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 apath?
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 a business might choose it.
What is liquidation?
Liquidation involves winding up the financial affairs of a company as well as selling off the 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.
Liquidation is the only way to wind up a company and terminate its existence. A liquidation may include a sale of business and assets as well as the transfer of employees to another company.
What does it mean when a business enters 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 involuntary court liquidation. Thisinvolves a court procedure and a court order, made after a creditors winding up application. Alternatively, a company may liquidate voluntarilythough its directors and a majority of shareholders.
With voluntary liquidation, the company may have already undertaken a voluntary administration and/or a Deed of Company Arrangement (DOCA) procedure, where it is no longer viable, and creditors have chosen to wind it up.
Once the company is in liquidation, creditors cannot instigate or continue legal proceedings without permission from the liquidator and a court.
Liquidation can last as long as necessary, but the process has to conform to strict rules and procedures depending on the type of liquidation it is. On average the processes can take between 3 to 6 months.
Find out more about members’ voluntary liquidation in our comprehensive guide.
Why choose liquidation?
Liquidation is a suitableoptionto wind down operations of a company in an orderly way. It ensures assets are appropriately and legally distributed and helps minimise 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 afair and legal option foran insolvent company to deal with its financial affairs.
The top three reasons why you would chooseliquidation:
- Planning and Control: When liquidation is voluntary, a company’s management is able to utilise an independent and qualified third party to minimise the financial impact on the Company and its creditors where management can be prepared for the outcomes of a planned and controlled wind up.
- 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 including reduced ongoing financial impact on employees and other creditors potentially not being paid
Liquidation vs. Voluntary Administration
Voluntary Administration is verydifferent from liquidation. Though liquidation is a possible outcome, voluntary administration does not necessarily always result in a liquidation. The Voluntary Administration option is an opportunityfor directors to assist and overcome a company’s financial problems and improve normal trading. 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. In contrast, liquidation means the company will soon cease to exist with steps taken to wind down and or sell the business and assets.
While both processes involve bringing in anindependent 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?’.
Outcomes of Liquidation for employees
Once the liquidator is appointed, steps may be taken to terminate the employment ofcompany employees. However, if the liquidator believes temporarily continuing trading and or a sale process is appropriatemay be the bestt 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.
Why would a successful business liquidate?
Liquidation is sometimes voluntarily entered into by a previously profitable businesses as it enables a way forward to a company’s management to finalise the financial affairs of a corporation. This is likely where there aresignificantunmet liabilities (i.e., alitigation judgement made against the company) which has unexpectedly arisen. A Liquidation of a Companyenables the utilisation of the separate corporate veil to limit liability of the shareholders in respect to unmet liabilities.
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 from the insolvent company. Stakeholders including Management as well as employees and creditors generally can benefit from this option.
Are you ready to talk liquidation?
For directors and shareholders unable to fund due and 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. If you’re thinking of liquidating your business, speak to our experts on 1300 750 599.