Financial difficulties are a simple fact of doing business. Changes in markets, customers, competitors and the economy can all have an impact on your company.
If you find yourself struggling to stay afloat, there are several options available, one of which is liquidation. Liquidating a business is a final solution for managing debts and repaying creditors.
For creditors, liquidation is a way to recover some of the money they are owed, but it can be a confronting process for directors, employees and internal stakeholders.
In this article, we’ll cover the basics of liquidation, and how it’s used to manage the debts of insolvent companies.
What is Liquidation?
Liquidation is the formal procedure of dissolving a company that has become insolvent (e.g. if it’s unable to pay its bill on time). During liquidation, the insolvent company is controlled by a specialist that can investigate its financial situation and satisfy as many company debts as possible.
There are two main types of liquidation in Australia:
- Creditors’ Voluntary Liquidation (CVL) – The directors of a company are required to stay abreast of the company’s position. If the directors notice that the company is insolvent, they can voluntarily enter into liquidation and wind the business up.
- Court Liquidation – Anyone who lends money to a business is entitled to have their debt repaid. If a company fails to repay a debt on time, creditors can apply to the court to have the company placed in liquidation. A liquidator is appointed immediately if the court approves the liquidation order.
Creditors can initiate a court liquidation if they’re owed $2,000 or more. While this is a viable option for recovering money, creditors are discouraged from using liquidation as a simple debt recovery tool.
If a company owes you money, you should try alternative debt collection methods before resorting to a liquidation order.
What Happens During Liquidation?
Liquidation begins as soon as the liquidator is appointed. This can either be done by the directors or by court order. Once the liquidator takes control of the business, they become responsible for the business’ assets, liabilities and day-to-day concerns.
The liquidator will begin by investigating the company’s financial affairs. The goal is to locate and secure assets, as well as to collect claims from creditors. At this stage the liquidator will also investigate company officers to make sure there has been no misconduct.
As the liquidator collects company assets, these assets will be auctioned off to raise money that can be used to pay company debts. Assets sold during liquidation are sold on short notice. This means they are often disposed of for a fraction of their value.
Once all assets have been sold and the liquidator’s investigations are complete, they will distribute money to creditors in the order outlined below.
Finally, the liquidator will apply to ASIC to have the company deregistered, at which point it ceases to exist.
The Order of Distributions in Liquidation
Any money collected by the liquidator during the process is distributed to secured and unsecured creditors of the insolvent company. This distribution is made in a predetermined order that’s set out by ASIC. The order is as follows:
- The liquidators fees and any costs they incurred during the process
- Secured creditors
- Outstanding employee wages
- Outstanding employee superannuation
- Outstanding employee entitlements (such as annual leave)
- Employee redundancy pay
- Unsecured creditors
As you can see, secured creditors and priority creditors (e.g. employees) receive the lion’s share of distributions in liquidation.
Each category must be paid in full before the next category receives a pay out. If there isn’t enough money to pay a category in full, each creditor receives a pro rata amount and then the following categories receive nothing.
The liquidator is first to be paid during liquidation. This is done to ensure that there are always financial professionals that are willing to take on this type of work. The cost of the liquidation depends on the size and complexity of the company.
Shareholders are the last to receive a pay out during liquidation. It is very uncommon for shareholders to receive a dividend.
Alternatives to Liquidation
Liquidating a business is a final solution. At the end of the process, the business is deregistered and ceases to exist, with most remaining debts being extinguished.
This creates a problem for companies that are experiencing moderate financial difficulties. In many cases, it’s possible to save these companies from liquidation through alternative processes such as Administration.
During Administration, a company appoints a financial professional to assess its position and develop a plan for moving forward. This plan typically involves negotiating partial repayments with creditors. While creditors receive less money than they’re entitled to, Administration provides better returns than creditors would receive through liquidation.
As with liquidation, it’s important to commence Administration as soon as possible. The sooner the directors of a company act, the more likely they are to save the business from liquidation and deregistration.