If a company is unable to pay its debts as they fall due or its liabilities exceed its assets, the company will be deemed insolvent. If the company is insolvent or facing insolvency, an insolvency procedure known as liquidation (or winding up) may be instigated either voluntarily by the shareholders or creditors of the company or by the initiation of court proceedings.
A voluntary liquidation by the shareholders of a company is only appropriate where the directors are willing to make a statutory declaration that the company is solvent, meaning that it will be able to pay all its debts in full within a specified period. The shareholders will pass a resolution to the effect that they wish to liquidate the company. If the directors are not willing to give a statutory declaration of solvency (a director who makes a declaration without reasonable grounds is liable to criminal sanctions), a creditors’ voluntary liquidation will be initiated, which gives the creditors more control over the process. In addition to the shareholders’ meeting to resolve on liquidation, a creditors’ meeting will take place during which the company must present the creditors with details of the company’s assets and liabilities, creditors and security.
A compulsory liquidation is commenced by the presentation of a petition to the court, often by a creditor on the grounds that the company is unable to pay its debts. The court will then decide whether to make the order for liquidating the company.
In the event of either a voluntary or compulsory liquidation, an insolvency practitioner, known as the liquidator, will be appointed, whose principal duty will be to realise the assets of the company and distribute them to those entitled, before dissolving the company.
Note: In the UK, the term ‘bankruptcy’ does not apply to companies but, rather, only to individuals. In the US, companies as well as individuals can go into bankruptcy. For companies, there are ‘Chapter 7’ bankruptcies (referring to Chapter 7 of the Bankruptcy Code) which involve a liquidation of the debtor company, and ‘Chapter 11’ bankruptcies involving a reorganization of the debtor company.