Liquidation or Administration : does it matter?

If all attempts to avoid formal insolvency have been exhausted and the company is about to fold, directors might be forgiven for having scant regard to the type of process that might be  suitable for their company.  When a director is faced with the prospect of losing his business, some simply walk away, but others remain interested when they realise that some or all of the trading activities might be saved in a new company under their control.  So, what should a director think about if the company is heading towards collapse ?

In Scotland, the ability to appoint a receiver has been with us since the enactment of the Companies (Floating Charges and Receivers) (Scotland) Act 1972, the terms of which were updated when the Insolvency Act 1986 “the Act” came into force.  The holder of a floating charge, typically a bank, appoints a licensed insolvency practitioner “IP” to act as receiver.  The IP is the bank’s agent and works to return as much money as possible to the bank i.e. a clear focus about realising assets for best value as the bank’s agent.  However, in September 2003 the corporate landscape changed because a bank holding a floating charge dated after 15 September 2003 cannot appoint a receiver. Thus, the use of receivership in the last ten years or so has been minimal.

The holder of a floating charge now tends to appoint an IP to be an administrator.  It is quite normal for the director to appoint an administrator : achieved after a formal written notice has been provided to the holder of a floating charge, giving them 5-business days in order to consider their response.  The concept of administration was introduced by the Act in order to create the opportunity of saving all or part of an existing business, either within the current corporate shell or through a new entity.  The IP has power to trade, buy/sell assets, recruit/dismiss employees and generally do whatever is necessary in order to help preserve a business activity and create maximum value for the general body of creditors.  This creates an opportunity for the board to be involved in the process, because some of the directors of the failed entity may wish to establish a new company in order to acquire certain assets or parts of the business.  Insolvency legislation helps to regulate a pre-pack sale when the business or key assets are sold to a director’s new company, such that full value is paid and creditors’ interests are protected.

A company voluntary arrangement “CVA” is broadly similar to administration.  Creditors are offered the prospect of a dividend if there is a realistic view that the company can trade out of its current difficulties, howsoever incurred. Typically, creditors should receive a better financial return than if liquidation incepts.  The difficulty with a CVA, and hence their relatively infrequent use, is that many creditors find it difficult to accept that the company to whom they have provided services/foods will continue to operate yet only pay a dividend of, say, 30p in the £, whilst they are expected to provide ongoing support.

Liquidation is generally seen by many as the end of the road and tends to be less expensive than administration.  It is unusual for a liquidator to trade, other than for a short period of time e.g. to finish a contract or retain the value of licensed premises pending an early sale.  When liquidation incepts, directors tend to have less interest in the process although the law requires them to cooperate with the IP as appropriate.  Liquidation is normally instigated either by the board or a creditor e.g. HMRC or a trade supplier.

Two types of liquidation are possible, a creditors voluntary liquidation and a court liquidation.  The overall outcome is the same and it should be noted that most insolvency matters these days no longer require a physical meeting of creditors.  Current legislation means that unless 10% in value of creditor claims, 10% in number of the total creditors, or 10 separate creditors ask the IP to convene a meeting, everything is handled online.

Whether liquidation or administration, directors should note that the IP has a legal obligation to submit a report to the Director Disqualification Unit. There is no escape.

Occasionally, a director will seek to close the company using an informal route i.e. selling assets privately and paying creditors from the proceeds, without necessarily adhering to the legislation of determining who is preferential and who is unsecured.  The difficulty with this is that a director has no protection against subsequent challenge to his activities should a creditor elect to liquidate the company. Human nature tends to mean that it is difficult to ignore local creditors/friends when distributing scarce resources (deemed an unfair preference under the Act) and hence, a DIY route is ill advised. Further, without a formal insolvency process, former employees are not able to readily access the Redundancy Payments Office in terms of being paid for unpaid wages, notice pay, holiday pay and redundancy ( the rate is up to £571 per week for each part of the claim ).

Whether to appoint a liquidator or an administrator can be a complex issue and is invariably decided upon the facts of a case.  Directors need to be fully advised of the consequences of whichever formal insolvency route is adopted and be satisfied that they are acting in the best interests of all stakeholder groups, whilst observing their fiduciary duty.  Don’t be scared to ask your local insolvency practitioner for advice.

This article is written by Michael J M Reid, licensed insolvency practitioner and partner of Meston Reid & Co, Aberdeen. The views expressed in this article are his rather than those of the firm.