Company liquidation is an option of last resort for both solvent and insolvent companies. Liquidation eventually results in a company ceasing operations and entering deregistration.
But what are some of the reasons that companies choose to enter the liquidation process?
In this comprehensive guide to liquidation, we explore what is liquidation, the process involved, the driving factors behind commencing liquidation, and what it means for stakeholders like directors, employees, and creditors as a consequence of this process.
What Is Company Liquidation?
Company liquidation is the formal process for winding up a registered company, ie companies registered with the Australian Securities and Investment Commission (ASIC), and it can only be done through ASIC. The aim of liquidation is to have an independent, qualified external administrator take control of the company, finalise its financial affairs, and sell off its assets. The liquidator – who must be a registered liquidator with ASIC – will dismantle the company’s structure and wind up its affairs for the benefit of creditors. One of the liquidator’s key tasks is to ensure the company ceases trading permanently as cost effectively as possible.
Businesses operating under other types of structures, such as sole traders or partnerships, cannot utilise the liquidation process. It’s a distinctly different process from bankruptcy, which applies to individuals and not companies.
Of note, while liquidation is often associated with insolvency, companies that enter liquidation aren’t always in financial strife or insolvent – it might be that the business owners simply wish to close their business or take advantage of tax free distributions of pre CGT assets by a Liquidator.
Liquidation is usually the final option, or an option of last resort, because it almost always leads to the company’s permanent closure. Unlike other insolvency processes like receivership or voluntary administration, liquidation does not allow for the possibility of a company turnaround.
Why Would A Business Move Into Liquidation?
Liquidation offers a formal, structured process to wind up a company, sell off and dispose of its assets, and eventually deregister the business. A company might move into liquidation by choice, or it could be forced into liquidation and enter the process involuntarily. Generally, voluntary liquidation applies to solvent companies, whilst involuntary liquidation applies to insolvent companies, who might be forced into liquidation by creditors.
Note that insolvency is defined as a company being unable to pay debts as and when they fall due.
Insolvent companies could opt to enter liquidation for the following reasons:
- Because company directors have a duty to prevent insolvent trading.
- The prospect of receiving director penalty notices from the ATO, which imposes personal liability for the company’s tax debts on the directors.
- Liquidation might be the best route if the company is insolvent and has no prospect of returning to viability. For company directors, it could help to end the stress of dealing with most creditor and/or ATO demands, and the possibility of facing action by ASIC for breach of directors’ duties.
- As part of a restructure of the business.
What Are The Different Types Of Liquidation?
Liquidation comes in different forms, and these different types differ by
why or how they’re initiated.
Voluntary liquidations are started based on a resolution by the company directors and then its shareholders. If the company is insolvent, this type of liquidation will be further categorised as a ‘creditors’ voluntary liquidation’. On the other hand, if it’s a solvent company, it also falls under the definition of a ‘members’ voluntary liquidation’.
Members’ Voluntary Liquidation
Members’ voluntary liquidations offer a formal way to wind up a solvent company in a legally compliant and tax-efficient way. This type of liquidation allows directors and shareholders to extract the value of a company that’s no longer required, whether it’s because the company is part of a larger group or the company simply wants to cease operating.
The company needs to be solvent (be able to pay all of its debts) and have up-to-date tax lodgements. In this type of liquidation, the directors need to sign a declaration of solvency that confirms the company will be able to pay all debts in full within 12 months of lodging the declaration. With a members’ voluntary liquidation, the creditors are paid in full and the surplus proceeds of the liquidation go to the shareholders.
Creditors’ Voluntary Liquidation
The most common type of liquidation is a creditors’ voluntary liquidation, which applies to insolvent companies. A creditors’ voluntary liquidation can be initiated by the directors and subsequently shareholders of the company pass the required resolutions. The directors might determine the company is insolvent and/or be subject to recovery action by creditors such as the ATO, and so seek a shareholders’ resolution to enter liquidation.
Alternatively, a company can be placed into creditors voluntary liquidation at the end of a voluntary administration if creditors vote for the company to be liquidated or if a deed of company arrangement (DOCA) has been unsuccessful. Creditors often play a more active role in this type of liquidation as members.
Court Or Official Liquidation
A Court or Official Liquidation usually begins by a party such as a creditor applying to the court for an order of winding up, meaning that a company can be liquidated involuntarily. This typically happens after a creditor has served a statutory demand on the company to pay a debt under section 459E of the Corporations Act, and the company hasn’t paid the debt within the period.
In other cases, directors, shareholders, ASIC, or other interested parties could also apply to the court for a winding-up application to initiate this type of liquidation.
A provisional liquidation can happen in cases where there’s a dispute between a company’s shareholders and/or directors, and the company, its directors, or its creditors apply to the court to have a liquidator appointed to prevent dissipation of the company’s assets. The liquidator then steps in to safeguard assets and assess the company to make a recommendation to the Court. Usually, the applicant will present evidence about the company’s financial status and why the directors need to be removed, such as directors not acting in the best interest of the business.
Provisional liquidations are an emergency measure as they occur in the period between first, an application to wind up a company is filed, and second when the application is heard by the court. As such this type of liquidation is provisional because it could be reversed at the wind-up hearing, or because another (non-provisional) liquidator could be appointed at that hearing. Effectively the provisional liquidator needs to maintain the status quo until the court has a chance to hear the original wind-up application.
The appointment of a provisional liquidator is not common since voluntary administration were created and legislated into the corporations law.
What Is The Liquidation Process?
For voluntary liquidations (creditors’ voluntary liquidation and members’ voluntary liquidation), the company starts with a resolution of the directors, followed by a resolution by the shareholders. Then the company contacts a liquidator, who gives his/her written consent to be appointed. In practice, the nominated Liquidator will generally provide all the documents necessary for the directors and shareholders to appoint a liquidator.
With a creditors’ voluntary liquidation, the directors will resolve that the company is insolvent before calling an extraordinary general meeting – with the liquidator’s help – for the shareholders to pass a special resolution to wind up the company.
The liquidation process can last as long as it needs to last and generally will include the following steps, with strict time frames set out by legislation depending on the type of liquidation.
Liquidator’s appointment – All types of liquidation involve the directors relinquishing control and the liquidator taking over. The appropriate appointment documents will be lodged with ASIC. Additionally, the liquidator will need to advise different government organisations (like the ATO and the state revenue office) of his/her appointment.
Records and books – Early on in the process, the liquidator will ask the directors to complete a questionnaire and provide the company’s records and books to the liquidator. The accountant and any other advisors will generally also be asked for any records they may be in possession of.
Realise the assets – The liquidator will collect the assets and sell them to realise their value.
Creditors’ reports and meetings – The liquidator will, at different stages, prepare reports for the creditors and hold creditors’ meetings to keep creditors informed of the progress, to find out more about their wishes on specific issues, and/or to seek approval of liquidator’s fees.
Report to ASIC – Where there is less than a 50 cent in the dollar return to creditors, or where offences have been identified, the liquidator will review the company’s books and records before reporting his/her findings to ASIC.
Recovery processes – If assets or actions such as voidable preference payment need to be recovered the liquidator could commence recovery processes to recover these assets or transactions for the benefit of creditors.
Pay creditors – If the asset disposal realises sufficient funds, the liquidator pays a dividend to creditors in order of priority.
Finalisation – The final steps of liquidation typically involve the liquidator preparing a final report for the creditors, lodging the relevant documents with ASIC, and making a request to ASIC to deregister the company & destroy the records.
The Liquidator’s Duties
If liquidation commences because the company is insolvent, the liquidator has a legal duty to act in the interest of the company’s creditors while winding-up the company’s affairs and disposing of its assets as quickly and cost-effectively as possible. In this type of liquidation, the liquidator has to collect, protect, and realise the company’s assets. He/she will investigate the company’s affairs and report on this to the creditors. The liquidator will also look into things like factors behind the company’s failure and any offences committed by people involved with the company which are ultimately to report to ASIC.
Distribution And Costs
Once the liquidator has realised the assets, he/she will cover the costs of the liquidation from the proceeds and distribute the rest of the proceeds to priority creditors (including employees) before unsecured creditors. This distribution is, however, subject to the claims of any secured creditors against specific assets.
Where the company has insufficient assets, third parties such as directors could meet the liquidator’s costs and expenses. In cases where the liquidator suspects offences may have been committed by those involved with the company, he/she can apply to ASIC for funding to carry out further investigations.
What Does Liquidation Mean For Creditors?
If you’re a creditor, then the company owes you money – whether it’s because you’ve provided goods and services, made loans to the company, paid for goods and services not delivered, or for some other reason. Employees with outstanding wages and entitlement are also creditors.
The implications of liquidation for creditors can depend on whether a creditor is a secured or unsecured creditor.
- Secured creditors – Secured creditors hold a security interest over the company’s assets as collateral for a loan or outstanding debt due by the company. Examples of security interests include mortgages, equipment and machinery finance, and vehicle loans.
- Employees: Employees are unsecured creditors however are considered as priority creditors when it comes to liquidation. This means their outstanding pay and entitlements are paid before the claims of other unsecured creditors.
- Unsecured creditors – An unsecured creditor is one who doesn’t hold a security interest in the company’s assets.
Once a company enters liquidation, creditors other than secured creditors are prevented from commencing or continuing legal action unless they obtain permission from a court. Moreover, when all the investigations have been completed, assets have been realised and distributions made, the company will be deregistered. At this stage, creditors will no longer have any claims against the company.
Creditor Participation In The Process
In a liquidation, all creditors are concerned with recovering as much of what’s owed to them as possible, and they can participate in a number of ways. At the start – with the liquidator’s appointment – they’ll receive notice of their rights. Three months later, liquidators will send a report to creditors, and this report will detail facts like the company’s assets and liabilities, the progress of the liquidation, and whether the creditors are likely to receive a dividend. The liquidator might also outline possible recovery actions the liquidator could pursue.
Creditors can arrange and attend creditors’ meetings, vote on resolutions at the meetings, and even act to remove and replace the liquidator. They can form and serve on a committee of inspection to assist and monitor the liquidator’s progress, approach specific steps in the liquidation, and give directions to the liquidator. However, the liquidator doesn’t always have to comply with these directions, though he/she must have regard to them.
What Does Liquidation Mean For Employees?
A company entering liquidation usually results in the termination of employees, though the liquidator has discretion to continue trading the company for a short period if he/she believes it’s in the best interests of the creditors. The liquidator can rehire employees or continue their employment.
Employees As A Special Class Of Creditors
For employees with unpaid wages, super, annual leave, and other entitlements and benefits, liquidation means these employees are categorised as priority creditors – preferential creditors – with priority ahead of unsecured creditors.
Note that contractors are not considered employees of a company, but are classified as ordinary unsecured creditors if they have outstanding payments from the business.
The proceeds from the liquidator’s disposal of company assets are used to, first, pay the fees and expenses of the liquidator/liquidation. Next, any remaining funds are used to pay secured creditors. Employees then have the right to be paid from any leftover funds in priority to other unsecured creditors (including the ATO) before shareholders, who are last in line.
Employee entitlements are generally paid in the following order:
- wages and superannuation,
- leave of absence,
- and then retrenchment pay.
Each category of entitlement is paid in full before the next category is paid, and if there are insufficient funds to pay a class in full, the funds are used to make payments on a pro rata basis. Note that if the liquidator decides to continue operations in the interim, employee entitlements are considered a cost of liquidation and will be paid in that priority for their services employed by the Liquidator.
Proof Of Debt
Employees need to complete a proof of debt form for the liquidator. The liquidator might also be able to help employees with information on whether funds will likely be available when assets are sold, and what the company records say about the debt owed to employees.
Liquidators can reject an employee’s claims if records are inadequate or if there’s insufficient information to justify them.
Directors As Employees
Directors and their spouses or relatives are subject to limits when it comes to outstanding pay and entitlements. Wages and super are capped at $2,000 and leave entitlements at $1,500. In addition, directors and their spouses or relatives aren’t entitled to any priority retrenchment pay. are inadequate or if there’s insufficient information to justify them.
Fair Entitlements Guarantee
Most employee claims can be submitted to a government funded program created under the Fair Entitlements Guarantee Legislation administered by the Federal Attorney General’s Department. In most cases, employees make a claim with Fair Entitlements Guarantee (FEG) and it is usually paid, even if the company would have had insufficient funds to pay all the employee entitlements. Once the payment is made under the FEG scheme to the employee the Attorney General’s office then makes a claim in the Liquidation taking the place of the employee. The FEG scheme is a safety net scheme of last resort, and it doesn’t include unpaid superannuation contributions (claims which should go through the ATO). Those claims are still made directory against the company in liquidation.
What Does Liquidation Mean For Directors Of The Company?
When a liquidator is appointed, the directors of the company relinquish their control, their powers cease completely, and the liquidator takes full control over the company. In addition, liquidation has other implications for company directors.
Assisting The Liquidator
Directors need to cooperate fully with liquidators, and this could include helping them with any enquiries as reasonably required and attending creditors’ meetings, to assisting with providing information to creditors. Generally, directors should assist the liquidator by providing information on considerations like the location of company records and property. They should ensure the liquidator has access to the company’s books and records, and provide a written report about the business, property, and financial situation of the company within certain time frames depending on the type of liquidation. A company director must not obstruct the liquidator in fulfilling his/her duties in any way.
Actions Against Directors
If the director has provided personal guarantees for company debt, a creditor with a personal guarantee could continue to enforce the guarantee even though the company has moved into liquidation. In contrast, this would not apply to a company in voluntary administration.
ASIC could ban individuals who have been directors of two or more companies that have entered liquidation in the last seven years from acting as company directors for up to five years. Other actions taken against directors could include insolvent trading actions by creditors and/or ASIC. Creditors or liquidators can pursue directors for recovery of compensation for loss resulting from insolvent trading, and ASIC can initiate proceedings against directors for civil and criminal penalties against insolvent trading.
High-Profile Liquidations Of 2019
Some of the high-profile liquidations of 2019 were in sectors like engineering, mining and
exploration, insurance, and energy.
- Merlin Diamonds – Troubled ASX-listed metals and mining operator Merlin Diamonds was ordered by the court to enter liquidation in September 2019.
- IAB Holdings – A provider of telecommunications products and services to Australian SMEs, IAB Holdings entered liquidation in August 2019.
- Carbon Energy – Specialising in oil and gas exploration and production, Carbon Energy was listed on the ASX before entering liquidation in mid 2019.
- CBL Corporation – The ASX-listed New Zealand specialist insurer was placed into liquidation by court order in 2019, and it owed creditors more than $173 million at one stage.
- RCR Tomlinson – Perth-based ASX-listed engineering firm RCR Tomlinson entered external administration soon after raising $100 million in late 2018. In March 2019 the company was placed into liquidation. Cost blow-outs on several major projects could have been factors in RCR Tomlinson’s failure.
- Snakk Media – Surry-Hills-based (though incorporated in New Zealand), mobile advertising business Snakk Media entered voluntary administration in late 2018 before having liquidators appointed in early 2019. Agencies incorporating mobile marketing into their core marketing capabilities could have led to the mobile-focused company’s demise.
- GO Energy Group – Formerly ASX listed, solar specialist retailer GO Energy Group had executed a deed of company arrangement before progressing to liquidation in early 2019. A combination of rapid growth and high wholesale electricity prices could have contributed to the company’s mounting challenges.
- Central Asia Resources Group – This Perth-headquartered Australian metals and mining company entered liquidation in 2019, having spent the greater part of 2018 in external administration.
Is Liquidation The Right Option For Your Company?
Liquidation offers a systematic, legally compliant way for solvent companies to wind-up and cease operations. For insolvent companies, liquidation could be an involuntary or voluntary pathway to shut down a business that’s no longer viable. The process is prescribed by Australia’s Corporations Act and it can vary depending on the type of liquidation involved. Liquidation has different implications for employees and other creditors as well as company directors, and any of these stakeholders should obtain advice and get informed about their obligations and rights (and duties where applicable) if they’re involved in a company facing liquidation.
TPH Advisory employes two experienced Registered Liquidators. We specialise in offering tailored solutions to companies in strife Australia-wide. We’ll always aim for the best solution and outcome, whether it’s a rescue plan to save your business or a swift liquidation.
Liquidation is not the only option for businesses experiencing financial difficulties – there are a number of routes that a business could take to turn their business around. As experts in business turnaround, voluntary administration and liquidation services, TPH Advisory can assist you with making an informed decision about your best plan of action moving forward.
Find out more about how we can help you with liquidation or other insolvency processes here.