Understanding Compulsory Liquidation: A Guide for Creditors

If a UK company owes you or your organisation money, you might be considering your options for recovering the debt. One effective method is applying for compulsory liquidation, also known as 'winding up' the company. This process can be faster than traditional debt recovery claims, potentially taking as little as 7–12 weeks. However, there are important details you should understand before starting this process.  

Is the Company Insolvent?  

The company's insolvency is a requirement for the court to accept a winding-up petition. The Insolvency Act 1986 (the “Act”) states that insolvency is established if the company's assets are not sufficient to cover its debts and liabilities.  

Specifically, a company is insolvent if:    

• It owes more than £750 and fails to pay or negotiate repayment terms within three weeks of a creditor's written demand (s.123(1)(a) of the Act);  
• It cannot pay its debts as they fall due, known as the 'cash flow test' (s.123(1)(e) of the Act); or
• The value of its assets is less than its liabilities, considering future and contingent liabilities, known as the 'balance sheet test' (s.123(2) of the Act).  

Meeting any of these conditions suggests that pursuing a winding-up petition could be an appropriate course of action.  

Before Issuing a Winding-up Petition  

While a winding-up petition can be a quick way to deal with an unpaid debt, it should be considered a last resort. It is the most serious legal step a creditor can take. Before going down this route, a creditor should try other ways to recover the debt. This could include attempting to negotiate a commercial resolution, sending a formal letter of demand or issuing a statutory demand in the case of an undisputed debt (which is a formal notice requiring payment or a payment plan within 21 days failing which a winding-up petition will be presented). Additionally, assessing the debtor company's asset situation is crucial. If the company lacks sufficient assets to cover the debt post-liquidation, the costs of petitioning might not justify the potential recovery.  

Remember, winding up a company means it will cease to exist, so it is not a good option if you want to keep a business relationship with the debtor.  

Costs to Consider  

Launching a winding-up petition incurs several fees: legal representation, court fees, the cost of a process server to personally serve the petition, a deposit for the Official Receiver, advertising expenses, and more. While the general rule in legal proceedings is that the loser pays the winner's costs, the court's discretion in cost awards means this is not always guaranteed.  

What Happens Next?  

If the court approves the petition and grants a winding-up order, the company enters compulsory liquidation. An Official Receiver, or a liquidator nominated by creditors, will investigate and collect the debtor company’s assets, which are then used to pay the company’s debts. There is an order of priority for the repayment of creditors in a liquidation and, usually, secured creditors are prioritised, followed by preferential creditors (such as employees) with unsecured creditors at the end. For unsecured creditors, repayment is on a pari passu basis, meaning they share equally in any available funds.  

Key Takeaways  

• Compulsory liquidation can be a useful tool but requires careful consideration.
• View winding-up as a last resort, after exploring other debt recovery methods.  
• Be mindful of the costs associated with issuing a winding-up petition.  
• Understand the order of creditor repayment in the event of a winding-up order.  

If you have any questions about compulsory liquidation or need assistance in any insolvency related matters, please contact us.

Jenny Lau:
‍jenny.lau@ilaw.co.uk

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