Liquidation is the shutdown of a business or business segment. The business sells off assets to pay off creditors and other liabilities. After settling all the claims, the residual funds get distributed among the owners, shareholders, and investors.
Most businesses wind up due to bankruptcy or dissatisfactory business performance. Alternatively, it could be caused by major investors walking out or corporate restructuring. After liquidating, the name of the company is also removed from the register of companies (ROC).
- Liquidation or dissolution is the method of dissolving a firm’s identity by selling its assets to settle liabilities. Shareholders and owners take home what is left of it.
- Dissolution is mainly classified into forced and voluntary. In a forced dissolution, the court orders the shutdown via the sale of the firm’s assets. This is to compensate the creditors. In a voluntary dissolution, the owners submit an application to wind up their business.
- Upon dissolution, the company ceases to exist and is taken from the registrar of companies (ROC). The reasons behind winding up involve bankruptcy, negative cash flow, poor performance, indebtedness, restructuring, and the exit of investors.
Liquidation is also known as dissolution and winding up. Winding up is a strategic decision, and it is mainly taken to step out of a non-performing business or asset. Assets could be land, building, property, machinery, furniture, vehicle, equipment, tool, or inventory. Whenever these assets fail to generate satisfactory returns for meeting business expenses, the business is liquidated. Winding up is done to cut the losses.
A liquidator or an insolvency practitioner is hired to handle the dissolution professionally. The liquidator then sells corporate assets in the open market and generates funds. This directly compensates creditors and lenders. Liquidators also impose their charges for services rendered. The process varies slightly from business to business based on different factors like complexity, firm size, etc.
Although the primary measure is to save the business from insolvency, a resolution plan is chalked down and implemented. But if this step fails, the company has to go for dissolution. In other words, dissolution is brought out by insolvency. A business can file for liquidation owing to bankruptcy under Chapter 7 of the US Bankruptcy Code. If the bankrupt business wishes to continue operations instead of winding up, they have to file a petition as per Chapter 11 of the US Bankruptcy Code.
The standard steps involved in the process of business liquidation are stated below:
- The directors decide to voluntarily liquidate a business due to inadequate cash flow. Dissolution becomes the only option for paying off the creditors. Alternatively, the court can order the compulsory dissolution of a business.
- The company or the court appoints an insolvency professional (IP) as the official liquidator to take charge of the process.
- At this stage, the owners lose their powers and rights, the liquidator takes over.
- The insolvency professional dissolves the assets after assessing.
- Next, the liquidator determines all the payables and debts of the company.
- Finally, the authorized liquidator distributes the funds among claiming parties based on the standard order of priority order.
- The company ceases to exist and is taken off the registrar of companies (ROC).
Priority of Claims
The primary sequence of claim settlement in the liquidation process is as follows:
- Secured: First, the company settles its preferential creditors such as employees and landlord; reimburses all secured creditors like the bank that provided mortgage loan; and pays the insolvency practitioner hired for liquidation.
- Unsecured: Then come the suppliers, HMRC, contractors, debenture holders, credit card companies, and other lenders or creditors not backed by collateral.
- Stakeholders: Finally, the residual funds are distributed among shareholders, investors, and owners.
Types of Liquidation
Dissolution is the end of the road; however, it can be forced or voluntary. The classification is as follows:
#1 – Forced or Compulsory Liquidation
When that is the case, the creditors appeal to the court to dissolve the firm. The creditors no longer believe the firm can pay them back.
#2 – Members Voluntary Liquidation
When a company is solvent and can pay off all its liabilities, dissolutions occur by consent. Sometimes the purpose behind the forming of a company is fulfilled, and the owners want to wind up. Alternatively, business owners could be transferred, or the firm may undergo a restructuring.
#3 – Creditors Voluntary Liquidation
In this case, the company becomes insolvent, and the directors or owners initiate this process to avoid court intervention or compulsory dissolution. In short, the business declares insolvency before the creditors take any legitimate action against it.
Once dissolution is complete, the name of the company is removed from the registrar of companies (ROC). When a firm closes, many employees lose their jobs. However, contractual workers are entitled to compensation brought out by this loss.
Also, as the dissolution process starts, all the rights of the owners cease to exist and are transferred to the insolvency practitioner. Hence, the company cannot dispose of properties or assets the way they like. The insolvency professional presides over all such decisions.
Consider the following examples to better understand liquidation.
#1 – Marka
The popular retail and leisure brand of UAE was declared bankrupt by the Dubai Court. The court ordered liquidation. Along with the parent firm legal notices were sent to the company’s subsidiaries as well. The court-appointed bankruptcy trustee asked the directors to hand over all the documents, assets, and funds.
Also, the court ordered the board of directors to pay 448 million Dirhams to the creditors. The penalty was levied because the directors were responsible for the company’s mismanagement and non-disclosure of accurate financial information.
#2 – Design Studio Group
The Singapore-based global interior design company decided to wind up voluntarily. The DSG Board of Directors filed a winding-up application on October 27, 2021. This action was taken due to the business’s inability to generate sufficient cash flow to pay off corporate debts.
Frequently Asked Questions (FAQs)
A liquidator is authorized by the court, the company, or the insecure creditors to proceed with the liquidation process of the respective firm. Such an individual is responsible for raising money by selling the business assets.
Going into liquidation means that the business entity ceases to exist. As a result, both assets and liabilities are nullified. On one side, assets are disposed of, and on the other hand, liabilities are settled.
A forced dissolution occurs when business owners or directors have no intention of closing the company. Still, due to bankruptcy or any other legal action, the court may order business closure. The assets are then sold off to settle the liabilities. After paying off all the claimants, whatever funds are left over is distributed to the owners, shareholders, and investors.
This has been a guide to Liquidation and its Meaning. Here we discuss its types, process, consequences, and examples. You can learn more about financing from the following articles –