28 November 2023

Guide to Liquidation

The real meaning of liquidation, what it involves, and why you might choose it.
Australia Insolvency/Bankruptcy/Re-Structuring
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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 businesses may choose to enter liquidation. But what does it actually mean when a business goes 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 pathway for the business. When a business is in financial trouble, it has a number of insolvency options. Whether you're an advisor to a business in financial strife or you're in charge of such a business, liquidation is only one possible outcome.

Here, we break down the real meaning of liquidation, what it involves, and why you might choose it.

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. The liquidator is also tasked with investigating what might have gone wrong if the company is liquidating due to financial issues.

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 oversee 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. A liquidation may include a sale of business and assets as well as the transfer of employees to another company.

A liquidation may include a sale of business and assets as well as the transfer of employees to another company.

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 an court liquidation. This involves a court procedure and a court order, made subsequent to a creditors winding up application. Alternatively, a company may liquidate voluntarily by resolution it's 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.

Liquidation timeline can vary for each business, but the process has to conform to strict rules and procedures depending on the type of liquidation it is. On average a simple liquidation can last from 3-6 months.

Benefits of entering liquidation

A business may choose liquidation for its many benefits such as, ability to plan and control the company's affairs without pressure from creditors.

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 an insolvent company to deal with its financial affairs.

Why you would choose liquidation:

  • Lower costs: Aside from the upfront costs there is little to no cost. The registered liquidators' fees are drawn from the realisation of company assets given they are sufficient.
  • 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
  • Solve your Director Penalty Notice (DPN):
  • If you have received a DPN, you may be personally liable for the company's debt if you do not act within the stated time period. One option to resolve your DPN is to enter liquidation.

Voluntary and involuntary liquidation

An individual should know the difference between voluntary and involuntary liquidation. A company can be liquidated either voluntarily or involuntarily.

Voluntary liquidation occurs when a solvent 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 the most common type of insolvent company liquidation. A liquidation is started voluntarily by the company's shareholders by way of a resolution. This may enable the company to act immediately, minimise the possibility of significant consequences, and avoid incurring further debt.

A meeting of all 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 your shareholders have resolved to appoint a liquidator, your chosen liquidator will handle the rest. You will provide information as part of a summary statement. The statement includes details about your company's property, affairs, and financial condition.

Members Voluntary Liquidation
A solvent company may cease operations voluntarily, this is called a Members Voluntary Liquidation. A members' voluntary liquidation could begin if the company's directors declare that the corporate 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 liquidation. Alternatively, the company must go into Creditors Voluntary Liquidation. Once the liquidator is appointed, he or she can begin winding down the company's affairs once the appointment takes effect.

Simplified Liquidation
There is a less comprehensive form of the current Creditors Voluntary Liquidation (CVL) known as Simplified Liquidation. A firm with creditors less than $1 million is wound up when it can't afford to pay them. Following the announcement on September 24, 2020, the Federal Government proposed a Simplified Liquidation plan to create a cheap and simple liquidation process with Small Businesses in mind.

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. 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. Court Liquidations proceed in a similar process as Creditors voluntary liquidations,a liquidator has been appointed by the courts.

Provisional Liquidators
When you need to safeguard your company's assets from harm or loss, you might choose to undergo a provisional liquidation. Despite the fact that a provisional liquidation does not liquidate, a court-appointed liquidator takes charge of a company in the interim, which then may result in liquidation depending on the situation.

A provisional liquidation doesn't result in liquidation; it simply means an expert temporarily takes over your company. The circumstances that can lead to a company applying for a provisional liquidation are numerous. If you are a creditor and you suspect the debtor company of concealing or making inaccessible assets or funds, a provisional liquidation might be the right choice.

A provisional liquidation may be 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. 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, 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 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 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 in lieu of notice.

There are different types of creditors within the business.

Secured Creditors
Those holding a security interest in some or all of the company's assets, such as a bank or other lender, are secured creditors.

Unsecured Creditors
Employees of the company are unsecured creditors who receive priority in the distribution of realised assets and are paid prior to other unsecured creditors.

Contingent Creditor
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.

The order of who gets paid first in liquidation is as follows:

  1. The costs of entering liquidation
  2. Secured creditors
    A secured creditor is the first type of creditor to be paid in liquidation. A secured creditor 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.
  3. Priority creditors
    Next to be paid are priority creditors (employees), those who have a legal priority during the liquidation.
  4. 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:

  1. You are unable to resolve disputes between director and/or shareholders
  2. You are unable to sell the company due to key person business
  3. The passing down of the business hasn't been able to keep up with generation change
  4. 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.

At Mackay Goodwin, we have a team of registered liquidators to assist your business during this difficult time.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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