Author
Mitch BallChief of Insolvency Operations & ASIC Registered Liquidator
(02) 9220 7117
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? Let’s uncover everything you need to know about liquidation.
What does liquidation mean?
Liquidation involves winding up the financial affairs of a company and selling off its assets, to 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).
What happens when a company goes into liquidation?
A liquidator is appointed to undertake the liquidation process and take full control over the company’s operations, financial affairs, and assets. The liquidator must wind up the affairs as cost-effectively as possible, while also considering the creditors and other stakeholders.
A liquidation process can include the sale of business and assets, as well as the transfer of employees to a purchaser. It typically results in the company being formally closed and removed from the corporate register.
Once the company is in liquidation, creditors cannot instigate or continue legal proceedings without permission from the liquidator or the court.
Benefits of entering liquidation
Liquidation is a suitable option to wind down 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 consider entering company liquidation?
There are various reasons why a company enters liquidation:
- Cost: Beyond the initial setup costs, there are minimal ongoing expenses. The registered liquidators’ fees are typically covered through the proceeds from selling the company's assets.
- Mitigation of liability. Relieve the pressure on company management by minimising the risks of insolvent trading, including the financial strain of continuing operations that may leave employees and other creditors unpaid.
- Address a DPN: If a director receives a Director Penalty Notice (DPN) for outstanding company tax debts, they may become personally liable if they don’t respond within the required timeframe. One way to address a DPN is by placing the insolvent company into liquidation.
Voluntary vs involuntary liquidation
Liquidation can be segregated into two main types, 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.
- Involuntary liquidation occurs following a court order. This is known as Court Liquidation and 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 Liquidation (CVL) is a process initiated by a company’s directors and shareholders when the business is insolvent and unable to pay its debts. It involves appointing a liquidator to sell the company’s assets, repay creditors where possible, and formally close the business.
The most common liquidation process, Creditors’ Voluntary Liquidation is for insolvent companies. Unlike a Members’ Voluntary Liquidation (MVL), which is for solvent businesses, a CVL is initiated when a company can no longer pay its debts.
Members' Voluntary Liquidation
Members' Voluntary Liquidation (MVL) occurs when a solvent company agrees to close down a business. This may happen for various reasons including limited growth prospects, company restructure or lifestyle changes such as retirement.
In order to declare the company solvent to ASIC, 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.
Simplified Liquidation
Introduced by the Federal Government on 24 September 2020, Simplified Liquidation offers a faster, more cost-effective alternative to the traditional Creditors’ Voluntary Liquidation (CVL), specifically designed for small businesses.
It involves fewer investigations and formal reporting requirements, helping reduce costs - provided certain eligibility criteria are met, including:
- Being up to date with tax lodgements.
- Not having used restructuring or simplified liquidation in the past seven years.
- Creditors are not opting out within the set timeframe.
Court Liquidation
A Court Liquidation is when a company’s affairs are liquidated by the Courts when an application is made to do so. A statutory demand initiates court liquidation and can be issued by various parties, including but not limited to:
- Creditors
- Members
- Liquidators
- ASIC
- APRA
According to section 459E of the Corporations Act, the courts appoint a liquidator and then follow a similar process to Creditors’ Voluntary Liquidation.
Provisional Liquidation
Provisional liquidation is the process of safeguarding a company’s assets from potential harm or loss. 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 may result in Court Liquidation depending on the situation.
Provisional liquidation is suitable for solvent and insolvent companies and doesn't mean the company is immediately wound up. Instead, it involves the court appointing an independent expert to safeguard the company’s assets while its affairs are being reviewed.
Reasons for applying for Provisional liquidation include:
- Stakeholders suspect asset dissipation without commercial benefit
- Director misconduct
- Internal disputes affecting the company’s management
The liquidation process
The general liquidation process in Australia is as follows:
- 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 per cent.
- 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 the liquidation of a company. The Voluntary Administration process is an opportunity for directors to assist and overcome a company’s financial difficulties.
While both involve engaging an independent expert to manage the process, liquidators are the only qualified parties who are able to act as Voluntary Administrators.
A key difference is the outcome. Liquidation results in the closing down of a company, whereas Voluntary Administration opens the door to a wide range of possibilities, including:
- Entering a Deed of Company Arrangement (DOCA)
- Returning to the directors’ control
- Resuming trading
- Liquidation (as a last resort
Parties involved in the liquidation process
Company directors
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), which outlines the company’s assets and liabilities, must be submitted to ASIC by the appointed liquidator within:
- 14 days for court-appointed liquidations
- 7 days for creditors’ voluntary liquidations (CVL)
Creditors
Creditors can request information from the liquidator at any time during liquidation, with responses required within five business days - unless the request is unreasonable or breaches the liquidator’s duties. Creditors may also call a meeting to receive updates or vote to appoint a new liquidator. If the liquidator chooses not to follow creditor directions, they must record their reasons in writing.
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 sit under that title and receive priority in the distribution of realised assets and are paid prior to others.
- Contingent Creditors: 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' entitlements
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.
Creditors are entitled to 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 organise them to discuss the liquidator'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.
Liquidator
An independent liquidator is responsible for managing the company and 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.
Employees
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 of unpaid wages in lieu of notice.
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. They also have 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 (e.g. employees), those who have a legal priority during the liquidation.
- Unsecured creditors: Unsecured creditors are the last to be paid during liquidation as they have no collateral over the company’s assets (e.g. trading partners, ATO). 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:
- Inability to resolve disputes between directors and/or shareholders
- Inability 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, employees and creditors can generally benefit from this option.
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. If you’re thinking of liquidating your business, speak to our experts.
FAQs
Does liquidating a company affect my credit line?
Yes, your credit file is flagged. You can still obtain finance, however, but it is of course dependent on your financial position.
Are directors personally liable for the debts when I liquidate?
In most cases, NO, you are not liable for unsecured debt with creditors including the ATO – the debt goes with the business. There are some expectations such as superannuation and potentially PAYG with the ATO, depending on your history of lodging BASs. You also need to be aware of any bank debt that may be secured or guaranteed by you personally, and leases and/or personal guarantees for other debt such as a vehicle.
What evidence may support a reasonable suspicion of insolvency?
There is a long list of factors which are indicators of insolvency. In many instances, businesses may appear to be financially stable when they are in fact trading insolvent. Some common indicators are:
- Company debts outweigh assets
- Liquidity ratio below 1 – insufficient current assets to meet current liabilities when payable
- Declining profit margins
- Unpaid employee entitlements/loss of staff
- Legal proceedings against the company
- Unpaid creditors
- Overdue taxes
- Inaccurate reporting
- No access to alternative financing
What happens if a company goes into liquidation and owes money?
There are specific steps that you can take if a company that owes you money has gone into liquidation. The first step for a creditor is to send the party a letter of demand accompanied by supporting documentation such as invoices and debt slips which will outline the amount owed.
If the company has rejected your claim or refused payment, you must now file a Statement of Claim. This is an official application to the court which will then outline possible ways for the company to pay debts. There may also be circumstances where claims may be made directly against the directors.
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