Solvent vs Insolvent Liquidation
Liquidation means that a company is being closed and its assets sold. While the word is more commonly used to deal with insolvent businesses, it may also be used to refer to the process of closing down a solvent limited company.
In this article we’ll explore both processes, and what they mean for you as a director.
Let’s take a look at solvent and insolvent liquidation in more detail.
Solvent Liquidation Definition
Sometimes a director wishes to close the company for personal reasons. He may be retiring, or perhaps the market landscape has changed and the business is no longer viable. In these circumstances, and where the business has assets, solvent liquidation may be the most appropriate solution.
Solvent liquidations are known as a Members Voluntary Liquidation and require the services of a licensed insolvency practitioner to complete.
How Do You Close Down a Solvent Company?
We explain the process of a Members Voluntary Liquidation here.
Essentially, the decision to liquidate must be voted upon by shareholders, following which the liquidator (insolvency practitioner) takes care of the rest of the process.
Recent changes to legislation have meant that a MVL process must be used for any final shareholder distribution of funds that exceed £25,000 in order to receive automatic capital tax treatment. This system has replaced a HMRC concession that was used previously to receive the tax benefits.
These tax benefits are the main reason limited companies opt for an MVL. There is also the possibility of receiving Entrepreneurs’ Relief against the funds, which could potentially reduce the tax rate to 10%. This significant tax saving, therefore, usually outweighs the cost of the liquidation process itself.
Insolvent Liquidation definition
the term insolvent means that a company is unable to meet its liabilities as and when they fall due, or that its debts exceed its assets.
In this scenario, A Creditors’ Voluntary Liquidation (CVL) is a formal liquidation procedure that is used to close down an insolvent company. This is a voluntary process, which is initiated by the company’s directors/shareholders and it involves realising or selling the assets of the company to pay back creditors. This procedure requires the appointment of a licensed Insolvency Practitioner (IP) to manage the process.
Advantages of Choosing a Voluntary Insolvent Liquidation
Compared with a court-led compulsory liquidation, which is led by a disgruntled creditor, a CVL gives directors more control over the situation as they have the flexibility to decide on the IP, the opportunity to purchase the assets and the goodwill of the company if the directors wish to start afresh with a new trading company.
Solvent vs Insolvent Estate
All the money and property owned by an individual, especially at death, is known as his or her estate. A solvent estate is where the total value of the assets exceeds the debts. When the estate is solvent, the executor or personal representative of the deceased will have sufficient funds to pay all the bills the estate owes and once these debts are settled, the executor can then begin to distribute the remaining property as inheritances. The executor should distribute all money and property in line with the terms of the will.
In contrast, an insolvent estate is one where the debts exceed the total value of the estate. If the estate is insolvent, the executor will not have sufficient funds to settle bills. The rules of bankruptcy apply to insolvent estates and in a similar vein to insolvent companies, assets must be sold and creditors must be paid in a specific order of priority. In order to do this, the executor will have to determine which creditors should get paid first and in which order. Once the estate’s funds are depleted, some creditors may not be paid and there will be nothing remaining to distribute as inheritances.
Here is the order of priority for paying creditors from an insolvent estate also known as a hierarchy of payment:
- Secured creditors
- Funeral expenses
- Testamentary expenses (expenses relating to the will)
- Preferential creditors
- Unsecured creditors
- Interest due on unsecured loans
- Deferred debts, for example, between members of the family.
If the executor dealing with the estate pays an inferior debt before a superior one, in this way leaving insufficient funds to cover the superior debt, they could find themselves personally liable for all misdirected monies.
The executor can administer the estate informally outside of the Court or opt to apply for an insolvency administration order. If the person died intestate in other words without a will, the appointed estate administrator can make the petition. Administering the estate under the direction of the Court will provide the executor with certainty, but for the majority of insolvent estates this route is not an option. Once the administration order has been made, the power of the executor is suspended and can only be exercised with the sanction of the Court.
Creditors can also apply for an insolvency administration order, but they must demonstrate that it is “reasonably probable” that the estate is insolvent.
Administering an insolvent estate outside of the Court is typically the method used as it is more cost effective than making repeat applications to the Court for direction, which is also time consuming.In some instances, it may be necessary to appoint an interim receiver to protect the assets of the estate until the petition is heard by the Court.
What is Solvent and Insolvent in Accounting?
For a company to be considered solvent, the value of its assets must be higher than the total of its debt obligations. Accountants use ratios to assess a company’s solvency. For instance, the interest coverage ratio divides operating income by interest expense to show whether the company is able to pay the interest on its debt, with a higher result indicating a greater level of solvency.
Accountants also use the debt-to-assets ratio, which divides the company’s debt by the value of its assets to indicate whether a company has taken on too much of a debt burden.
Solvency ratios can vary depending on the industry in which the business operates. Ratios that indicate a lower solvency than the industry average may suggest that the company is heading for financial problems.
Can We Help?
If you are uncertain about the insolvency process and would like to know more about corporate insolvency tests which can determine whether a company can meet its liabilities as they fall due, please call 020 8444 2000 or email email@example.com today for free and confidential advice from one of our professional advisers.