Are Liquidation and Insolvency the Same Thing?

What are the Key Differences Between Liquidation and Insolvency?

Liquidation and insolvency are terms often used interchangeably but represent different aspects of financial distress and company closure:

• Insolvency is a financial state in which a company cannot pay its debts as they come due or its liabilities exceed its assets. It indicates a company’s inability to meet financial obligations but does not necessarily lead to company closure.
• Liquidation is a process initiated when a decision is made to close down a company. It involves selling off assets to pay creditors. While insolvency can lead to liquidation, not all liquidations result from insolvency, as seen in Members Voluntary Liquidation (MVL) for solvent companies.

The main difference lies in their scope: insolvency is about financial status, while liquidation is about the process of concluding a company’s operations, potentially due to insolvency or strategic decisions by its owners.

What Is Insolvency?

Insolvency occurs when a company cannot pay its debts as they become due or when its liabilities surpass its assets. It’s a state indicating financial distress, where the business lacks the liquidity to meet its financial obligations.

This situation can lead to various formal proceedings, including liquidation or restructuring, as a means to address and potentially resolve the financial instability. Insolvency is a serious situation that necessitates immediate attention to prevent compulsory liquidation by creditors.

What is Liquidation?

Liquidation refers to the process of closing down a company by selling, or ‘liquidating,’ its assets to convert them into cash.

This procedure is often the result of insolvency, and the proceeds from the sale of assets are used to repay creditors to the extent possible.

However, there are two main types of liquidation, one of which is chosen for solvent companies:

Creditors Voluntary Liquidation (CVL): Initiated by directors of insolvent companies unable to pay debts, this form hands control to a liquidator to dissolve the company responsibly, prioritising creditor repayment from asset sales.

Members Voluntary Liquidation (MVL): This route is chosen for solvent companies wishing to close in a tax-efficient manner. It’s typically selected when directors retire or if there’s no succession plan, ensuring assets are liquidated and proceeds distributed among shareholders.

Click here to read our full guide to company insolvency

What is the Difference Between an Insolvency Practitioner and a Liquidator?

An Insolvency Practitioner (IP) is a professional authorised and licensed to act on behalf of companies or individuals facing financial distress in the UK. Their role encompasses a broad range of duties, from advising on insolvency matters to executing formal insolvency procedures. An IP’s expertise includes attempting business rescues, negotiating with creditors, and, if necessary, overseeing the orderly winding up of a company.

A Liquidator, on the other hand, is a specific type of Insolvency Practitioner appointed during the liquidation process of a company. The liquidator’s primary responsibility is to liquidate the company’s assets, settle legal disputes, manage creditor claims, and distribute the proceeds from asset sales to creditors according to the legal priority order. In the context of a CVL or compulsory liquidation, the liquidator also investigates the company’s financial affairs, including the conduct of its directors, to ensure fairness and legality in the process.

While all liquidators are Insolvency Practitioners, not all Insolvency Practitioners serve as liquidators. The role of an IP can vary widely, serving in capacities such as administrators or trustees, depending on the specific insolvency procedure being undertaken. The distinction lies in the scope of their duties and the context in which they are appointed to act.

What are Our Options if We’re Insolvent?

One of the first steps in dealing with insolvency is to seek advice from a financial advisor or an insolvency practitioner such as ourselves. We can assess the situation accurately and recommend the best course of action, whether restructuring the business, entering into an insolvency procedure, or considering liquidation.

Before opting for liquidation, there are several options to try and rescue the business:

• Company Voluntary Arrangement (CVA): This is an agreement between a company and its creditors to pay debts over a fixed period while continuing to trade.
• Administration: This process aims to reorganize the business to improve its financial health or to sell the business as a going concern to pay off creditors.
• Refinancing: Seeking new finance or renegotiating existing debts can provide the breathing space needed to restructure the business.

Directors of insolvent companies should also be aware of the legal obligations to prioritise the interests of their creditors to avoid worsening their financial position. Failure to comply with these obligations can lead to directors’ personal liability.

Sometimes, despite best efforts, rescue or recovery may not be feasible. In such cases, initiating a voluntary liquidation process might be the most responsible course of action to ensure creditors are paid as much as possible.

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