Creditors' Rights in Liquidation: What Happens When a Company Is Wound Up

When a company you are owed money by enters liquidation, you have more rights than you may realise. Creditors can nominate and remove the liquidator, demand information, challenge the liquidator's decisions in court, sit on a creditors' committee and require the directors to be publicly examined. How much you recover depends on where your claim ranks in the statutory order of priority.

This guide explains the three types of liquidation, what a liquidator can and cannot do, creditors' rights at each stage of the process, and how a company's assets are distributed when it is wound up.

Key points at a glance

• Liquidation ends a company's existence: its assets are realised, distributed to creditors, and the company is dissolved.
• Control passes from the directors to a licensed insolvency practitioner, who owes duties to creditors as a body.
• Creditors are not passive. You can influence who is appointed, require information, and apply to court.
• Your recovery depends almost entirely on your ranking - secured, preferential or unsecured.
• Unsecured creditors may still recover something through the prescribed part, even where a floating charge covers everything.

What is liquidation?

Liquidation, also known as winding up, is the formal statutory process of bringing a company's affairs to an end. The company's assets are collected and realised, and the proceeds are distributed to its creditors in a strict order of priority. If a surplus remains after all debts and interest are paid, it is returned to shareholders. Once the process is complete, the company is dissolved and ceases to exist.

Liquidation is not the same as administration, which is a rescue procedure aimed at saving the business or achieving a better result for creditors than an immediate winding up. Liquidation is terminal.

The three types of liquidation

Which route applies depends on whether the company is solvent or insolvent, and whether the court is involved.

Members' voluntary liquidation (solvent companies)

A members' voluntary liquidation, or MVL, is used where a company is solvent. The directors must make a formal declaration of solvency stating that, having fully investigated the company's affairs, they believe it will be able to pay all of its debts, together with interest, within 12 months of the winding up starting.

A liquidator is then appointed to wind up the company's affairs and distribute its assets. Directors who make a declaration of solvency without reasonable grounds commit an offence, so the declaration is not a formality.

Creditors' voluntary liquidation (insolvent companies)

A creditors' voluntary liquidation, or CVL, is used where a company is insolvent, Meaning it cannot pay its debts as and when they fall due. The company passes a resolution to wind up, and the directors must send a statement of the company's affairs to creditors.

Creditors may then nominate a person to act as liquidator. If the company and the creditors nominate different people, the creditors' choice will generally prevail. Either party can apply to the court if there is a dispute. For most creditors, this is the single most useful right in the whole process, and it is exercisable only at the outset.

Compulsory liquidation (winding up by the court)

A company may be wound up by order of the court on a number of statutory grounds, most commonly that it is unable to pay its debts. This route begins with a winding-up petition.

Under section 123 of the Insolvency Act 1986, a company may be treated as unable to pay its debts where:

• a creditor owed more than £750 serves a written demand at the company's registered office, and the company fails to pay, secure or compound for the debt within three weeks;
• execution or other court process on a judgment is returned unsatisfied;
• the court is satisfied the company cannot pay its debts as they fall due (the cash flow test); or
• the company's liabilities exceed its assets, taking account of contingent and prospective liabilities (the balance sheet test).

The court may also order a winding up on other grounds, including where it considers it "just and equitable" to do so.

What does a liquidator do?

Once a company enters liquidation, control passes from the directors to the liquidator.

A liquidator is a licensed insolvency practitioner appointed to take control of the company. Acting as an officer of the court and agent of the company, the liquidator's primary duty is to collect the company's assets, turn them into cash, and distribute the proceeds to creditors in the correct order of priority.

The liquidator's powers

The liquidator has wide-ranging statutory powers to gather in and realise the company's estate for the benefit of creditors. They may:

• take custody and control of all company property;
• sell the company's assets;
• bring or defend legal proceedings in the company's name;
• carry on the business so far as necessary for a beneficial winding up; and
• compromise claims, subject in certain cases to sanction.

Investigating the directors

A key part of the liquidator's role is to investigate the conduct of the company's directors. The liquidator will examine how the company's affairs were managed in the period leading up to liquidation, including:

• whether the directors acted properly and complied with their duties;
• whether they continued trading when there was no reasonable prospect of avoiding insolvent liquidation; and
• whether any transactions unfairly prejudiced creditors.

Where appropriate, the liquidator reports their findings to the Insolvency Service, which may lead to director disqualification proceedings.

Recovering assets: antecedent transactions

One of a liquidator's central responsibilities is to maximise returns for creditors. That often means investigating and, where appropriate, challenging transactions entered into before the liquidation. These are known as antecedent transactions, and the main categories are:

• Transactions at an undervalue (s.238) – a gift, or an asset sold for significantly less than its worth, within two years before the onset of insolvency.
• Preferences (s.239) – putting one creditor, surety or guarantor in a better position than they would otherwise have been in, within six months before the onset of insolvency, or two years where the recipient is connected to the company.
• Transactions defrauding creditors (s.423) – an undervalue transaction entered into to put assets beyond creditors' reach. There is no fixed time limit for this claim, and any victim of the transaction can bring it, not only the liquidator.
• Wrongful trading (s.214) – continuing to trade when the directors knew, or ought to have concluded, that insolvent liquidation was unavoidable. The court may order directors to contribute personally to the company's assets.
• Fraudulent trading (s.213) – carrying on business with intent to defraud creditors. This is the more serious claim and can carry both civil liability and criminal penalties.

If a claim succeeds, the court can order the asset returned or its value paid into the liquidation estate, increasing the pot available to creditors. Our guide to antecedent transactions sets out the look-back periods, the tests and the available defences in full.

Can a liquidator be removed?

Yes. The process depends on the type of liquidation.

In a voluntary winding up, a liquidator may be removed by order of the court. In an MVL, the members may also remove the liquidator at a general meeting called for that purpose. In a CVL, the creditors may remove the liquidator through a formal decision procedure.

In a compulsory winding up, a liquidator may be removed by order of the court, or by a qualifying decision procedure of the creditors convened specifically for that purpose.

A qualifying decision procedure is a formal process which can consist of a virtual meeting, correspondence or electronic voting, through which creditors can collectively decide on removal without applying to court. Any creditor may request one, provided they can demonstrate sufficient support among the creditor body.

The court also has a general power to remove a liquidator and appoint a replacement where there is good cause: a lack of independence or diligence, for example, or a breakdown in confidence. A liquidator must vacate office if they cease to be qualified to act, and may resign in prescribed circumstances.

When a liquidator ceases to hold office they obtain a formal release, which generally discharges them from liability for their conduct. The court nonetheless retains a separate power to grant a remedy against a liquidator or director who has misapplied or retained company property, or been guilty of misfeasance or breach of duty.

Your rights as a creditor in a liquidation

Creditors are not merely passive participants. Creditors' rights in liquidation are set out in the Insolvency Act 1986 and the Insolvency (England and Wales) Rules 2016, and depending on the circumstances you may be able to influence key decisions, obtain information, challenge the liquidator's actions and take part in overseeing the process.

Nominating and removing the liquidator

In a creditors' voluntary liquidation, you can nominate a person to act as liquidator. Where the creditors and the company nominate different people, the creditors' choice generally prevails. You can also seek to remove a liquidator later through a formal decision procedure.

Receiving information and requiring decisions

Creditors are entitled to receive information about the company's financial position and the progress of the liquidation. Creditors representing a specified proportion in value may also require certain matters to be put to a vote, or require the liquidator to seek decisions on particular issues.

Challenging the liquidator's conduct

Any creditor can apply to the court about the way a liquidator is exercising, or proposes to exercise, their powers. If you are unhappy with a decision, you can ask the court to confirm, reverse or modify it. Creditors can also apply to the court to resolve any question arising in the winding up. These applications are part of our contentious insolvency practice.

Requesting a public examination of directors

Where a company is being wound up by the court, creditors holding at least half of the total debt can require the official receiver to apply for the public examination of any person who is or was a director or officer of the company, or who was otherwise involved in its promotion, formation or management. This can be a valuable tool for uncovering information about the company's affairs.

Objecting to the liquidator's release

Before a liquidator's release takes effect, creditors have the opportunity to object. An objection can affect both the timing and the terms of the release, and preserves the prospect of a claim against the liquidator.

Who gets paid first? The order of priority in a liquidation

For most creditors this is the only question that matters. Not all creditors are treated equally: how much you recover depends on how your claim is classified.

In a liquidation, a company's assets are distributed to creditors in the following order of priority:

1. Fixed charge holders: Security over a specific asset, such as a mortgage over premises. Paid from that asset first.
2. Expenses of the winding up: The liquidator's fees and the costs of the liquidation itself.
3. Preferential creditors: Certain employee remuneration claims and certain HMRC debts.
4. Floating charge holders: Security over a changing class of assets, such as stock or receivables.
5. Unsecured creditors: Trade creditors and others, sharing rateably, plus access to the prescribed part.
6. Shareholders: Only if a surplus remains.

Each class must be paid in full before anything passes to the class below it. In most insolvent liquidations the assets are exhausted well before the later classes are reached, which is why an unsecured creditor's recovery so often turns on the prescribed part.

Secured creditors

A secured creditor holds security over the company’s assets. A creditor with a fixed charge over a particular asset is generally entitled to look to that asset for repayment ahead of all other classes of creditor.

A creditor with a floating charge, a charge over a class of assets that changes from time to time, such as stock or book debts, ranks behind fixed charge holders, the expenses of the winding up and preferential creditors, but ahead of unsecured creditors.

Expenses of the winding up

The costs of the liquidation itself, including the liquidator’s fees, are paid from the company’s assets ahead of other claims. Where the general assets are insufficient, these expenses take priority over floating charge claims.

Preferential creditors

Certain debts are given preferential status by law under Schedule 6 to the Insolvency Act 1986. These include certain employee remuneration claims and certain amounts owed to HMRC, which since December 2020 ranks as a secondary preferential creditor for VAT, PAYE and employee National Insurance contributions.

Preferential debts rank ahead of floating charge holders and ordinary unsecured creditors. They are paid from the assets available to general creditors and, where those are insufficient, from property subject to a floating charge. Preferential debts rank equally among themselves within their class; if funds are insufficient to pay them all in full, they abate proportionately.

Unsecured creditors and the prescribed part

Unsecured creditors rank behind secured and preferential creditors. They are paid only from what remains, and if the assets are insufficient they share in proportion to their debts, known as pari passu distribution.

Where a company’s assets are subject to a floating charge, section 176A of the Insolvency Act 1986 requires a portion of the company’s net property, the prescribed part, to be ring-fenced for unsecured creditors. It is calculated as 50% of the first £10,000 of net property and 20% of the remainder, subject to a cap of £800,000 where the floating charge was created on or after 6 April 2020, and £600,000 for earlier charges.

The practical effect is that unsecured creditors may receive something even where all the company’s assets are covered by a floating charge, subject to certain exceptions.

The creditors' committee

In some liquidations, creditors appoint a smaller representative body to oversee aspects of the process.

In a creditors’ voluntary liquidation, creditors may appoint a committee of up to five people. In a compulsory winding up, a committee is established if creditors or contributories decide one is needed; the liquidator must put the question to them if requested by creditors representing at least one-tenth in value of the debts.

The committee is generally made up of creditors. In a compulsory winding up, shareholders may also participate if both creditors and shareholders agree.

The committee gives a smaller, representative group a practical way to oversee the liquidator without convening all creditors each time. The liquidator may need the committee’s approval, or the court’s, before entering into certain arrangements — accepting shares in exchange for company property, for example. Where the liquidator sells company property to a connected person, or engages a solicitor in a compulsory winding up, they must notify the committee.

The committee therefore acts as a check on the liquidator’s use of their powers.

Key points for creditors

• Liquidation is a formal statutory process for winding up a company’s affairs, whether the company is solvent or insolvent.
• The liquidator takes control of the company’s assets and has a duty to investigate the directors’ conduct, including transactions entered into before the liquidation.
• Creditors have real, enforceable rights: nominating the liquidator, receiving reports, applying to court and sitting on a creditors’ committee.
• How much you recover depends on your ranking. Fixed charge holders are paid first, followed by the expenses of the winding up, preferential creditors, floating charge holders and finally unsecured creditors, whose position may be improved by the prescribed part.
• The most valuable creditor rights are exercisable early. Once a liquidator is appointed and the estate realised, your options narrow considerably.

Frequently asked questions

Will I get my money back if a company goes into liquidation?

It depends entirely on your ranking and on what assets the company has. Secured creditors with a fixed charge are paid first from the charged asset. Unsecured creditors are paid only from what remains and often recover little or nothing, although the prescribed part may provide a limited return where a floating charge exists.

Can creditors choose the liquidator?

In a creditors’ voluntary liquidation, yes. Creditors can nominate a person to act as liquidator, and where the company and the creditors nominate different people, the creditors’ choice generally prevails. Either party may apply to the court if there is a dispute.

Can a creditor challenge a liquidator's decision?

Yes. Any creditor can apply to the court about the way a liquidator is exercising, or proposes to exercise, their powers, and ask the court to confirm, reverse or modify a decision. Creditors can also seek the liquidator’s removal through a formal decision procedure or by court order.

What is the prescribed part?

The prescribed part is a portion of a company’s net property that must be ring-fenced for unsecured creditors where the company’s assets are subject to a floating charge. It is 50% of the first £10,000 and 20% of the remainder, capped at £800,000 for floating charges created on or after 6 April 2020.

What is the difference between a CVL and a compulsory liquidation?

A creditors’ voluntary liquidation is started by the company itself, by resolution, when it is insolvent. A compulsory liquidation is ordered by the court, usually on a creditor’s winding-up petition. Both result in the company being wound up,

but the routes in, and the creditor rights available, differ.

How KaurMaxwell can help

This article is for general information only and does not constitute legal advice. It should not be relied upon as a substitute for advice tailored to your specific circumstances.

If you are a creditor, director or other party affected by a company liquidation, our insolvency and restructuring team can advise on creditors’ rights, your recovery options and the practical steps available to protect your position. We regularly advise creditors and lenders on security enforcement, debt recovery and contested insolvency proceedings.

The rights that matter most are the ones exercisable early. If a company that owes you money has entered, or is heading towards, liquidation, contact us for a confidential discussion.