How Creditors Voluntary Liquidation Works and the Effect on the Business?

When a business is suffering from debts they cannot honour and creditors are demanding payment, the directors of the business are often in the position of having to consider liquidating the company. In some cases, creditors will have petitioned the court and forced the company into compulsory liquidation. However, if it hasn’t got that far, there is the option of a Creditors Voluntary Liquidation, or CVL.

A CVL is a formal insolvency process; the directors voluntarily choose to cease trading and wind up the insolvent company. Whilst no company director wants to be in this position, it is often the best course of action for all parties. So, how does a Creditors Voluntary Liquidation work and in what way does it affect the business?

Why a Creditors Voluntary Liquidation?

If a company is unable to meet its financial liabilities when they fall due – the cash flow test – and its liabilities are greater than its assets – the balance sheet test – it is classified as an insolvent company. In these circumstances, it is important that the company ceases trading; if the business continues to trade, the directors could be held personally liable and it could result in the insolvency practitioner reporting wrongful trading, known as misfeasance, which may lead to legal action.

In addition, it is not wise to pay one creditor over and above another when insolvent. This is considered a preference payment and directors may become personally liable to repay that sum in a liquidation process.

Now that we’ve explained what not to do when a company is classified as insolvent, how can a CVL help an insolvent company. Whilst there are other forms of insolvency procedures, such as a Creditors Voluntary Arrangement (CVA) or administration, where a buyer is sought for the company, when a business is beyond the point of rescue, a Creditors Voluntary Liquidation process not only allows the necessary funds to be raised to pay creditors through the sale of assets, the directors are able to move on to another business, if desired, as long as it is not the same name as the previous company.

Another advantage is that if there are insufficient funds raised from the sale of assets, any outstanding debts are then written off when the company is officially liquidated. The only exception is any debt that has been personally guaranteed by a director; that director then becomes responsible for repayment.

It does mean that any creditors who are at the bottom of the list when it comes to being paid can, and often do, lose out. Creditors have to be paid in a specific order that is in accordance with the Insolvency Act 1986.

How does a Creditors Voluntary Liquidation work?

Once the directors of the company have decided that a CVL is the best option, usually under the advice and guidance of an insolvency practitioner, or IP, there is a formal process that must be followed.

Depending on the company’s structure, it can take as little as two weeks to liquidate an insolvent company, i.e. a small business with just one or two directors. However, with bigger companies that have a complicated structure, it can take a lot longer.

The directors meet and appoint an insolvency practitioner – this is usually the IP that has been working with the company to try and resolve their debt problems. Once this has been agreed and confirmed, there follows a meeting with the shareholders to get their agreement that the company is (a) insolvent and (b) the best option is a Creditors Voluntary Liquidation. Of course, if there are no shareholders, this step of the process is not necessary.

At this point, the IP takes control of the company and commences the liquidation process. The directors no longer have any say in what happens, including the sale of the company’s assets. However, if the directors want any of the assets, i.e. to start a new business, they can notify the IP. When this occurs, known as an ‘in specie’ distribution, the IP is able to arrange the transfer of the assets but the directors must pay the current value of the asset that has been ascertained by the IP.

The appointed insolvency practitioner liaises and negotiates with the company’s creditors, collects any outstanding book debts, handles any employee redundancy claims, arranges for assets to be valued and sold, distributes the realised funds to creditors in accordance with the Insolvency Act 1986’s specific order, submits the necessary reports to finalise and pay any tax liabilities, and finally closes the company including applying for it to be removed from Companies House register.

The impact of a Creditors Voluntary Liquidation

Dealing with any debt situation is stressful; when it gets to the level of insolvency, it can seem like there is ‘no light at the end of the tunnel’. The first step is making the decision to liquidate an insolvent company. Once this has been agreed and the liquidation process has commenced, it can often feel like a weight has been lifted off the shoulders.

Because it has been a voluntary process, the directors are able to start again but not for a minimum of five years if wanting to start another com with the same or similar name.

A Creditors Voluntary Liquidation in theory wipes the slate clean. In reality, it is a different matter. Most directors of liquidated companies often find that their reputation has been affected and they may find it difficult to get credit in the future, particularly if it is with creditors that have suffered with them in the past. It is also a very difficult time for any employees who will find themselves out of a job. That said, choosing a CVL is a better option than being forced into a compulsory liquidation through the courts.

If you are considering closing an insolvent company that is considering a Creditors Voluntary Liquidation, contact Simple Liquidation for assistance. Company or individual insolvency is not something that anyone wants to deal with; however, the sooner a financial problem is recognised, the sooner it can be dealt with and the more potential the company has in recovering. For more information on how our professional insolvency practitioners may be able to help your business contact us today.