What is the difference between insolvency and liquidation?

The main difference between insolvency and liquidation

The key difference between insolvency and liquidation is that insolvency describes a position where a company cannot pay its financial obligations when they are due. A company that cannot pay its debts is said to be insolvent. 

Liquidation, on the other hand, is a formal procedure to close a limited company. You can use liquidation to close an insolvent company, but you can liquidate solvent businesses, too.

What is company insolvency?

Insolvency is a financial position a company is in when it can no longer pay the money it owes to third parties such as landlords, HMRC, suppliers and utility providers. A company is technically insolvent when:

• It cannot pay its debts when they are due; and/or
• The value of its liabilities exceeds its assets. 

There are several common warning signs of insolvency, such as your overdraft facility always being at its limit, struggling to pay staff and receiving constant creditor pressure and threats of legal action.

It’s important you recognise these signs, as the earlier you realise your company is insolvent and seek help, the better your chances of getting your business back on track and avoiding liquidation.

What is company liquidation?

Liquidation is a formal insolvency procedure to close limited companies. You must appoint a licensed Insolvency Practitioner to liquidate the company on your behalf. 

They will sell the company’s assets and pay the proceeds to the shareholders or creditors, depending on whether the business is solvent or insolvent. They’ll then remove the company from the official register and it will cease to exist. In the case of an insolvent business, any debts the company cannot repay will usually be written off. 

As a company director, you can voluntarily put your business into solvent or insolvent liquidation. A creditor, such as HMRC or a bank, can also force your business into Compulsory Liquidation to protect its interests or recover a debt. 

What are the different types of liquidation?

There are three types of liquidation that can be used depending on the financial position and circumstances of the business. 

• Members’ Voluntary Liquidation (MVL) - The directors or shareholders of profitable companies can initiate a Members’ Voluntary Liquidation. They may choose to close the business to retire or they want a new challenge. An MVL is usually the most tax-efficient way to extract the profits.
• Creditors’ Voluntary Liquidation (CVL) - A Creditors’ Voluntary Liquidation is an efficient and legally responsible way to close a business that cannot pay its debts and is no longer viable. The directors will appoint a liquidator who will sell the assets and use the proceeds to repay the company’s creditors as much as possible.
• Compulsory Liquidation - A creditor may seek to force you into Compulsory Liquidation if it has tried and failed to collect a debt from your business. They will issue you with a Winding Up Petition. If the court decides to close your business, it will make a Winding Up Order before appointing an Official Receiver to manage the liquidation. 

How do insolvency and liquidation differ?

Here are some of the key ways in which insolvency and liquidation differ:

Nature

• Insolvency is a condition or state of being when a company cannot pay its debts, similar to bankruptcy in individuals. 
• Liquidation is a legal procedure used to close a business so its value can be released and paid to its shareholders or creditors.

Duration

• Insolvency is a temporary condition you must resolve either through the rescue and recovery of the company or its closure.
• Liquidation is a permanent process that always leads to a company’s closure. 

Director’s role 

• The directors of an insolvent company must seek advice from a licensed Insolvency Practitioner (IP). With the help of the IP, they can determine whether to rescue or close the company.
• When a company enters liquidation, the directors lose control of the business but must cooperate with the liquidator by handing over company records and attending an interview as required. 

Does insolvency always lead to liquidation?

It’s important to note that company insolvency does not always lead to liquidation. There are informal and formal company rescue procedures that can help to return a business to profitability. 

For example, it may be possible to negotiate a payment plan with a creditor to repay a debt. Alternatively, you could explore alternative funding options to access working capital to get the business back on track.

There are also formal procedures that can reverse the fortunes of insolvent companies. A Company Voluntary Arrangement (CVA) is a legally binding agreement that gives you more time to repay your creditors while you continue to trade. Administration is another procedure that can restructure your company and return it to profitability. And even if you do have to liquidate, you could use a Pre-Pack Administration to continue your business with a new company that’s debt-free.  

Confidential insolvency and liquidation advice

At Real Business Rescue, we provide guidance and advice from the earliest signs of insolvency. We can discuss your circumstances, assess your finances and give you the best possible chance of saving your limited company. On the other hand, if your business is no longer viable, we can liquidate your company and protect your interests. Please contact our team for a free consultation or arrange a meeting at your local office.