Considering the current state of the worldwide economy following the effects of the pandemic, it’s no surprise the business owners are rethinking their exit strategies.
Some business owners have seriously weighed up the option of closing their company doors to avoid possible negative consequences down the road. But for other business owners, the negative impact of a struggling economy has been unavoidable.
If your company is drowning in debt, insolvency is likely looming, and liquidation is the only way out.
But what happens when a company goes into liquidation? What happens to the company’s debts and assets when it goes under? What does this process entail?
This blog post will answer all these questions, so you have a better understanding of what it means for a company to go into liquidation.
- 1 What Is Liquidation of an Insolvent Company?
- 2 The Liquidation Process
- 3 What Are The Consequences of Going into Liquidation for the Company?
- 4 What Does Liquidation Mean for Unsecured Creditors and Shareholders?
- 5 What Does Liquidation Mean for Company Directors?
- 6 What are the Pros and Cons of Liquidation?
- 7 Key Takeaways
What Is Liquidation of an Insolvent Company?
When a company’s liabilities exceed its assets, and they have debts they can’t afford but that are due and payable, they are essentially declared insolvent. In other words, the company owes money to creditors that they can’t afford to pay. And unfortunately, according to Australia’s insolvency laws, insolvent companies are not allowed to trade.
In fact, a director has a positive duty to ensure that the company doesn’t continue trading and incurring debts while insolvent.
You can’t continue trading, and you can’t apply with the Australian Securities and Investments Commission (ASIC) for voluntary deregistration, so the only way to pay off your creditors and close your company is through insolvent liquidation.
The Liquidation Process
The insolvent liquidation process involves appointing an independent, external administrator or liquidator to wind up the company’s affairs and ensure that the creditors are fairly compensated. The process involves:
- assessing the company’s financial affairs,
- assessing claims against the company directors,
- establish claims against a debtor company (i.e. gather all funds from companies who owe the insolvent company money),
- reporting to creditors,
- realising the company assets to pay outstanding debt, and
- paying the creditors in order of priority.
- and apply for deregistration of the company on completion of the liquidation.
Liquidation can occur after voluntary administration or by court order.
When a company’s directors have reason to believe that insolvency is imminent or where the company is already insolvent, they can voluntarily appoint an independent administrator to investigate the company affairs, find solutions to its financial problems and make recommendations to the creditors.
This process is known as voluntary administration and occurs before liquidation.
The creditors of insolvent companies can decide to enter into a deed of arrangement with the company, which essentially involves restructuring the company to see if it can continue trading and create a better return for the creditors.
Alternatively, the creditors can vote for liquidation (creditors voluntary liquidation). If the majority of the creditors agree to proceed with the liquidation, the same liquidation process follows.
Where an insolvent company doesn’t take action to resolve the financial issues, a creditor or shareholder can institute legal proceedings to liquidate the company. If the court is satisfied that there are enough grounds to liquidate the company, they will issue a court order and appoint a liquidator to begin the liquidation process.
What Are The Consequences of Going into Liquidation for the Company?
Once the liquidation process is complete, the company will no longer exist as a trading entity. However, while the liquidation process is underway, the company can continue trading providing that they have permission from the liquidator to do so.
Among the employees, creditors and shareholders (see discussion below), the liquidator also has to meet certain tax obligations. Each company’s obligations with the Australian Tax Office (ATO).
Regardless of whether a company enters liquidation voluntarily or involuntarily, the unsecured creditors can’t institute legal proceedings to recover their debt once the process has begun.
The purpose of liquidation is to realise what’s left of the company assets to settle their outstanding debt as fairly as possible. In an ideal situation, the unsecured creditors will have all their debts paid out, but that is not always the case.
While the liquidator has to maximise the company assets to distribute amongst the company’s creditors, it’s not always possible to satisfy all the debts. This is because the liquidator must make payments according to the following priority list:
- Liquidation costs
- Unpaid wages and superannuation
- Outstanding employee entitlements such as retrenchment payments
- Unsecured creditors
If, after the liquidation costs are settled, and the company employees are fairly compensated, there is insufficient funds to fully settle the debt, creditors will receive payment according to the proportion of their debt.
As shareholders are last on the priority list, it is unlikely that they will receive the full dividend payout during liquidation.
What About Secured Creditors?
Secured creditors hold a vested interest over some of the company’s assets. For example, they might hold a security interest in the company’s assets as a result of a mortgage loan. If their security interest has been properly registered according to the Personal Property Securities Act, secured creditors essentially fall outside of the liquidation process because they have a legal guarantee to get their money back from the liquidated companies.
What About Those Who Miss Out On Their Claim?
While the liquidator will do their best to ensure that all parties are fairly compensated, there isn’t always sufficient funds to meet all the claims.
In the event that employees don’t receive a settlement of their entitlements, they can seek assistance from the Fair Entitlements Guarantee – which is a scheme that allows employees who have been retrenched due to liquidation to claim up to 13 weeks of their various entitlements, including unpaid wages.
Unfortunately, as mentioned previously, a consequence of liquidation for unsecured creditors is that they aren’t allowed to pursue legal recourse to recover their debts because they no longer have an interest in company assets. So, there is no recourse for creditors who miss out – it’s simply part of the risk of lending.
Shareholders also don’t have much recourse if they miss out on a claim because they are last on the list to be paid. So, their only recourse is to realise their loss as a capital loss.
What Does Liquidation Mean for Company Directors?
Once a liquidator has been appointed, either voluntarily or involuntarily, company directors will no longer have any decision-making authority. The liquidator now manages all the company’s affairs.
And while the director(s) are generally protected during the liquidation process, there are some instances where they may be held personally liable, including:
- where they were in breach of their director duties,
- where operated unlawfully by trading insolvent or by breaching the requirements of the Corporations Act, and
- where they made a personal guarantee to creditors (in other words, they agreed to be personally liable for creditor debts if the company was unable to pay them).
Liquidators are permitted to institute proceedings against the directors in the first two instances (breach of duties and insolvent trading), and creditors can institute proceedings against the debtor in their personal capacity (i.e. not against the company) to claim their outstanding debt.
While there is some risk being banned as a director, it’s not a likely or automatic process. In fact, directors generally won’t get disqualified unless ASIC believes it’s in the public’s interest to impose a ban.
Generally, ASIC may disqualify a person from managing a corporation for up to five years if they have been an officer of two or more companies that have entered liquidation within the previous seven years, although this also depends on the circumstances and relationship between the companies. It may also depend on whether they committed one of the offences listed above.
It’s worth noting that credit reporting agencies keep track of companies that enter liquidation and the names of the directors of those companies. But, it’ll only impact you in circumstances where the information is relevant. For example, if you are applying for a personal loan then it’s unlikely to be noticed. But, if you’re applying for a business loan, it’s likely to be a point of interest for the potential lender.
What are the Pros and Cons of Liquidation?
As with any strategy, it’s important to weigh up the pros and cons of voluntarily entering into liquidation.
Some advantages include:
- Outstanding debts are written off
- Creditors can’t pursue legal action
- Relatively inexpensive
- Lease terms are automatically cancelled
Some disadvantages include:
- All business assets will be sold
- Staff will become redundant
- Directors may face personal liability for debts (personal guarantees)
No business owner opens a company with an exit strategy that involves liquidation. It’s not an ideal situation to be in, but given how tough the last two years have been, it may end up being an inevitable situation for a lot of companies.
However, if you haven’t quite reached the stage where it’s necessary to appoint a liquidator, you’ll definitely want to consider engaging the services of expert chartered accountants and business advisors who can help you navigate through your problems and possibly avoid the liquidation process.
At Box Advisory Services, our team of qualified accountants and business advisors will work closely with you to provide the insight and guidance needed to ensure that all aspects of your business are running smoothly and efficiently. Whether this means helping you with tax planning advice throughout the year or ensuring that everything from payroll taxes to sales tax compliance is handled properly—we have got you covered!
Our mission is to help guide our contractors and small business owners in making better decisions that will build strong business foundations.
If you need some guidance on managing your company’s financial health so that it continues to succeed for years to come, get in touch with us today.
Please note that every effort has been made to ensure that the information provided in this guide is accurate. You should note, however, that the information is intended as a guide only, providing an overview of general information available to property buyers and investors. This guide is not intended to be an exhaustive source of information and should not be seen to constitute legal, tax or investment advice. You should, where necessary, seek your own advice for any legal, tax or investment issues raised in your affairs.