A guide to compulsory liquidation

What is compulsory liquidation? And what does it mean for creditors, company directors and employees? Fiona Gaskell of Clough & Willis explains what you need to know about compulsory liquidation.

What is compulsory liquidation?

Compulsory liquidation is an insolvency process which is initiated by someone petitioning the court for the winding up of the company. The grounds for this are:

• a resolution of the company
• the company is unable to pay its debts as they fall due
• it is just and equitable that the company should be wound up

Inability to pay debts can be evidenced by failure to respond to a statutory demand or if it’s proved that the value of the company’s assets is less than the amount of its liabilities.

Compulsory liquidation can be started by the members or directors of the company of the company itself, however usually it commences when a creditor of the company is owed a debt of at least £750 by issuing a winding up petition. However, in practice most creditors would not want to incur the costs of a compulsory liquidation unless the debt owed is significantly more than £750.

How does a company go into compulsory liquidation?

In order to commence the process to put a company into compulsory liquidation, a creditor must issue a winding up petition. This is verified by a statement of truth and is then served on the company and advertised in The Gazette. If the company does not oppose the winding up petition, the compulsory liquidation occurs when the court makes an order at the hearing and is shown on the petition.

It’s important to note that as a result of COVID-19 additional processes are required so that even if the petition meets the COVID criteria set under the Corporate Insolvency and Governance Act 2020 a pre-advertisement hearing will be scheduled to ensure advertisement should be permitted.

A creditor may already have issued proceedings and obtained a judgment which remains unpaid. They may also have served a statutory demand upon the company, giving the company 21 days in which to pay the debt. If that demand is ignored winding up proceedings can begin, which can result in compulsory liquidation.

Some creditors may feel that they have enough grounds to present a winding up petition if their debt has been acknowledged as due but simply remains unpaid. However, it is extremely risky to issue where a debt is disputed. If there is a dispute “on substantial grounds” the petition will be dismissed, and the petitioner may have to pay substantial costs.

Many creditors may not actually want to put the company into liquidation but will simply use the process as a way of forcing a company to pay its debts. However, this is a gamble. Winding up is a collective procedure and without knowing the company’s other creditors a liquidation may produce no dividend to unsecured creditors, especially post-1 December 2020 when the Crown’s preferential creditor status returns.

What should a company do if it receives a winding up petition?

A winding up petition should be taken very seriously by a company. One of the main reasons for this is that the petition will be advertised in The Gazette where it will be seen by banks, financial institutions and other lenders, all of whom are likely to close down the company’s bank account as soon as they become aware of a pending petition.

This is disastrous for a struggling company as it may find itself unable to access funds which it was relying on to pay staff and priority creditors. In such cases the company may have no option other than to accept the winding up order and accept that it will go into compulsory liquidation.

The alternative is for the company to try to pay off the creditor who has presented the winding up petition using third party funds in the hope that the petition can be withdrawn at the court hearing. However, this is not guaranteed as the company may have other creditors who become aware of the petition and may support the existing petition and be substituted in taking carriage of the petition. The original petitioner can only withdraw the original petition pre-advertisement and if it can verify there are no supporting creditors.

So far as the creditors are concerned, it is essential that any payment comes to them from third party funds, as if the company subsequently goes into liquidation any payments made to them by the company may be clawed back by the liquidator. This is because they may be seen as a void payment (if the petition is taken over by another creditor) or possibly as amounting to a preference, which is when the company chooses to pay one creditor rather than others – creditors are generally considered equal and the order of who gets paid first when a company goes into liquidation is something which is legally set out in the Insolvency Act 1986. 

Can compulsory liquidation be stopped?

Compulsory liquidation can only be stopped if:

• the debt of the petitioning creditor is disputed (by an application for injunctive relief)
• the debt of the petitioning creditor is paid in full
• the company agrees terms with the petitioning creditor and no other creditors come forward to take over conduct of the winding up petition

A company may ask the court for time to pay its creditor, and if it can demonstrate that it has a reasonable prospect of making a payment within a relatively short period of time (usually weeks rather than months), the court may be prepared to agree an adjournment, particularly if this is supported by the creditor.

The court is unlikely to agree to repeated adjournments except in the most exceptional of cases. If a court is not satisfied that there is any benefit to the creditors or indeed the company itself in granting adjournments, then a winding up order will be made.

What is the role of the liquidator?

Once a winding up order has been made, the Official Receiver automatically become liquidator. If most of the creditors wish, a private practitioner can be appointed liquidator, who must be a licensed Insolvency Practitioner.

The liquidator is appointed to protect and preserve the assets of the company, collect in debts and generally gather money (including bringing claims) together to pay off the company’s debts in accordance with a statutory order.

How much does compulsory liquidation cost?

Compulsory liquidation is an expensive process:

• The court fee for presenting a winding up petition is currently £280.
• A creditor needs to pay a deposit to the Official Receiver of £1,600, which is intended to cover the costs and expenses of the Official Receiver immediately following a winding up of the company.
• A winding up petition should be personally served on the company at its registered office as should a statutory demand which is often the first step in the winding up process, which will incur process server’s fees and a fee for advertising the winding up petition in The Gazette.
• If a creditor instructs a solicitor to issue the petition and deal with the court process then this is likely to add a few thousand pounds to the costs, especially if the company seeks to defend the process or wants to engage in negotiation about time to pay.

The expense of a winding up petition means that most creditors will not consider it unless the debt owed is for a significant sum on money. However, that is a decision which needs to be made by creditors and their advisers on a case by case basis.

What does compulsory liquidation mean for creditors?

Once a winding up order is made the company will not be able to pay any creditors and the creditors will be asked to provide proofs of debt with evidence and details of their debts which will form the basis of any payment which is ultimately made. In most cases the liquidator will realise what money they can, but for most unsecured creditors any payment is often no more than a small percentage of the debt.

If the creditors are aware of any information which may assist the liquidator in realising assets for the benefit of creditors, then they are encouraged to contact the liquidator with that information.

What does compulsory liquidation mean for employees?

Following a winding up order and the appointment of a liquidator the company is likely to be closed down if it has not already been closed by the business owners. Employees will usually be made redundant and will be entitled to statutory redundancy payments which should be paid from the assets of the company if it is able to do so; if it is not, employees can make a claim upon the Redundancy Payment Service.

In some cases, the owners of the old company may ask employees to transfer to a new company which they have set up in anticipation of the winding up order being made. If they work for the new company in substantially the same business their employment transfers by operation of law. Employees in this situation should get legal advice.

What does compulsory liquidation mean for company directors?

Once a winding up order has been made the directors are no longer in control of the company. They have a duty to cooperate with the liquidator to provide all books and records which the liquidator may require in order to understand the company’s financial position, what assets there are and the full extent of liabilities.  

The liquidator will look at the conduct of the directors over the years leading up to the presentation of the winding up petition and if the liquidator believes that the directors have acted in a way which benefited them but which disadvantaged creditors, or the company generally, then they may find that their conduct is reviewed and that claims may be made against them for breach of their duties and claims, such as:

• the reimbursement of directors’ loans
• the repayment of monies taken out of the company as dividends
• payments which appear to be irregular and have benefited either the directors or their families
• preferential payments
• transactions at undervalue

This may include the directors having to return to the company cars which have been paid for by the company and other assets of value which can be sold for the benefit of the creditors generally.