Checklist of steps to close a business and declare insolvency

It is a common misconception that closure means failure, but directors increasingly choose to dissolve in good condition, either because the industry has changed or they simply fancy something new.

The first thing to understand about company closure is the distinction between solvency and insolvency. If the company is solvent, there is much more flexibility when dissolving it and the directors have much more control.

If the company is able to meet its financial commitments long-term and pay all creditors, in full, within a 12-month period, it is classed as solvent.

Of course, there are exceptions. Many businesses run into problems, when suppliers miss payments or a bunch of creditors send invoices at once, despite being viable long-term. There are two key tests to distinguish short-term turbulence and genuine business bankruptcy.

The first, known as the cash-flow test, assesses whether a company can pay its debts both now and in the “reasonably near future.” However, this can be subjective. A more reliable alternative is the balance-sheet test, which weighs the company’s assets against current and future liabilities.

If liabilities outweigh assets, the directors are obliged to declare insolvency. If they keep trading, they can be held liable for any additional debts – and even be disbarred from further directorships for 15 years.

Solvent closure

Ok, so let’s assume the company is solvent but wants to close the business anyway. What then?

Well, there are two options. Either the directors can pursue a formal dissolution known as a Members’ Voluntary Liquidation (MVL), or simply ‘strike off’ the business at Companies House, an option primarily aimed at those that have already ceased trading.

The MVL is more complicated, and requires a business insolvency practitioner, otherwise known as a liquidator. A strike-off can be handled by the directors themselves – they don’t even have to call a board meeting.

However, there are significant financial benefits to an MVL for bigger, active companies.

Assets disposed of under an MVL can be released as capital to the shareholders, rather than income, and may be eligible for entrepreneurs’ relief. Under strike-off, the maximum value of assets and share capital that can be distributed is £25,000. Another key advantage is that creditors only have 21 days to claim, compared with two months under strike-off. It is also far harder for them to take action in the future.

Rick Smith, managing director of company rescue and recovery specialists Forbes Burton, says: “Strike-off is generally used when a company has nothing in it. The director can carry out the whole process themselves.

“But this can prove complicated. If the creditor objects, as HMRC often does, the director has to negotiate with creditors to find a solution.

“Creditors are able to serve the company with a winding-up petition before it is dissolved and can bring the company back to life, reinstating it to the register, after dissolution, to pursue further action against the company and its members.”

However, he says, this step is rare.

Requirements for a solvent closure

To strike off a business, the directors simply have to file a DS01 form, signed by a majority of the board. They must also pay a fee of £10, which cannot come from the account of the business they’re striking off.

To qualify for strike-off, directors must be able to demonstrate that they stopped trading at least three months before the DSO1 filing. They must also be able to prove there is no insolvency risk, and they haven’t frozen their debts under what’s known as a company voluntary arrangement, or CVA (more on that later).

They must then close the business bank account and distribute the assets. Any undisposed assets will be returned to the crown.

For an MVL, the company must hold a formal board meeting and table a winding-up resolution, which requires support from 75% of voting members. Then, it must appoint a liquidator to oversee the winding-up process. The Government maintains a nationwide list of liquidators which you can find here.

The most significant part of the MVL is the Declaration of Solvency, which must be filed no later than 15 days after the winding-up resolution is passed. It must include both the liquidator’s endorsement and the sworn testimony of a majority of directors (or both, in the case of a two-person team). If the company is subsequently found to be insolvent, the directors can face fines and imprisonment – so it pays to be honest.

Insolvent closure

In the case of business bankruptcy, the above options do not apply, and it is creditors, rather than members, who will receive the proceeds from the sale of the company’s assets.

However, once again, there are different routes. A company can apply for a winding-up petition proactively, via a creditors’ voluntary liquidation, or one can be brought by a claimant – perhaps a disgruntled shareholder or creditor – whose demand exceeds £750.

To trigger a CVL, companies must hold a formal board meeting and get the support of 75% of shareholders for the wind-up. As with an MVL, they must then appoint a liquidator.

If a hostile party files the petition, the court will appoint its own liquidator, known as an Official Receiver, to first secure the company’s assets during the hearing, then oversee liquidation if the winding-up order is granted (they may also appoint their own liquidator to handle specific steps).

The Receiver is also required to investigate whether the directors committed wrongful or fraudulent trading during insolvency, either by filing improper records or over-paying themselves. Again, imprisonment is an option for any transgression.

Avoiding liquidation

At this point it’s worth mention that companies can avoid ‘going bust’, even if liquidation appears likely.

For example, when a married couple running a family business wish to separate, they may want to dissolve their company too. In this situation, the partner who wishes to exit can apply for a ‘just and equitable’ wind-up order, which will trigger the MVL. But the court may also grant a ‘company divorce’, facilitating a buy-out by the partner who wishes to carry on.

Another option, applicable to all companies, is the aforementioned CVA, which allows an indebted company to agree a fixed repayment schedule with creditors over a period of up to five years, giving it the chance to trade out of trouble with no risk of further legal action. The creditors, meanwhile, will receive more money than they might under a liquidation.

To apply for a CVA, all directors or members have to agree. Once again, the company must appoint a liquidator, and they must be satisfied that the company remains a going concern. The liquidator must also propose a repayment schedule, which requires approval by creditors holding at least 75% of the total debt.

A more simple option is to lie dormant, which is similar to strike-off – except that the company can resume trading at a future date. As well as being solvent, the company must complete several regulatory steps, such as closing all bank accounts, informing all clients, notifying the corporation tax office and terminating supplier contracts.

Once ‘dormant’ the directors must avoid any activity from company accounts – and remember that, as with strike-off, creditors can ‘resuscitate’ the business if they have unmet claims.

Informing interested parties

Whether a company’s closure is voluntary or compulsory, the directors are legally required to inform all interested parties. Failure to do so is treated the same as providing misleading information during the wind-up process, and can result in disbarment, fines or jail time.

As a general rule, the company should notify anyone who might be entitled to object. Typical stakeholders include employees, creditors, shareholders, HMRC and any directors who weren’t involved in the wind-up process.

If a company is being wound up voluntarily, all interested parties must be informed within seven days of filing the application at Companies House. If the company is in receivership, the Receiver will notify all parties within 48 hours of the winding-up order.

The company is also required to advertise in The London Gazette, which provides an official record of the business insolvency. In the case of an MVL or CVL, the advert must be placed within 14 days. In the case of compulsory liquidation, it must be placed within seven days of the winding-up petition.

Selling assets

Asset sales provide a crucial source of revenue, either to reward internal parties or satisfy external ones, and a company may sell practically anything: plant, machinery, equipment or property. Solvent companies may also offer shareholders a ‘distribution in specie’, giving them the actual physical assets rather than the proceeds from them.

But while directors of solvent companies can handle the sell-off themselves, it is advisable to engage a specialist practitioner. Personal contacts should not be given preferential treatment, says Rick Smith.

“It’s advisable to sell via the open market if possible, either via sites such as eBay, or an auction house,” he says. “The point is to ensure you haven’t sold assets to family or friends at a preferential rate.

“If you can demonstrate this, it’s a big advantage if creditors pursue subsequent action.”

Liquidators of insolvent companies have complete control over the process and can sell to anyone who is interested. If a director wants to buy an asset back, they must do so at market rate.

How to settle debts

Whether a company is solvent or not, settling debts cleanly and transparently is probably the biggest challenge when directors want to close a business. Again, it’s advisable to leave the process to a professional.

The liquidator will begin the process by contacting each creditor, asking them to fill out what is called a proof of debt template. If they can prove a legitimate claim, they will take their place in the hierarchy of creditors established by the 1986 Insolvency Act, which is as follows:

• Secured creditors with a fixed charge. Banks, or other asset-based lenders, that have secured a specific asset as collateral.
• Preferential creditors. Typically employees, or people who have filed suits.
• Secured creditors with a floating charge. These creditors haven’t secured a specific asset, but they are guaranteed a share of the assets in the event of liquidation.
• Unsecured creditors. These creditors don’t have collateral but they are legally entitled to payment. Examples include contractors, or the inland revenue.
• Interest on the debts the company has accrued.
• Shareholders and directors.

As Rick Smith says, the process can be brutal if all the assets are consumed by those at the top of the chain.

“Once a company has been liquidated, all money falls into a pot,” he explains. “Each layer of the pecking order gets a percentage-in-the-pound distribution based on their position.

“If the ones in the top brackets take everything, the rest get nothing.”

Paying employees

At least, when it comes to payment, the company’s employees have a security blanket. If the business hasn’t got the money, pay-outs are made by the Government through the Redundancy Payments Office.

At the start of liquidation, each employee will be contacted by the liquidator (or a director in case of strike-off) and advised on how to make their claim. Employees can claim for a variety of things, including statutory redundancy (provided they meet the criteria), eight weeks’ wages, six weeks’ holiday pay, compensation for the full notice period and, in certain cases, unfair dismissal.

The amount each employee will receive depends on the length of time they have worked for the company, and the hours they have put in. There’s no seniority bias; C-suite executives won’t take priority over entry-level staff.

The RPO can only pay a maximum of £508 a week, so higher-paid employees may not receive their full entitlement. However a solicitor is likely to advise them against taking individual action, as the company’s circumstances mean redress is unlikely.