You may have clicked on this article, unsure if entering liquidation is right for you and your business.
Many people are surprised to discover that even profitable, thriving corporate businesses may choose to enter liquidation. But what does it actually mean when a business is placed into liquidation and why would a thriving business choose this as a path?
Or, you may be experiencing financial distress, uncertain if entering liquidation is the suitable solution . When a corporation is in financial trouble, it has a number of insolvency options. Whether you’re an advisor to a company in financial strife or you’re in charge of trading its business, liquidation is only one possible outcome.
- Navigating the liquidation landscape involves understanding different types of liquidations, costs and procedures.
- Liquidators are appointed to oversee the process and manage assets, company’s debts with secured creditors prioritised for repayment.
- Unsecured creditors have no legal claim over assets while directors may be held responsible for a breach of duties leading to personal liability.
What is liquidation?
Liquidation involves winding up the financial affairs of a company as well as selling off it’s assets to, if possible, fully, or partially repay debts. The process includes dismantling the company’s structure in an orderly way.
Liquidation applies only to corporate entities (businesses operating under the company structure). Whereas bankruptcy – a different concept that is sometimes confused with liquidation – only applies to individuals, including sole traders and partners in partnerships.
During liquidation, a liquidator is appointed to undertake the process and has full control over the company’s operations, financial affairs, and assets. The task of the liquidator is to wind up the affairs as cost-effectively as possible while also considering the creditors and other stakeholders. A liquidation process can include a sale of business and assets as well as the transfer of employees to a purchaser.
What happens when a company goes into liquidation?
When a company is unable to pay its debts as and when they fall due it may be forced into liquidation by creditors. This is called a court liquidation. This involves a court procedure and a court order, made subsequent to a creditor’s winding up application. Alternatively, a company may liquidate voluntarily by resolution of the directors and a majority of shareholders.
Once the company is in liquidation, creditors cannot instigate or continue legal proceedings without permission from the liquidator or the court.
A liquidation timeline can vary on the circumstances of each matter, b. On average al iquidation process can take from 3-6 months.
Benefits of entering liquidation
Liquidation is a suitable option to wind down the operations of a company in an orderly way. It ensures assets are appropriately and legally distributed, minimising the impact of insolvent trading. It also gives shareholders, creditors, and directors the opportunity to have an independent expert investigate and manage the liquidation. Creditors understand that liquidation is a fair and legal option for a company to deal with its financial affairs.
Why you would choose liquidation:
- Cost: Aside from the upfront costs there is little to no cost. The registered liquidators’ fees are able to be drawn from the realisation of company assets;
- Certainty and Mitigation of Liability. Alleviates the stress on company management from potential insolvent trading, such as reducing the financial impact of ongoing trading on employees and other creditors potentially not being paid;
- Address a Director Penalty Notice (DPN):
If you have received a DPN regarding debts owed by a Company, as a director you may be personally liable for the company’s taxation debt if an acceptable response is not made within the stated timeline. . An option to resolve your DPN is for an insolvent company to enter liquidation.
Voluntary and involuntary liquidation
An individual should know the difference between creditor’s voluntary liquidation and involuntary liquidation.
Voluntary liquidation occurs when a company’s members or creditors decide to liquidate the business. This is known as Members Voluntary Liquidation for solvent companies and Creditors Voluntary Liquidation for insolvent companies.
In contrast, involuntary liquidation occurs following a court order. This is known as Court Liquidation. A Court Liquidation occurs when a liquidator is appointed by the court to wind up the company. This process is usually initiated by a creditor of the company after an application to the Court.
The different types of liquidation
There are different types of liquidation, these include:
Creditors Voluntary Liquidation
Creditors’ voluntary liquidations are a common type of insolvent company liquidation and undertaken by shareholders resolution.
A meeting of shareholders is called, which is usually held on short notice. The company resolves to place the company into liquidation, and the liquidator is appointed. Once shareholders have resolved to appoint a liquidator, a proposed liquidator will undertake the appointment. You will provide infoa statement with details about the company’s property, affairs, and financial condition.
Members Voluntary Liquidation
A solvent company may undertake a Members Voluntary Liquidation (“MVL”). A MVL may begin if the company’s directors declare that the company is solvent and send a statement to the Australian Securities and Investments Commission (ASIC). In order to declare the company solvent, the directors must believe that the firm will be able to repay all of its current debts within twelve months of the company’s date of liquidation. Alternatively, the company is insolvency and may be placed into another form of external administration susch as a CVL. Once the liquidator is appointed, they undertake the winding down of the company’s affairs and realising assets held and distributing remaining funds to shareholders.nSimplified Liquidation
Following an announcement on September 24, 2020, the Federal Government have enacted a Simplified Liquidation process to create a cost-effective and time-efficient liquidation alternative with small businesses in mind.
This is a less comprehensive form of the current Creditors Voluntary Liquidation (CVL) but with restricted eligibility criteria such as a requirement the proposed company to be wound up has not previously undertaken a restructuring or simplied liquidation in the prior 7 years and taxation lodgements are up to date There is a reduced level of investigation and formal reporting undertaken subject to creditors opting out of the process within a timeline. As a consequence the costs of a simplied liquidation are likley to be less than a traditional CVL. . Court Liquidation
A company’s affairs are liquidated by the Courts if an application is made to do so, this is referred to as Court Liquidation (“ÖL”). A statutory demand can be issued by various parties, including but not limited to creditors, members, liquidators, ASIC or APRA to initiate court liquidation. According to section 459E of the Corporations Act, the courts appoint a liquidator. The liquidator is appointed by the Courts, then follows a similar process to Creditors Voluntary Liquidation.
When you need to safeguard company’s assets from potential harm or loss, you might choose to undertake an application for a provisional liquidation. Despite the fact that a provisional liquidation does not liquidate, a court-appointed liquidator takes charge of a company’s financial affairs in the interim, which then may result in a future Court Liquidation depending on the situation. This may occur whether the company is or may become insolvent or alternatively on just and equitable terms (ie not insolvent).
A provisional liquidation does not result in immediate liquidation; it provides an a court imposed independent expert to provide a view of the company and to ensure assets are likely to be preserved pending an assessment of the company’s affairs.. . The circumstances that can lead to a company applying for a provisional liquidation are numerous. If you are a stakeholder such as a shareholder and you suspect the debtor company of potentially disposing of assets to third parties without a commercial benefit, a provisional liquidation may be the right option.A provisional liquidation may be also appropriate if you believe that the company’s directors are acting unprofessionally, recklessly, or in a self-interested or unprofessional manner. If you’re a stakeholder and you suspect that the company’s directors are in a dispute, you may choose to apply to the court to place the company into provisional liquidation.
The general process of liquidating a company
The general steps include:
- The directors or company secretary call a meeting of members (shareholders) at the shareholders’ meeting, where they (the shareholders) determine that the company is insolvent.
- The shareholders select a liquidator, who must be accepted by a majority of 75 percent.
- The liquidator may not hold a creditors’ meeting and, instead, may file a progress report with ASIC.
- The report must include the liquidator’s activities, the winding up process, a summary of unfinished tasks, and an estimation of when the liquidation will be complete.
The liquidator may also ask creditors whether they wish to appoint a committee of inspection. This committee assists the liquidator and approves fees.
Liquidation vs. Voluntary Administration
Voluntary Administration is very different from liquidation. Though liquidation is a possible outcome of entering into voluntary administration, it does not necessarily always result in a liquidation of a company. The Voluntary Administration option is an opportunity for directors to assist and overcome a company’s financial difficulties.
Liquidators are the only qualified parties who are able to act as Voluntary Administrators. A company could enter a Deed of Company Arrangement (“DOCA”) and trading returned to the directors’ control or be liquidated.
While both processes involve bringing in an independent expert to manage the process, voluntary administration opens the door to a wider range of possibilities than liquidation.
For more information on voluntary administration, read our article ‘What is Voluntary Administration?’.
The parties affected
During the liquidation process, Company Directors must cooperate with the liquidator. They must meet with the liquidator and hand over all company information, including all records and documents, inform the liquidator about all company property and its location, and advise the liquidator on all company matters. A Report on Company Activities and Property (ROCAP) detailing the company’s assets and liabilities must also be submitted by registered liquidator to ASIC within fourteen days of the appointment of the liquidator (for court liquidation) or seven days.
Once the liquidator is appointed, steps may be taken to terminate the employment of company employees. However, if the liquidator believes temporarily continuing trading and or a sale process is appropriate may be the best course of action for the benefit of the company’s creditors, employees may continue in their roles.
Employees are likely to lose their employment in the event of liquidation. Additionally, they could also lose out on entitlements if there are insufficient assets to cover the cost of the entitlements. However, employees may be able to recover outstanding entitlements (excluding superannuation) through the Fair Entitlements Guarantee (FEG). The FEG is a government scheme that lets liquidation-affected employees claim up to 13 weeks of unpaid entitlements like wages, annual leave, redundancy pay, long service leave, and payment unpaid wages in lieu of notice.
There are different types of creditors within the business.
Those holding a security interest in some or all of the company’s assets, such as a bank or other lender, are secured creditors.
Employees of the company sit under that title and receive priority in the distribution of realised assets and are paid prior to others.
A contingent creditor is a creditor who is owed funds and may or may not be liable depending on a certain event. A contingent creditor has an existing obligation that may or may not become subject to liability depending on a certain event. In that event, the company is obligated to pay a certain amount of money.
Creditors play an important role in corporate liquidations in a number of ways. Whether secured or unsecured, the firm’s creditors aim to regain the greatest amount of the money they are owed.
The firm’s creditors participate in the liquidation process in the following ways:
- They receive initial notice of the liquidator’s appointment and their rights as creditors.
- After three months, the liquidator will release a report providing information about the corporation’s asset and liability values, the status of the liquidation, the likelihood of receiving a dividend, and possible recovery strategies.
- Creditors may either attend meetings or organize them to discuss the liquidation’s progress. If the meeting requires a vote, the creditors can vote on resolutions such as the amount being offered to creditors, the liquidator’s fees, and the removal and replacement of the liquidator.
- A committee of inspection (formed of creditors) may assist and advise the liquidator
An independent liquidator is responsible for managing the company, ensuring adequate protection for creditors, officers, and members. The liquidator will:
- Inform and keep all creditors (including banks), employees, and suppliers informed about the liquidation process.
- Find, protect, and realise the firm’s assets.
- Investigate the company’s operations.
- If there are any assets left after the liquidation costs are paid, they will be distributed to secured creditors, employees, unsecured creditors, and, if there is a surplus, shareholders as well.
Who gets paid first during liquidation?
A company’s assets are distributed to interested parties in the order of their priority and likelihood of receiving payment for selling assets.
The order of who gets paid first in liquidation is as follows:
- The costs of entering liquidation
- Secured creditors
A secured creditor is the first type of creditor to be paid in liquidation. The term refers to those who have an interest over the company’s assets (mortgage or charge).
A secured creditor also has the right to retrieve a receiver for those who default on their repayments. Engaging in an independent receiver results in the receiver selling some or all of the company’s assets to ensure the debt is repaid.
- Priority creditors
Next to be paid are priority creditors (employees), those who have a legal priority during the liquidation.
- Unsecured creditors
Unsecured creditors are the last to be paid during liquidation. An unsecured creditor are those who have no collateral over the company’s assets (trading partners, ATO etc). They may be able to retrieve funds in the form of dividends after secured and priority creditors are paid.
Why would a successful business liquidate?
Liquidation is sometimes voluntarily entered into by a previously profitable business as it enables a way forward for a company’s management to finalise the financial affairs of a corporation.
We’ve listed a few reasons why a successful business may choose to liquidate:
- You are unable to resolve disputes between director and/or shareholders
- You are unable to sell the company due to key person business
- The passing down of the business hasn’t been able to keep up with generation change
- To realise the proceeds of pre-CGT assets
For example, if a business has been built based on the services of a single person, then the stepping down of that person may require the business to be liquidated even though the business has been and or is otherwise likely to be currently viable. A liquidation also allows for commercially justified options by a Liquidator including a process of transition of an otherwise viable business operation. Stakeholders including Management as well as employees and creditors generally can benefit from this option.
After liquidation: What options are available to creditors?
At any time during the liquidation, creditors may request information from the liquidator. When a request is made, the liquidator must provide the creditor with the requested information within five business days unless the request is unreasonable, irrelevant, or breaks the liquidator’s duties. If the liquidator requires extra time to complete the request, the creditor will be notified via writing.
The liquidator, is not required to follow the directions if they choose not to do so, they must document the reasons behind their decision. Creditors may arrange for a creditors’ meeting to learn about how the liquidation is progressing. They may also pick a new liquidator at the meeting.
Liquidation with Mackay Goodwin
For directors and shareholders unable to fund any payable liabilities of insolvent companies, choosing to liquidate is the best way to ensure assets are fairly distributed to creditors by an independent external expert, and in a controlled and orderly way.