What is liquidation?
Liquidation (or “winding up”) is the process by which a company’s existence is brought to an end.
First, a liquidator is appointed, either by the shareholders or the court. The liquidator represents the interests of all creditors. The liquidator supervises the liquidation, which involves collecting and realizing the company’s assets (turning them into cash), discharging the company’s liabilities, and distributing any funds left over among the shareholders in accordance with the company’s constitution (or the COMPANIES ACT 1993 if there is no constitution). After these steps have been carried out, the company is formally dissolved.
What are the different types of liquidation?
The law classifies liquidations into two types: voluntary (which is by a shareholders’ resolution) or compulsory (by a court order).
Liquidations are also classified according to whether the company is solvent or insolvent.
Solvent and insolvent liquidations
If the company is insolvent, this means it is unable to pay its debts as they fall due. In this situation there is potential conflict between creditors (those to whom money is owed), as there will be insufficient assets for all creditors to be paid in full.
The law attempts to maintain an equality between creditors, so the assets are distributed proportionately according to the size of each creditor’s claim. However, the law gives priority to secured creditors (those with a charge over some of the company’s property as security for the debt). In addition, a number of rules exist to prevent one or more creditors from gaining an unfair advantage.
Voluntary liquidation (by shareholders’ resolution)
Voluntary liquidation refers to the process whereby the shareholders appoint a liquidator, who is then answerable to the creditors or shareholders. It is not necessary to make any application to the court for this; however, the liquidator may apply to the court for directions and the court has power to remove a liquidator.
A voluntary liquidation may also by commenced by the board of directors if an event specified in the company’s constitution has occurred.
Voluntary liquidation may be in one of two forms, depending on whether or not the company is solvent. If the company is solvent the shareholders can supervise the liquidation. However, if the company is insolvent, the creditors may take control of the liquidation process by applying to the court. The court will require proof of solvency or insolvency to determine this matter.
Compulsory liquidation (by court order)
Compulsory liquidation of a company requires obtaining a court order. This process starts with an application to the court alleging that one or more of the required grounds exist. The application may be brought by the company or a majority of its directors, or by the Registrar of Companies, or by a creditor. Applications by creditors are by far the most important and common.
Applications may be brought on a number of grounds, the most important being that the company is unable to pay its debts. There are a number of factors that the court will take into account when deciding whether or not to make a compulsory liquidation order. The court has a discretion as to whether or not to make the order.
How to liquidate a company
Broadly speaking, the procedure for liquidation is as follows:
- A liquidator is appointed, either by the company shareholders passing a resolution (voluntary liquidation) or by the Court making an order (compulsory liquidation).
- The liquidator collects the assets of the company (including uncalled capital; that is, amounts unpaid on shares) and pays the creditors in order of priority.
- The liquidator distributes any surplus funds to the shareholders.
- The company is then formally dissolved.
What are the consequences of liquidating a company?
The main consequences of the company being liquidated are as follows:
- The company no longer has the power to dispose of its property.
- The company may carry on business only for the limited purpose of completing the liquidation process.
- The powers of the company directors come to an end when a liquidator is appointed.
- A liquidation order operates as a notice of dismissal to all of the company’s employees. Note, however, that if an employee is on a fixed-term contract and is required under this contract to be given a period of notice, then a liquidation order will breach this and the employee will be entitled to damages.
- When an application is made for a court-ordered liquidation, the court may stay or restrain any proceedings against the company as the court sees fit. When a liquidator is appointed, no person can begin or continue legal proceedings against the company or in relation to its property, unless the liquidator agrees or the court permits it.
Order of distributing the company’s assets
There is a hierarchy that determines the order in which a company’s assets must be distributed in a liquidation. This is strictly enforced by the Courts. Any secured creditors have the first right to the assets and are usually paid out before there is a distribution. After this is paid out, any remaining debts are paid in the following order of priority:
- the costs, charges and expenses involved in the liquidation
- all wages and salaries payable to employees, including holiday pay
- unsecured creditors
- any interest that is attached to any debt (but only if the debt became due before the liquidation process began)
- any debt owed to shareholders of the company, such as dividends or profits
- The compulsory liquidation process cannot be used if there is a genuine dispute about the amount of debt owed by the company, because in this type of situation the company cannot be said to have “neglected” to pay.