Disadvantages of liquidation
Understanding the disadvantages of liquidation will prevent you from making a costly decision when the environment is already unfavourable.
This helpful guide will explain the primary disadvantages of liquidation. But, first, we'll take a look at the different types of liquidation, and when they are likely to come into play.
What is liquidation?
Liquidation is a process that facilitates the closure of companies and apportioning of assets via agreement or litigation. There are three types of liquidation:
- Creditors' voluntary liquidation (CVL): The most common form of liquidation, CVL happens when your company can no longer pay its debts and you involve your creditors in the liquidation process.
- Compulsory liquidation: Your company is no longer able to pay its debts (often with creditors chasing significant late payments) and an application is made to court for the liquidation of the company.
- Members' voluntary liquidation (MVL): Your company is able to settle the debts currently in place, however you still want to close it.
This article will focus on the disadvantages of liquidation in relation to the creditors' voluntary liquidation model.
What are the disadvantages of liquidation?
These are the most detrimental disadvantages of liquidation you should be aware of before you make a decision for your company:
1. Some payments may still remain
Liquidation is generally a cost-effective option that will prevent you from having to make further payments.
However, there are some instances where you will still be held liable for settling outstanding amounts:
If you've given personal guarantees to creditors regarding company debt repayments, you (or your guarantor) will be held legally liable for settling these amounts.
Alternatively, if you've borrowed money from the company in the form of dividend payments, you'll need to pay this back.
This is known as an 'outstanding loan account'. It's most likely to occur when directors have drawn dividends while the business wasn't profitable.
2. Valuable assets will be lost
Though you are likely to be shielded from most costs via liquidation, assets linked to the company will be used to settle your debts.
Your company assets will be sold to settle your debts (unless you have a 'Pre pack' agreement in place). Pre pack means your assets will still be sold, but can be bought by a 'newco'.
Company assets often have more value in combination, when they facilitate an entire process or procedure. When separated, these are likely to offer less value, both in terms of re-use and re-sale.
This means the returns are likely to be much lower than your initial expenditure. And, it means you will not be able to use these assets again for future ventures.
With redundancy, your employees – and their shared expertise – will be split up. This will make it harder to re-establish these skill sets elsewhere. However, you can avoid this by selling part of the business as a going concern.
Any tax losses in the company cannot be used against another company.
3. Director's conduct investigations
The Insolvency Practitioner will report any proven instances of misconduct to the Insolvency Service. The insolvency practitioner has a duty to investigate the conduct if they think there has been an instance of malfeasance or fraud on the part of the directors.
This could lead to director disqualification, liability for company debt or even a custodial sentence in extreme circumstances.
With all of these considerations to bear in mind, you should not enter into liquidation lightly. However it should be remembered that liquidation is really the only option for the company if there is no money left to pay creditors. If the company or directors cannot afford to pay an insolvency practitioner to liquidate the company via a creditors voluntary liquidation then there are two options depending on the size of the debt. If the debts are small then it may be possible to dissolve the company. If not, then it is likely that the creditors will seek to wind the company up. i.e a compulsory liquidation.
The disadvantages of this type of liquidation are as follows;
- It can take a long time 6-12 months which means that ex employees will not be able to claim redundancy until the process has finished
- The official receiver has a mandatory duty to investigate the directors conduct, whether or not they have suspicions malfeasance.
- You will need to go to court.
- It doesn’t look good on your company/personal credit record if someone does an extended credit check. This is most likely if you are involved in heavily regulated industries or national security
Categories: Creditors Voluntary Liquidation CVL