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While both bankruptcy and liquidation could involve insolvency, these terms are not interchangeable and therefore, it’s important for business owners to understand difference.
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Why business owners must understand the liquidation process
15 March 2019
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Liquidation involves finalising the financial affairs of an organisation, selling off the business’s assets to repay any debts, and dismantling the company’s structure. Often confused with bankruptcy, liquidation is the only way to wind down operations and shut down an organisation in an orderly way.
Liquidation commonly occurs if a company can’t meet debt obligations or if the members wish to cease operating. It applies to companies and the businesses operating under a company structure.
Bankruptcy, on the other hand, applies to individuals, including sole traders and partners in partnerships, who are declared insolvent. Bankruptcy is also an interim legal state, lasting three years, whereas liquidation leads to a permanent winding down of a company.
When a company goes into liquidation, a liquidator is appointed to oversee the process. The liquidator’s role includes taking over from the company directors and investing the company’s affairs to work out what went wrong.
During this process, liquidators have full control over the organisation’s operations, financial affairs, and assets, and their task is to cease trading as cost-effectively as possible. Once an organisation has been liquidated, it is completely dissolved and permanently ceases operations.
Liquidation can be voluntary or involuntary. Voluntary liquidation usually occurs after a resolution by members or creditors, who can vote for the company to liquidate after it has gone into voluntary administration or when a Deed of Company Arrangement is terminated. This can also be initiated when the company’s shareholders decide to liquidate the company as it is no longer viable.
Involuntary liquidation takes place when a business can’t pay its debts. It usually involves a court order made after an application by a creditor, director, or a majority of shareholders.
Profitable businesses may also voluntarily choose to enter liquidation if the owner cannot sell the business or if the company has been built based on the services of a single person who is stepping down. This may also occur if there has been a hostile takeover attempt on a successful business. To prevent the business from being taken away, the owners may choose to liquidate.
Once the company has entered liquidation, unsecured creditors (those without a claim to the company’s assets) cannot instigate or continue legal action unless they have permission from the court. Directors no longer have authority, employees can be terminated, and the company’s bank accounts are frozen.
Any trading that continues is at the discretion of the liquidator and can only resume if the liquidator believes that continued trading would be in the best interests of the creditors. Any necessary employment can be rehired by the liquidator.
The liquidation process can last as long as necessary; however, it has to conform to strict rules and procedures depending on the type of liquidation.
Liquidation ensures assets are distributed among creditors in an orderly way and helps minimise the risk of insolvent trading. It also gives shareholders, creditors, and directors the opportunity to have an independent expert investigate and manage the liquidation. It is the only way to completely wind up a company and shut it down.
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For many business owners, liquidation is not an imminent or inviting prospect. However, it’s essential to understand the liquidation process so that owners know what to do when it’s time to cease trading.
Domenic Calabretta, managing director, Mackay Goodwin
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