Understanding Compulsory Liquidation: Process and Outcomes

Section 122(1) of the Insolvency Act 1986 sets out six circumstances in which a company may be wound up by the court.  They are when:

1. The company is unable to pay its debts.
2. The court is of the opinion that it is just and equitable for the company to be wound up.
3. The company has passed a special resolution that it is to be wound up by the court.
4. The company is a public company but has not been issued with a trading certificate within a year of its registration.
5. The company is an old public company within the meaning of schedule 3 to the Companies Act 2006 (Consequential Amendments, Transitional Provisions and Savings) Order 2009.
6. The company does not commence its business within a year from its incorporation or suspends its business for an entire year.

It is the first ground above, that the company is unable to pay its debts, which is the most common basis used by creditors seeking a winding-up order.  It is this ground which is the focus of this blog.    

Section 123 of the Insolvency Act 1986 sets out two tests as to when a company is unable to pay its debts:

1. The cash flow test. A company is deemed unable to pay its debts if it is unable to pay its debts as they fall due.  This is a commercial test where the court looks to see if, on the evidence, the company is paying its debts as they fall due.  If not, the company is considered insolvent and the fact that its assets may exceed its liabilities is irrelevant. 
2. The balance sheet test. A company is deemed unable to pay its debts if there is a shortfall in the value of its assets compared with the amount of its liabilities, taking into account its contingent and prospective liabilities.  This test is not a simple assessment by the court of whether a company has “reached the point of no return” but a consideration of the evidence before it, the particular circumstances of the company whose solvency is being assessed and the company’s prospective and contingent liabilities. 

Section 123 of the Insolvency Act 1986 also sets out two sets of circumstances in which a company may be deemed to be unable to pay its debts:

1. A company fails to pay an undisputed debt demanded in a statutory demand within 21 days of the statutory demand being served on the company. Whilst a creditor does not have to serve a statutory demand on a company prior to presenting a winding-up petition, it is often the first step taken by a creditor that intends to present a winding-up petition.
2. A company fails to satisfy in full a judgment debt (or similar court order) where execution or other process issued on the judgment is returned unsatisfied in whole or in part.

The liquidator (whether this is the Official Receiver or an IP) will:

• Advertise the fact that the winding-up order is made;
• Notify Companies House that the company is in liquidation;
• Require the company’s directors to prepare a statement of affairs which will include details of the company’s assets, debts and liabilities, and any other information required;
• Send regular reports to creditors and contributories in respect of the winding-up and the state of the company’s affairs;
• Contact all known creditors and invite them to submit a proof of debt with details of the amount they are owed by the company, and any supporting evidence; and
• Seek any necessary decisions from the company’s creditors and contributories – this is normally done by way of correspondence as opposed to physical meetings taking place (although creditors can request physical meetings subject to meeting the necessary threshold).

A liquidator’s role is to fulfil the primary function of collecting in, realising and distributing the assets of the company to its creditors.  If it is likely that there will be a distribution to creditors, the liquidator has a duty to assess proofs of debt and may accept, reject or seek to compromise the debts. 

When the assets of the company have been realised and the liquidation is otherwise complete, the liquidator will distribute the funds in accordance with the statutory order of priority (see below).    

A liquidator also has a duty to investigate the reasons for the failure of the company and to report on its directors.  The liquidator’s report on the directors is sent to the Insolvency Service and may lead to director disqualification proceedings if there is evidence of misconduct. 

The liquidator’s costs of fulfilling their duties will be met from the company’s assets. 

A liquidator has a number of statutory powers to enable them to fulfil their duties. 

These are set out in the Insolvency Act 1986 (please see sections 165 and 167 and Schedule 4).  Pursuant to Schedule 4, a liquidator has the power to:

• Carry on the business of the company, but only to the extent that it 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.
• Bring legal proceedings to challenge antecedent transactions such as transactions at an undervalue, preference payments or transactions defrauding creditors.
• Pay debts and compromise claims.
• Sell any of the company’s property.
• Execute deeds and other documents in the name of the company.
• Appoint an agent to do any business that the liquidator is personally unable to do.
• Do all other things that may be necessary to wind up the company’s affairs and to distribute its assets.