When your business is in financial trouble, there are a number of potential solutions available. But remember, it’s best to seek financial advice first about what to do because there’s a few different options that you should investigate prior to going down the path of liquidation:
- Receivership – if you have an unpaid debt to a secured creditor such as a bank, they may appoint a receiver to come in and arrange the sale of company assets to repay the money they’re owed. This doesn’t necessarily mean the end of the company, because companies are quite capable of recovering after being in receivership.
- Voluntary administration – if the directors believe the company is close to becoming, or already is, insolvent, they can appoint an administrator to look at ways to restructure the business in order to either turn it around, or make it attractive to buyers. Again, many companies who appoint a voluntary administrator can and do recover.
However, if you find your business at the stage where neither of these options are viable and liquidation is the only recourse, then it’s important to fully understand exactly what liquidation is.
What is business liquidation?
Liquidation often occurs when a company can’t pay its debts, or if members of a company want to end operations. Generally, the process involves winding up the financial affairs, dismantling the company’s structure in an orderly manner, and investigating what went wrong. The company’s assets are also sold in an attempt to pay off all business debts.
It’s important that you don’t get confused between bankruptcy and liquidation. While some understand them as the same concept, bankruptcy applies to individuals and liquidation applies to companies.
It’s also vital to understand the difference between voluntary liquidation and involuntary liquidation. Voluntary liquidation is decided by a resolution of members or creditors. Creditors vote for liquidation following the company going into voluntary administration, or when a deed of company arrangement is terminated. Alternatively, a company’s shareholders can resolve to liquidate the company.
In comparison, involuntary liquidation occurs following a court decision. A court-ordered liquidation occurs when a liquidator is appointed by the court to wind up a company. This generally happens following an application to the court, usually by a creditor, but a director or majority of shareholders can also make an application.
Once a company goes into liquidation, its unsecured creditors (those without a claim to the company’s assets) cannot instigate or continue legal action against the company unless permitted to do so by the court.
Liquidation is the only way to fully wind up a company and terminate its existence. If you merely sell the company’s assets and pay its debts, the company structure is still in place and so the company still exists.
What does it mean when a company goes into liquidation?
While the company structure survives during the liquidation process, once the process is finalised the company is dissolved. During the process, all control of assets, the conduct of business, and any other financial affairs are transferred to the liquidator.
Essentially, directors have no authority, all bank accounts are frozen, and all employment can be terminated. Business trading can only resume if the liquidator believes that continued trading would be in the best interests of the creditors, and any necessary employment can be rehired by the liquidator. This generally happens when the liquidator believes the business will be sold as a ‘going concern’, or to complete and sell works-in-progress.
Importantly, the liquidator is obliged to wind up the affairs and cease trading as quickly and as cost-effectively as possible.
What is the difference between business liquidation and voluntary administration?
There are large differences between voluntary administration and liquidation. Voluntary administration is often instigated by the company’s directors when they see insolvency looming and hope that by appointing an administrator they may be able to overcome the company’s financial problems and return to normal trading.
Voluntary administration normally leads to the company either being liquidated, returned to the control of the directors, or entered into a Deed of Company Arrangement (DOCA), and this is decided at a creditors’ meeting about a month after the administrator has been appointed.
The DOCA is a formal agreement between the creditors and the company to administer the company in a certain way, and this may include continuing to trade, selling assets, or refinancing debts. The aim is always to create a better return for creditors than what would result from liquidation.
Liquidation is quite the opposite to voluntary administration. Whether called for by creditors, shareholders, or the courts, liquidation means the writing is on the wall and the company will soon cease to exist. All that’s involved in the process is winding up the company’s affairs, selling the assets to pay the creditors in order of priority, and closing the doors forever.
Why should a business go into liquidation?
There are numerous reasons why liquidation is chosen as the method to cease the existence of a company, including:
- The assets of the company will be distributed equally among creditors.
- The cost to the community in having insolvent companies trading is reduced.
- A dormant company can be deregistered.
- Enables a check and balance on directors and shareholders. Liquidation ensures an independent investigation into the affairs of the company and gives creditors the opportunity to receive compensation.
What are the pros and cons of liquidation?
There are both advantages and disadvantages to business liquidation.
Pros of liquidation
- Control – if the liquidation process is voluntary, you’re in control of what happens and are fully prepared for the outcome.
- Relatively low costs – while you’ll need to pay for the cost of arranging a Statement of Affairs and holding a creditors’ meeting, there are few other costs to liquidation as everything else should be paid off from the sale of company assets.
- Outstanding debts can be written off – once the process is complete, you should be free from debt provided the assets sold by the liquidator generate enough money to pay your creditors.
- The stress will be over – all the stress you have suffered as a director of a failing company will be behind you and you can look forward to moving on to a more positive time in your life.
Cons of liquidation
- All assets will be gone – once the assets have been sold they’re gone forever, and the business you dreamed of building will be gone along with them.
- You’ll be put under the microscope – it’s the liquidator’s job to investigate directors, so you’ll be required to provide access to everything, which can feel like an invasion of privacy for some people.
- You’ll be held accountable – make sure you don’t have any skeletons in your financial closet, because if the liquidator finds them, they’ll be reported to the Australian Securities and Investment Commission (ASIC).
- There are real consequences for others – when the business is wound up, your employees will lose their jobs and some creditors may miss out on what they are owed, both of which can make you feel like you’ve failed.
What are the roles involved?
The role of directors during business liquidation
The role of directors during the liquidation process is to cooperate fully with the liquidator. They must meet with the liquidator to help as required, hand over all information about the company including all books and records, advise the liquidator about all company property and its location, and, if requested, attend a creditors’ meeting with the liquidator to provide information to creditors about the company.
Directors must also produce a written report about the company’s business, property, and finances within fourteen days of the appointment of the liquidator (for involuntary liquidation), or within seven days (for voluntary liquidation).
Among other things, the liquidator will be looking closely at the directors to see if there’s been any inappropriate dealings, or if the directors knew the company was in trouble and continued trading whilst insolvent. To date, this has been a big concern for company directors as they can face criminal proceedings for insolvent trading. This has caused many directors to go straight to liquidation to protect themselves from liability, rather than fully exploring all the possible options for the company.
New legislation just passed will hopefully reduce the likelihood of this occurrence, providing a ‘safe harbour’ for directors from charges of trading whilst insolvent as long as they’re taking positive steps to try and prevent the company from entering liquidation. The new legislation will also prevent suppliers and business partners from prematurely sealing the company’s fate by cancelling their contracts with them via the ‘ipso facto’ clause.
The role of the liquidator during business liquidation
Appointing an independent liquidator to undertake the liquidation process ensures adequate protection for creditors, directors and members. The liquidator will:
- Find, protect, and realise the assets of the company.
- Investigate the affairs of the company to discover why it’s insolvent, whether directors have been trading whilst insolvent, whether any inappropriate payments or transactions were made or offences committed by officers or directors, and report back to ASIC.
- Hold creditors meetings.
- If there are assets available after the cost of liquidation is covered, distribute the proceeds to secured creditors, employees, unsecured creditors, and if there is a surplus, then also to shareholders.
Importantly, a liquidator isn’t required to do any work unless there are enough assets to pay their costs, with the exception of lodging documents and reports required under the Corporations Act.
If there isn’t sufficient assets, the creditors can pay the liquidator’s costs and then take action to recover further assets from which they can be compensated. Or, if there are allegations of illegal actions by parties associated with the company, the liquidator can also cover their costs by applying to ASIC for funding to carry out further investigations.
The role of creditors during business liquidation
There are two types of creditors:
- Secured creditors – those who hold a security interest in some or all of the company’s assets, such as a bank or other lender.
- Unsecured creditors – those who are owed money but hold no interest in a company asset. Employees of the company are unsecured creditors who receive priority in the distribution of realised assets – their outstanding entitlements are paid ahead of the claims of other unsecured creditors.
Whether secured or unsecured, the role of creditors is to regain all or as much as possible of what is owed to them by the company, and they participate in the liquidation process in the following ways:
- Receive initial notice of the liquidator’s appointment and their rights as creditors.
- Receive a report from the liquidator after three months advising of the estimated value of company assets and liabilities, the progress of the liquidation, their likelihood of receiving a dividend, and possible recovery actions available to them.
- Arrange or attend creditors’ meetings to discuss progress and, if required, vote on any resolution put to the meetings such as the amount being offered to creditors, approval of the liquidator’s fees, and even removal and replacement of the liquidator.
- Form or sit on a committee of inspection (made up of creditors) to assist and advise the liquidator, monitor their conduct, and approve or deny certain steps in the liquidation process where appropriate.
Note: secured creditors are entitled to vote at creditors’ meetings if they don’t receive all that the company owes them and are also entitled to share in any dividend being paid to unsecured creditors.
Steps involved in business liquidation
Business liquidation follows a series of clearly defined steps, and these are outlined in the Corporations Act. If a company is solvent (able to pay its debts), then it can simply be wound up by a resolution of its shareholders.
Winding up an insolvent company is a more complex procedure that involves the following steps:
- The directors resolve that the company is insolvent and call a meeting of shareholders.
- The shareholders appoint a liquidator, who must be approved by a 75% majority.
- The liquidator notifies known creditors and calls a creditors’ meeting within eighteen days of being appointed, and may also organise possible additional meetings to keep creditors informed of the progress.
- If the liquidation is court-ordered, the liquidator is not required to call a creditors’ meeting and may choose instead to lodge a progress report with ASIC, which must be made available to the creditors free of charge. The report must include the liquidator’s acts and dealings, the conduct of the winding up in the preceding year, a summary of the tasks yet to be completed, and an estimate of when the liquidation will be finalised.
- The liquidator may also ask creditors whether they wish to appoint a committee of inspection. This committee assists the liquidator, approves fees, and in some cases, approves the use of the liquidator’s powers.
When a company goes into liquidation, who gets paid first?
The order, and the likelihood, of interested parties being paid from the realisation of a company’s assets depends on the type of liquidation:
- Voluntary members’ liquidation – when a solvent company resolves to wind up voluntarily, all its debts are normally covered.
- Voluntary creditors’ liquidation – when the company is insolvent and the liquidation is requested by its creditors, priority of debt repayment to creditors depends on whether they are secured or unsecured creditors, with secured creditors having priority over unsecured.
- Court-ordered liquidation – enforced liquidation by the courts follows a strict payment priority, with the liquidator’s costs being covered first, followed by secured creditors, then employees, and finally unsecured creditors.
What are the consequences of going into business liquidation?
Different parties are affected in different ways by liquidation, including:
- The company – during the liquidation process the company can continue to trade with permission under the control of the liquidator, and at the conclusion of the process, the company ceases to exist.
- Secured creditors – those with proprietary claims over the company’s assets have priority over unsecured creditors so they are generally not negatively affected. It’s common for secured creditors to allow the selling of assets, as long as the liquidator recognises their claims.
- Unsecured creditors – generally speaking, unsecured creditors are no longer able to pursue ordinary courses of action to recover debts. A raft of other claims are considered before theirs, including unpaid calls on shares, rights of actions for damages, compensation for insolvent trading, and property previously disposed of by the company.
- Shareholders – they’re are at the bottom of the priority list and only receive a return once the liquidator and all creditors are paid in full.
- The ATO – the liquidation of a company also gives rise to a variety of tax implications. Every liquidation has different consequences depending on the company’s balance sheet at the time of liquidation. Issues encountered will include collection, dividend, franking, and Capital Gains Tax (CGT), all of which will need to be considered during the liquidation process.
Recourse for those who miss out
While liquidators don’t work unless they’re going to be paid, and secured creditors have first claim to company assets, other groups directly affected by liquidation often end up with nothing or must take separate action to try and recoup their losses.
Employees not only lose their jobs as a result of liquidation, but if there’s insufficient assets to be realised, they may also miss out on entitlements. Fortunately, they may be able to recover some of their losses through the Fair Entitlements Guarantee (FEG). This is a scheme which allows employees of liquidated companies to claim up to 13 weeks of unpaid wages, annual leave, long service leave, up to five weeks payment in lieu of notice, and up to four weeks redundancy pay per year of service.
As mentioned before, unsecured creditors are no longer able to pursue ordinary courses of action to recover debts, such as taking legal action. Because they have no interest in any company asset, they’ll only be paid after the secured creditors have been paid, and depending on the company’s assets and liabilities, may only receive a percentage of what they’re owed. Many are simply forced to write the loss off and move on.
Shareholders have even less likelihood of compensation for their losses than unsecured creditors. The liquidator isn’t required to keep shareholders updated on progress and they don’t even have the right to vote on how the process is conducted and resolved as unsecured creditors do. The only real recourse for shareholders after liquidation is to realise their loss as a capital loss, which they can do as long as the liquidator provides them with written evidence of the loss.
Conclusion of the liquidation
There’s no set time limit on liquidation – the process lasts as long as necessary. However, the liquidator is obliged to complete the task as quickly and cost-effectively as possible. The liquidation is finalised when the liquidator releases the company’s available property and the funds are distributed accordingly. A report must also be submitted to ASIC.
In a court-ordered liquidation, the liquidator is not required to hold a final meeting of creditors. Following a decision that the company’s affairs are fully wound up, the liquidator may seek an order for release from the court and request that ASIC deregister the company, or go directly to ASIC to deregister the company.
In a creditors’ voluntary liquidation, a final joint meeting of the creditors and members must be held to provide an account of the overall process. Information regarding how the liquidation was conducted and how the company property has been disposed of must be provided. Following this final meeting, the company is automatically deregistered by ASIC, three months after notice of the meeting is lodged. The company then ceases to exist.
Fallout from liquidation
The first thing to remember as the director of a liquidated company is that you’re not alone. Since the GFC, there have been around 10,000 business insolvencies a year, which is a lot of directors in the same corporate boat.
As a former director of a liquidated company, you may experience some short-term fallout. For instance, obtaining finance may be a little more difficult because your credit file will have been red-flagged as a result of the liquidation. When you’re a director of a liquidated company, this is flagged on the ASIC file and this information then finds its way to the various credit agencies such as Veda or Dun and Bradstreet.
So if you’re applying for finance, you’ll be asked about what happened, and in most cases it won’t be a deal breaker with the financer. Providing your own financial situation is sound, you should still be able to obtain finance, even if you have to pay a little more for it.
Contrary to popular belief, you can also become a director of another company after liquidation. Most directors who liquidate a business don’t do so out of malicious intent and are therefore given the benefit of the doubt that they’ll learn from their mistakes and go on to build a new and successful business.
ASIC has the power to disqualify someone from managing a corporation for up to five years if they have been an officer of two or more liquidated companies in the last seven years. But before they would do so, they would consider whether the companies were related to each other, whether any offences were committed, and whether disqualifying that person from being a director would be in the public interest.
In fact, the only time ASIC will seriously consider banning someone from being a director is if they have had multiple failed companies and have continually committed irresponsible, immoral, or potentially criminal acts.
However, if you do decide to start a new business, one thing to avoid if possible is forming a new company on the ashes of the old. While this is perfectly legal, you may find yourself having to deal with suppliers who were unsecured (and potentially unpaid) creditors during the liquidation of your previous company, in which case your reception is likely to be frosty and your trading rates less than favourable.
Want to find out more?
At Castle Debt Solutions we’re experts at solving debt-related issues for businesses large and small, all the trustee’s Castle work with are registered liquidators and administrators with ASIC and members of the Australian Restructuring Insolvency & Turnaround Association (ARITA).
If you have any questions about liquidation that haven’t been fully answered by this guide, or you’re requiring specialised advice tailored to your business situation, feel free to contact us and we’ll be happy to help. We’ve helped countless Australian businesses through the liquidation process, and we offer a complete in-house service, meaning we can keep your costs to a minimum.