Times are tough right now, and more businesses than ever before are being forced to close their doors.
As a result of the Coronavirus pandemic, global corporate insolvencies are forecast to increase by 26% in 2020, whilst in the UK, the Office for National Statistics reported that GDP fell in the second quarter by 20.4% - the biggest quarterly decline since records began.
With so much uncertainty, it’s no wonder that a number of UK businesses are struggling. But if your business is facing liquidation, what is the difference between compulsory and voluntary liquidation? We explain everything you need to know in this blog.
The lowdown on liquidation
Liquidation is the process of closing a business and selling the assets to pay back its debts. It is a formal insolvency process whereby a liquidator (or insolvency practitioner) ‘winds up’ a company’s affairs.
In a business liquidation, the company’s bank accounts are frozen, directors’ powers are removed, and the company stops trading - and by the end of the liquidation process, the company is completely dissolved and struck off the Companies House register.
There are two core types of liquidation: compulsory and voluntary.
Compulsory liquidation versus voluntary liquidation
Whilst both compulsory and voluntary liquidation involve the formal closure of a limited company, there are some key differences between the two, mainly with regards to the way they are initiated and how the liquidator is appointed.
It’s important to understand what the difference is between the two because they have vastly different implications for you as a director and for your company.
What’s more, to make things even more complicated, there are also two different types of voluntary liquidation: Creditors’ Voluntary Liquidation (CVL) and Members’ Voluntary Liquidation (MVL) - and although these are both classed as voluntary, they are used in very different circumstances.
7 common questions around CVLs and MVLs:
What is a Members’ Voluntary Liquidation?
A Creditors’ Voluntary Liquidation is a voluntary process but one that is essentially an admission on the part of a company’s directors that the business is insolvent.
A Members’ Voluntary Liquidation, on the other hand, is quite different. Sometimes referred to as ‘solvent liquidation’, it takes place when a business is still solvent and able to meet its liabilities, but the shareholders agree to wind up the company.
A MVL can function as a way for cash to be generated and profit extracted, and because the company can pay its debts and meet its obligations on time, the process is quite orderly.
If, however, your business is unable to pay its debts, a Creditors’ Voluntary Liquidation would be the only form of voluntary liquidation available as an option.
What is a Creditors’ Voluntary Liquidation?
If a business is insolvent, the shareholders, directors and owners can vote to go through a Creditors Voluntary Liquidation.
A CVL is often turned to when creditor pressure gets too much for a company to deal with, and the main difference between a CVL and compulsory liquidation is that the directors of the company choose and appoint the insolvency practitioner themselves, rather than having it forced upon them.
It’s a quick yet powerful way to close a business whilst ensuring everything is dealt with legally and properly.
One of the biggest benefits of opting for a CVL is that you can make the decision about when the company should be closed, preventing any further losses to creditors. This means it can put a stop to creditor demands and show that you are acting responsibly in your role as a company director.
In addition, a CVL also gives the company a chance to prepare more thoroughly for what the future might bring and commence staff redundancy procedures more quickly.
How does a CVL work?
With a creditors’ voluntary liquidation, the company must pass a special resolution under the Companies Act 2006 declaring it is unable to continue due to its debts and liabilities.
Using the method of Deemed consent the day of liquidation will come and go, and providing there is no objection to the proposed liquidator being appointed the company will enter liquidation.
Alternatively, a meeting with the company’s creditors will then take place within 14 days where the businesses finances will be reviewed, and a liquidator will be appointed.
Neither the Court or Official Receiver are part of voluntary liquidation, and the process is quicker than a compulsory liquidation too because there is no need for creditors to apply for a winding up petition.
What is Compulsory Liquidation?
As the name suggests, compulsory liquidation is something that is forced on a company by an aggrieved party. Should you fail to pay a creditor the amount they are owed (providing the amount is over £750) within 21 days of them requesting payment, they are within their right to petition for your company to be wound up.
However, this is a very serious and expensive step for a creditor to take, which means that a winding up petition is usually only considered as a last resort.
How does Compulsory Liquidation work?
Once a winding up petition is served, you have a very short window of time to take action.
The notice of the winding up petition will be advertised in the Gazette after seven days, and you then have another seven days to settle the petition. If this isn’t done, the petition will be heard at court and a winding up order will be served.
On the issue of the court order, an Official Receiver is appointed, and the liquidation process begins. Your bank will freeze the company bank accounts and the Official Receiver will begin to investigate what led to the company’s insolvency.
If there are assets to recover, a liquidator will be appointed. The proceeds from the liquidation will go towards the cost of the liquidation, with any remaining funds going to the creditors - however, it is unlikely that they will receive the full amount owed.
Which is best for my company?
The main difference between compulsory and voluntary liquidation, then, is whether or not the process was the director's idea. However, the compulsory liquidation process is not ideal for any business.
Waiting for creditors to wind up the company suggests that directors were unaware, or ignoring, their company’s financial state - and if the Official Receiver finds this to be the case, the director could be held personally liable since they knew the company was insolvent. What’s more, the whole process can take a long time.
What are the benefits of a CVL?
There are a number of benefits to voluntary liquidation in the form of a CVL.
For starters, you will seem to be acting in the creditors’ best interests, which is very important when it comes to the conduct investigation, and your creditors will also know from the start whether they will receive some repayment through the sale of business assets.
You will also have more control with a CVL because you appoint the liquidator, rather than the creditors of the court in a compulsory liquidation - and because you will have time to discuss the liquidation with your insolvency practitioner, the process should be less stressful and leave you feeling more prepared.
What’s more, because a CVL involves less urgency, directors are able to carry out their duties properly and carefully in line with the Insolvency Act 1986.
Finally, a creditors’ voluntary liquidation is also much faster than a compulsory liquidation, taking just two to three weeks to facilitate the initial meeting of creditors, which means that it is better for your employees too.
If you are considering liquidating a company due to financial problems, make sure you compare all of the different options available.
Other courses of action, such as a Company Voluntary Arrangement (CVA) or administration could provide a way for your company to carry on trading, so make sure you assess all the options before making your final decision.
The sooner you seek professional advice, the more options you will have available to you. So, if your business is facing financial difficulty and you’re not sure where to turn, contact McAlister & Co today for free, confidential advice.
Alternatively, download our liquidation notes for company directors here.