The terms insolvency and liquidation are often used as though they mean the same thing, but they are actually two very different concepts. Understanding the distinction matters because it can affect the decisions you make about your company’s future.
If your Scottish limited company is struggling financially, this guide will explain exactly what insolvency and liquidation mean, how they are connected, and what your next steps should be.
What is insolvency?
Insolvency is a financial state where your company can no longer pay its debts as and when they fall due. A company that finds itself in this position is described as being insolvent.
It is important to understand that insolvency is not a procedure or a process. It is simply a description of your company’s financial health at a given point in time. A company can be insolvent without being in liquidation, and in many cases, there are steps you can take to turn an insolvent situation around if you act quickly enough.
There are two recognised tests for company insolvency in the UK:
- The cash flow test – your company cannot pay its debts when they become due. This might mean you are missing supplier payments, falling behind on HMRC obligations, or struggling to pay your staff.
- The balance sheet test – your company’s total liabilities exceed its total assets. Even if you are currently meeting payments, the business owes more than it owns.
If your company fails either of these tests, it is likely to be technically insolvent. At this point, your duties as a director change and you are legally required to act in the best interests of your company’s creditors rather than its shareholders.
What is liquidation?
Liquidation is a formal legal procedure that is used to close down a limited company when it is insolvent.
When a company enters liquidation, a licensed insolvency practitioner is appointed to wind up the company’s affairs in an orderly manner. They will sell the company’s assets, use the proceeds to repay creditors as far as possible, and then have the company removed from the Companies House register.
Once the process is complete, the company ceases to exist.
There are three types of liquidation:
- Creditors’ Voluntary Liquidation (CVL) – A CVL is is the most common liquidation route for insolvent companies. The directors make the decision to close the business voluntarily and appoint a licensed insolvency practitioner to manage the process on their behalf. A CVL is often the most suitable option for all parties when a company has no realistic prospect of recovery.
- Members’ Voluntary Liquidation (MVL) – A Members’ Voluntary Liquidation (MVL) is a tax-efficient way of closing a solvent company, typically when directors wish to retire, move on, or extract profits in a cost-effective way. The company must be able to pay all of its debts in full within 12 months of entering into an MVL.
- Compulsory liquidation – Compulsory liquidation occurs when a creditor forces your company into liquidation through a winding up petition. This is typically a last resort when a debt remains unpaid and the creditor has lost patience. While any creditor can issue a winding up petition, HMRC are the most common petitioner.
So what is the connection between insolvency and liquidation?
The connection between insolvency and liquidation is straightforward: insolvency is the financial condition, and liquidation is one of the procedures that may follow. If your company becomes insolvent, liquidation is one of several options available to you.
Think of it this way, if insolvency is the diagnosis, then liquidation is one possible treatment.
What are my options if my company is insolvent?
While liquidation can be used to bring an insolvent company to a close, being insolvent does not automatically mean your company has to be liquidated. Depending on your circumstances, there may be a number of routes available for an insolvent company:
- Company Voluntary Arrangement (CVA) – This is a formal agreement with your creditors to repay debts over a set period of time, typically three to five years. A CVA allows you to continue trading while getting your finances back on track and paying your creditors at a more manageable rate.
- Company Administration – When a company enters administration, a licensed insolvency practitioner is appointed to take temporary control of the company with the aim of rescuing the business as a going concern or achieving a better outcome for creditors than immediate liquidation would.
- Informal arrangements with creditors – In some cases, it may be possible to negotiate directly with creditors, arrange a Time to Pay arrangement with HMRC, or financially restructure the business to return to profitability.
The right option depends entirely on the specific circumstances of your company. There is no one-size-fits-all answer when it comes to insolvency, which is why seeking professional advice at the earliest opportunity is so important.
How can Scotland Liquidators help?
We understand that finding your company in an insolvent state can be a confusing and stressful time. We speak to Scottish company directors in your position every single day, and we are here to help you understand exactly where your company stands and what your options are moving forward.
Whether your company can be rescued, or whether closing it down is the most sensible course of action, our licensed insolvency practitioners will give you clear, honest advice tailored to your situation.
Your initial consultation is completely free and confidential. Call us today on 0141 278 6330 to speak to one of our experts, or take our 60 second test to get an immediate assessment of your company’s position.
