The Basics of Liquidation

Liquidation is a process that marks the end of a business. It’s often a time of significant financial distress for everyone involved.

Whether liquidation is initiated voluntarily or court-ordered, understanding the basics of liquidation is essential for stakeholders, directors and creditors alike. Knowing how the system works greatly improves outcomes and can help you navigate a difficult situation.

This article dives into the fundamental principles of what is liquidation, its key concepts and procedures, and the order in which assets are distributed to creditors in Australia.

What is Liquidation?

Liquidation refers to the legal process by which a company is wound up and its assets are distributed to its creditors. This occurs when a company becomes insolvent, e.g. it is unable to pay its debts as and when they are due. At this point, the company directors or its creditors can decide to cease operations and sell off assets to satisfy the company’s financial obligations.

The primary goals of liquidation are to fairly distribute the company’s assets to its creditors, investigate potential misconduct by offices, and permanently close the business.

Liquidation is a complex legal process, and it is essential to follow the appropriate legal procedures and regulations in Australia. It’s also a very final solution to financial stress. We strongly recommend consulting a professional adviser to find out whether liquidation is right for your business. Alternatives may be available, and a simple conversation can improve the outcome for directors, employees, creditors and shareholders.

Voluntary vs Involuntary Liquidation

In Australia, the directors of companies have a responsibility to act in the business’ best interests. Part of this duty means keeping abreast of the company’s financial position.

If the directors become aware that the company is insolvent, or that it’s likely to become insolvent, there are two options for initiating liquidation:

  1. Voluntary Liquidation: This is initiated by the company’s directors and shareholders when they believe the company is insolvent, or that it’s likely to become insolvent in the future. If this is the case, company directors can meet and resolve to wind up the company, at which point they will appoint a liquidator.
  2. Court-Ordered Liquidation: This type of liquidation is ordered by the court when a company is insolvent. Court-ordered liquidation is usually initiated by a creditor that is owed money. It can also be initiated by the Australian Securities and Investments Commission (ASIC). In court liquidations, the court will deny or grant the liquidation order, and appoint a liquidator to oversee the process.

What Does a Liquidator Do?

A liquidator is a licensed professional that is responsible for overseeing the liquidation process.

Their primary role is to wind up the affairs of the company and ensure that its assets are distributed in an orderly manner. The specific duties of a liquidator can vary depending on the type of liquidation (voluntary or court-ordered).

Some of the main tasks a liquidator performs include:

  • Controlling company assets: The liquidator is responsible for collecting, managing and protecting company assets.
  • Realising company assets: As the liquidator gathers company assets, they can begin the process of selling (realising) these assets. Money from the sale of assets is collected in a trust controlled by the liquidator.
  • Investigating the company’s finances: The liquidator will work with company officers to investigate its financial position. This is done to identify misconduct, fraud or unfair payment preferences. If an investigator finds evidence of illegal activity, the Australian Securities and Investment Commision (ASIC) may press charges.
  • Distributing funds to creditors: Once all assets have been sold, the liquidator will distribute money to the creditors (including employees and shareholders). Money is distributed in the predetermined order outlined below.
  • Managing creditor communication: Insolvent businesses often find themselves dealing with creditors. This can become overwhelming, and it adds a layer of stress and complication to managing a failing business. During the liquidation process, the liquidator is responsible for managing creditors and all communications from creditors. Creditors are unable to directly contact the debtor company during this time.

How Money is Distributed in Liquidation

The distribution of money in a liquidation in Australia follows a specific order as outlined in the Corporations Act 2001. The priority of payments in a liquidation typically occurs in this order:

  1. Secured creditors
  2. The costs and expenses of the liquidator
  3. Employee wages and superannuation
  4. Employee entitlements (such as annual leave)
  5. Employee retrenchment pay
  6. Unsecured creditors
  7. Shareholders

Not all liquidations involve making payments to secured creditors. In many cases, secured creditors have a right to repossess the assets over which they hold a security. Therefore, secured creditors can sell repossessed assets to recover their money without the need for liquidation. Secured creditors may choose to include their assets in the liquidation process, but this is rare.

In all other cases, money is distributed in the order above. Each category must be paid in full before the next category receives a payout. If a category can’t be fully paid, creditors are paid on a pro rata basis, and the following categories receive no payout.

Liquidation generally provides very low returns to creditors. Most creditors receive just a few cents on the dollar for every debt they hold. This means it’s often more cost-effective to allow a debtor to enter into voluntary administration so it can continue trading while making repayments.