April 17, 2020
Liquidation is the process of winding up a company and finalising its affairs. When a company is facing extreme financial difficulty, it may enter into liquidation to close the business down, sell any assets and pay off as much creditor debt as possible. There are 2 types of liquidation available for an insolvent company: court and creditors voluntary. It does not matter which process is taken, the result is the same.
This type of liquidation can begin in one of two ways as outlined in the ASIC Insolvency Guide For Shareholders:
In a court liquidation, a liquidator is appointed by the court with the purpose of winding up the company. This is usually following an application made by a creditor.
During all liquidations, the liquidator’s primary duty is to the company’s creditors. Any secured creditor is first, followed by unsecured creditors. Shareholders rank behind creditors and there is no guarantee that they will receive any dividend during the liquidation process. The amount a shareholder will receive depends entirely on how much money (if any) is remaining after all creditors have been paid.
In other words: shareholders are at the bottom of the chain.
Being a shareholder of a company carries a high risk as in the event of company liquidation you are last in line to be paid. In most cases, shareholders are unlikely to receive any money in a liquidation unless they also have a claim as a creditor.
Prior to liquidation, the company director has a duty to act in the best interests of the company, its creditors and its shareholders. The moment a liquidator is appointed, the directors duty is solely to its creditors. At this point, the director also forfeits any decision making power to the registered liquidators. While the director is unable to use their powers from this point, they are still required to assist the liquidator as deemed necessary. This is most commonly in the form of providing the company’s books, records and reports about the company’s affairs.
It is the liquidators role to realise, collect and liquify any company assets for the purpose of distributing the sale proceeds to proven creditors. The powers of a liquidator are further explained in Section 477 of the Corporations Act and include;
During a court liquidation, the liquidator is not required to report the process or outcome of the liquidation to the shareholders. Shareholders are still able to inspect the books and records kept by the liquidator upon request.
The process of liquidation is usually complete within 4-6 months. This means that after this short period of time the company will cease trading, all debts will be finalised and the business will be formally closed.
After liquidation, the company director is free of any company debts assuming they did not have any personal guarantees. Any outstanding debts of the company will be written off or dealt with during the liquidation process. Legal action is also halted as soon as the liquidation process commences. Section 471B of the Corporations Act prevents any person from commencing or continuing with legal actions against the company without first seeking a Court order to do so.
In Australia, a company is its own legal entity and is completely separate from its owners. It is for this reason that individuals are rarely held personally liable for the debts of a company. A personal guarantee is a promise by which the guarantor agrees to repay the debt in the event the company is unable to. While it is far more common for directors to agree to a personal guarantee, a shareholder may also provide a personal guarantee. If a shareholder does provide a personal guarantee, they may be personally responsible for paying back any debts of the company if it is liquidated.
As previously mentioned, when a liquidator is appointed they gain control over all business affairs. It is the liquidators role to realise, collect and liquify any company assets to distribute the proceeds to proven creditors.
In certain cases the company may continue to trade whilst in liquidation, however this is at the discretion of the liquidator. While the role of a liquidator is ultimately to bring a business and its affairs to an end or ‘wind up a company’, they do have the power under the Corporations Act to trade a company while in liquidation if it is commercially beneficial and practical to do so. A liquidator may continue to trade a business in order to sell the assets to pay its debts or if it is in the best interest of the creditors to do so. A liquidator may also continue trading a company for a short period of time in order to complete and sell an otherwise profitable business.
As a shareholder of an insolvent company, ASIC says you can realise a capital loss if:
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