Liquidation

Question 1

What is liquidation?

Answer 1

Liquidation is the process by which a company’s business is wound up and its assets transferred to creditors and (if there is a surplus of assets over liabilities) to its members.

Question 2

What happens to a company after liquidation?

Answer 2

The company will then be removed from the register of companies and dissolved.

Question 3

Can solvent companies be put into liquidation?

Answer 3

Solvent companies may also be wound up and this is not uncommon. Companies may be wound up simply because the business opportunity has come to an end, due to internal disputes or where the members wish to move on to new ventures.

Question 4

Function of a liquidator

Answer 4

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”).

Question 5

The ranking of creditors’ claims (that is, the order in which they must be repaid)

Answer 5

set out in the IA 1986, the IR 2016 and by general law.

Question 6

Powers of a liquidator to carry on the business of the company?

Answer 6

They will usually close a company’s business and dismiss employees very soon after their appointment. They 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.

Question 7

There are two types of liquidation:

Answer 7

1. Compulsory liquidation

2. Voluntary liquidation

Question 8

Voluntary liquidation – which is further subdivided into:

Answer 8

• Members’ voluntary liquidation

* Creditors’ voluntary liquidation.

Question 9

Compulsory liquidation

Answer 9

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.

When the court grants a petition for compulsory liquidation, the order operates in favour of all the creditors and contributories (members and some former members) of the company.

The Official Receiver will become the liquidator and continue in office until another person is appointed (s 136(2) IA 1986). The Official Receiver will notify Companies House and all known creditors of the liquidation. The Official Receiver has the power to summon separate meetings of the company’s creditors and contributories for the purpose of choosing a person to become the liquidator of the company in their place (s 136(4)).

Question 10

Who can apply for a winding up order?

Answer 10

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

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

Question 11

Grounds for compulsory winding-up petition

Answer 11

There are seven grounds on which the court can order a company to be wound up, which are set out in s 122(1) IA 1986:

• The company is unable to pay its debts.
• It is just and equitable for the company to be wound up.
• The company has passed a special resolution that it is to be wound up by the court.
• The company is a public company and has not issued the requisite share capital and more than a year has passed since its registration as a public company.
• The company is an old public company within the meaning of the Consequential Provisions Act.
• The company does not commence its business within a year from its incorporation or suspends its business for a whole year.
• There has been a moratorium for the company under s. 1A IA1986 which has come to an end and no voluntary arrangement has been approved in relation to the company.

Question 12

What happens following a liquidation?

Answer 12

Following 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.

Question 13

Most common ground for winding up petition

Answer 13

Company’s inability to pay its debts under s 122 (1) (f) IA

Question 14

Definition of company’s inability to pay its debts

Answer 14

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.

The creditor sues the company, obtains judgment and fails in an attempt to execute the judgment debt.

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.

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”) (Re Cheyne Finance plc [2008]).

Question 15

NY Corporate Trustee Services Ltd v Eurosail-UK 2007-3BL plc

Answer 15

Unable to pay its debts” - s 123(2) IA 1986
In this case the Supreme Court considered the meaning of “unable to pay its debts” and particularly the distinction between the cash flow and balance sheet tests. The case arose out of the 2008 collapse of the Lehman Brothers group and concerned the acquisition by the group of a portfolio of mortgage loans funded by loan notes repayable in 2045. The court held that the cash-flow test must include a consideration of debts falling due in the reasonably near future. What this means will depend on all the circumstances, but especially on the nature of the company’s business. However, once the court has moved beyond the reasonably near future, then the balance sheet test becomes the only sensible test. The burden of proof must be on the party asserting balance-sheet insolvency.

Question 16

Consequences of winding up order

Answer 16

To prevent an insolvent company from transferring its assets to third parties at the expense of its creditors, under s 127 IA 1986 certain dispositions of a company’s property, transfers of its shares and changes to its members will be void if made after the commencement of the winding up. This means if these dispositions etc were made during the period between the presentation of the winding up petition and a winding up order being made, then they will be void. This includes:

• Disposition of the company’s property;
• Transfer of the company’s shares;
• Altering the status of the company’s members.

Once a compulsory winding up order has been made:

• an automatic stay will be granted on commencing or continuing with proceedings against the company;
• all employees will be automatically dismissed, and
• the directors lose their powers and they are automatically dismissed from office.

Question 17

Voluntary winding up

Answer 17

Section 84(1) IA 1986 allows for the company to be wound up without a court order in 3 situations:

Where the company’s purpose according to the articles has expired and resolution of the shareholders
Rare

Where the company resolves by special resolution to wind up the company. The company must be solvent.
MVL

Where the company resolves that it is advisable to wind up the company due to its inability to carry on its business. Here the company is insolvent.
CVL

Question 18

Members’ voluntary winding up (MVL)

Answer 18

• may only be used for companies which are solvent
  -The directors are required to swear a declaration of solvency stating that they have made a full enquiry into the company’s affairs and they have formed the opinion that the company will be able to pay its creditors in full, together with interest at the official rate, within a period not exceeding 12 months from the commencement of the winding up (s 89(1) IA 1986)
  -The declaration must also contain a statement of the company’s assets and liabilities as at the latest practicable date before making the declaration.
  -

Question 19

What happens if a director makes a declaration for insolvency but does not have reasonable grounds for their opinion?

Answer 19

They are liable for a fine or imprisonment (s 89(4) IA 1986)
If the debts are not actually paid in full within the specified period it will be presumed that the director did not have reasonable grounds for their opinion.

Question 20

Conversion of MVL to creditors’ voluntary liquidation

Answer 20

On a MVL, if the liquidator considers that the company will be unable to pay its debts in full together with interest within the period stated in the directors’ declaration, they must change the members’ winding up into a creditors’ winding up by going through the procedural conditions in s 95. This involves the liquidator preparing and sending a statement of the company’s affairs to the company’s creditors.

The company’s creditors may nominate a person to be liquidator. In most cases this will be the insolvency practitioner who was appointed to deal with the MVL.The creditors’ voluntary liquidation takes effect from the date of nomination of the liquidator.

The members must then pass a special resolution to place the company into MVL and an ordinary resolution to appoint a liquidator. The winding up commences when the special resolution is passed (s 84(1) and s 86 IA 1986).

Question 21

Conversion of MVL to creditors’ voluntary liquidation

Answer 21

On a MVL, if the liquidator considers that the company will be unable to pay its debts in full together with interest within the period stated in the directors’ declaration, they must change the members’ winding up into a creditors’ winding up by going through the procedural conditions in s 95. This involves the liquidator preparing and sending a statement of the company’s affairs to the company’s creditors.

The company’s creditors may nominate a person to be liquidator. In most cases this will be the insolvency practitioner who was appointed to deal with the MVL.The creditors’ voluntary liquidation takes effect from the date of nomination of the liquidator.

Question 22

Creditors’ voluntary winding up (CVL)

Answer 22

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. Where a directors’ declaration of solvency has not been made, the liquidation will be a creditors’ voluntary liquidation.

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.

Question 23

Role of the liquidator

Answer 23

As noted above, the appointment of a liquidator terminates the management powers of the company’s directors, and these powers are transferred to the liquidator together with their fiduciary duties, meaning that liquidators must act in good faith, avoid conflicts of interest and not make a secret profit (Silkstone and Haigh Moore Coal Co v Edey [1900]).

The liquidator must be either a qualified Insolvency Practitioner (s 230 IA 1986) or the Official Receiver (appointed by the court in the short term) and acts as an officer of the court.

The liquidator in both a CVL and a compulsory liquidation have extensive statutory powers. The principal functions of a liquidator in a winding up by the court are:

• To secure and realise the assets of the company then distribute to the company’s creditors (s 143 IA 1986); and
• To take into his custody or under his control all the property of the company (s 144 IA 1986).

Question 24

Liquidator’s powers to manage the company

Answer 24

The liquidator’s powers to manage the company are set out in Part I to III Sch 4 IA 1986 and include the ability to:

• Sell any of the company’s property;
• Execute deeds and other documents in the name of the company;
• Raise money on the security of the company’s assets;
• Make or draw a bill of exchange or promissory note in the name of the company;
• Appoint an agent to do any business that the liquidator himself is unable to do;
• Do all other things that may be necessary to wind up the company’s affairs and to distribute its assets.
• Carry on the business of the company, but only to the extent that is necessary for the beneficial winding up of the company.
• Commence or defend court proceedings in the name of the company, for example to recover debts owed to it or dispute debts alleged to be owed by the company.
• Pay debts and compromise claims.

Question 25

Liquidator’s powers to avoid certain transactions

Answer 25

Liquidators have a duty to preserve the company’s property and to maximise the value of the company’s assets available for distribution. They are empowered to avoid certain antecedent transactions in order to maximise the amount of assets available for distribution to creditors as follows:

Disclaim onerous property (s178 IA 1986);Apply to court to set aside a transaction at an undervalue (s238 IA 1986);Apply to court to set aside a preference (s 239 IA 1986);Apply to court to set aside, or vary the terms of, an extortionate credit transaction (s 244 IA 1986);Claim that a floating charge created for no new, or inadequate, consideration is invalid (s 245 IA 1986);Apply to court to set aside a transaction that will defraud creditors (s 423 IA 1986).

Note that many of these powers also apply to administrators.