whether it could be subject to a winding-up petition being presented to court. This is because there are additional tests to prove a company’s insolvency.

Due to the serious nature of a company’s insolvency, it is essential that professional advice is obtained from a licensed Insolvency Practitioner immediately. An IP will consider the company’s position, explore the options available and recommend to the board of directors the most appropriate option to achieve the best outcome for creditors.

The three solvency tests

As a company director, there are three tests you can run to see if your company is solvent or insolvent.

1. Cash flow test A company should be able to pay its bills and liabilities as they fall due. If it cannot, then it may be insolvent.
   • The company is not up to date with PAYE, National Insurance and VAT payments.
   • The company is struggling to adhere to a creditor’s payment terms, and any outstanding money owed cannot be paid from cash in the bank or money due to the company.
     If any of the above warning signs are evident and there are cash flow issues, then it is likely that your company is insolvent.
2. Balance sheet test If your company’s liabilities exceed the value of its assets, then it is likely that your company is insolvent. The amount you owe to creditors should not be more than the value of your company’s assets, including any money it currently has in the bank.
3. Legal action testOther warning signs for your company are creditors threatening or taking legal action, such as a County Court Judgement (CCJ), a statutory demand, or issuing a winding-up petition for monies owed that the company cannot repay. Even if you dispute the amount claimed to be owed, the company cannot be seen as solvent until the claim is either settled or dismissed in court. However, if you do not act quickly with these proceedings, it can damage your credit rating and lead to further action.

How do you close down a solvent company?

To close down a solvent company you need an insolvency practitioner to carry out a Members Voluntary Liquidation.

Essentially, the decision to liquidate must be voted upon by shareholders, following which the liquidator (insolvency practitioner) takes care of the rest of the process.

Recent changes to legislation have meant that a MVL process must be used for any final shareholder distribution of funds that exceed £25,000 in order to receive automatic capital tax treatment. This system has replaced a HMRC concession that was used previously to receive the tax benefits.

These tax benefits are the main reason limited companies opt for an MVL. There is also the possibility of receiving Entrepreneurs’ Relief against the funds, which could potentially reduce the tax rate to 10%. This significant tax saving, therefore, usually outweighs the cost of the liquidation process itself.

How do you close down an insolvency company?

To close down an insolvent company you will need an insolvency practitioner to carry out a voluntary liquidation. This means that the  directors of the company are trying to minimise the risk to creditors, which in an insolvency situation is the right thing to do. Choosing a creditors’ voluntary liquidation can ensure all loose ends are tied up and the directors can have a clean break without being chased by their creditors

Conclusion

In conclusion, solvent liquidation and insolvent liquidation are two different processes that a company may go through when it decides to close its business or is unable to pay off its debts. Solvent liquidation occurs when a company has enough assets to pay off all of its debts and obligations, while insolvent liquidation occurs when a company does not have enough assets to pay off its debts.

Solvent liquidation can be voluntary, while insolvent liquidation can be involuntary and may involve bankruptcy proceedings. It is important for companies to carefully consider their financial situation and take appropriate action to ensure a smooth liquidation process.

Still not sure if Solvent vs Insolvent Company Liquidation is the best option to close your business, simply drop us an online enquiry and we will help you.