Is your business facing financial trouble? Liquidation is a term you've surely heard, but it's not the only option. Liquidation is used to wind up or end a company, but it's often confused with other options that may have the same or different goals.
What is Liquidation?
When a company enters liquidation, they are entering into their terminal stage. No one will be doing business with them any longer as they begin closing their doors permanently.
For secured creditors, liquidation means they need to begin looking to their securities to get their payout. For unsecured creditors, they need to be looking at their bottom line to see if they can retain any title clauses or guarantees they might have in their agreements. Of course, there are some exceptions.
What Are The Types Of Liquidation?
There are two types of liquidation a company can enter into: voluntary liquidation and insolvent liquidation. The latter, insolvent liquidation, is the most common. When a company goes into insolvent liquidation, it is doing so because it's no longer able to afford its debts. For creditors, that means they can hope for their money back plus something within 9 to 12 months.
The former, voluntary liquidation, is far less common. Voluntary liquidation occurs when a company's members simply want to get rid of or end the company. It's not insolvent and, therefore, the company will be in the position to pay back all of its debts, in full, within two years.
An insolvent company may also be forced into liquidation, putting them into involuntary liquidation. The only difference is how they get there. If an insolvent company doesn’t start the liquidation process themselves or take other actions (like forming a voluntary administration), a court can order liquidation.
A creditor who is owed by an insolvent company can also start the process themselves and may be able to successfully force the company into the liquidation process.
What's The Process of Liquidation?
When a company enters the liquidation process, a liquidator is appointed. The liquidator is an external expert that's brought in who is responsible for winding up a company's financial affairs. They will work to dismantle the structure of the company in an orderly way and, by doing so, liquidation is the only way to completely wind up and shut down a company.
It starts with selecting a liquidator, then the company must pass a director’s resolution stating that the company is insolvent. A meeting of the shareholders will then be called. During that shareholders’ meeting, members should resolve to appoint a liquidator and that resolution requires at least 75% majority votes to pass.
The guiding rule for a liquidator is to wind up the company in a manner that is as cost effective as possible. For the company itself, liquidation typically means that directors cease any and all control, employees get terminated, and the company's bank accounts are frozen.
The liquidator, in the meantime, will take over control from the directors of the company and begin to investigate the company's affairs. They will seek to figure out what went wrong with the company and begin selling the assets the company still holds in order to pay off its debts. This includes selling the business, calling in loans made to directors/shareholders (Div7a loans), and getting paid from customers.
What Reporting Is Required During Liquidation?
Under law, company directors must assist the liquidator in their investigations by providing records and books upon request and assisting with any other reasonable requests for help or information. When the investigation concludes, the liquidator has to report their findings to the creditors and ASIC.
What Is The Order of Priority With Liquidation?
The top priority for a liquidator is to pay back creditors. That means creditors get paid first using whatever profit comes from selling off the company’s assets, and shareholders will split whatever profit remains (if any).
The general rule of thumb is that parties who accepted the most risk when they lent or invested money will be paid last. Those who agreed to the least risk will be paid first. Even in the case of a voluntary liquidation where the company is not insolvent, the order of priority remains the same.
When Is Liquidation The Right Choice?
A company may enter liquidation if it has become insolvent and the company’s leaders decide to liquidate to halt creditors’ legal action and put an end to the company.
On the other hand, creditors may vote for a liquidation if the terms set forth in a Voluntary Administration agreement, or DOCA, are not met by the company. Remember, a court can also order the liquidation of a company or a creditor can start the process, putting them into involuntary liquidation.
How Is Liquidation Different from Voluntary Administration?
Voluntary administration is best understood by viewing it as a means by which a company may still be saved. When a company enters into voluntary administration, which is a common choice prior to liquidation as a type of "last resort," a company might already be insolvent or may be close to becoming insolvent.
Typically, an Administrator will be appointed to run the Voluntary Administration through a resolution of the company's directors. However, depending on the circumstances, the court, creditors, or liquidators may also appoint the Administrator. That Administrator is then responsible for checking the company's books and informing creditors about what they find. They will then make recommendations to creditors based on those findings and will report any offenses to the ASIC.
In most cases, voluntary administration results in one of two outcomes. Either the company puts a DOCA (Deed of Company Arrangement) into place, in which everyone agrees on how they will repay creditors with the hopes of continuing to operate, or the company enters liquidation.
The process of voluntary administration is, therefore, very different from liquidation. Liquidation means an end to the company in that it will permanently stop trading and, at the end of liquidation, cease to exist. While a company can find many ways back to trading if they enter a voluntary administration, liquidation almost always means that the liquidator will sell the company's assets and distribute profits to creditors, then take the final step to deregister the company.
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Can A Voluntary Administration Lead to Liquidation?
A company may enter liquidation following the establishment of a voluntary administration for many reasons, including them failing to uphold the terms agreed upon in the DOCA. At the creditors' meeting that is held about 26 days after an Administrator is appointed, creditors can also decide in a majority wins vote whether the company should enter liquidation or work to establish a DOCA.
There's also a very rare third possible option when a voluntary administration is started, and that is that the Administrator recommends for the company's control to be handed back to the directors if they feel the directors competent and equipped well enough to deal with creditors on their own. Those directors may then choose to liquidate or continue to try and operate.
What’s The Difference Between an Administrator and Liquidator?
In a voluntary administration, an Administrator is appointed who is responsible for investigating the company's affairs. They will work to bring out a resolution, deciding either on liquidation or holding a meeting to vote for a DOCA, depending on what will be the most lucrative for a company's creditors.
On the other hand, a Liquidator is appointed only once a company enters the Liquidation phase. Their goal is to wind down the company by realizing its assets, using profits to pay off creditors following the order of priority, and finally, deregistering the company.
How Are Liquidations and Administrations Different for Creditors?
In a voluntary administration, creditors will first have to agree to implement a DOCA and then they must agree upon the terms set forth in that DOCA in a majority vote. That means the impact an administration has on creditors can differ, depending on the unique and specific agreement an administration comes to, but the general goal with a DOCA is to achieve more favorable returns than liquidation would garner.
When it comes to a liquidation, creditors are given different levels of priority depending on the amount of risk they accepted when they first lent to or invested money in the company (with those who accepted the most risk being paid last) and other factors that are laid out in the law books. So, priority creditors get paid first during a liquidation and leftover funds are then distributed accordingly amongst lower priority creditors and, if any is left, shareholders.