Liquidation in business, finance and economics:
Liquidation in business, finance and economics is the process of bringing a business to an end and distributing its assets to claimants. It is an event that usually occurs when a company is insolvent, meaning it cannot pay its obligations when they are due. As company operations end, the remaining assets are used to pay creditors and shareholders, based on the priority of their claims.
A Liquidation Trustee is appointed and the company is placed under administration.
The purpose of the liquidation of insolvent companies essentially mirror the purpose of bankruptcy.
First, the liquidation process collective procedure that allows for an equitable and fair distribution of the asset of the debtors company amongst its creditors. This means that one creditor cannot be unfairly favoured vis-a-vis the others.
Secondly, liquidation aims to provide for the winding up of a company that is insolvent. In such circumstances it is considered necessary for the good of the community to put an end to the components trading and wind up its affairs in an orderly way.
Thirdly, liquidation is designed to allow for an investigation of the company’s affairs, with particular emphasis on the circumstances that precipitated the winding up. Such an investigation may reveal improper or dishonest conduct by officers of the company or others associated with the company that should be punished by prosecution or civil action. Further,
the investigation may disclose the fact that there were unfair transfers of property, which has reduced the ability of the company to pay its creditors, and which should be recovered.
There is less of a concept of a “fresh start” for an insolvent company as there is in personal insolvency, except by way of the voluntary administration process under Pt 5.3A of the Corporations Act, which may see the company and its business be revived and continue.
A company ceases to exist at the end of the liquidation process. But a director of that company may feel that although their first business venture failed, they are entitled to set up another company with a changed or new enterprise in mind.
As in bankruptcy, there are significant social and economic benefits in the corporate insolvency process. The limited liability company itself has been a major vehicle for economic progress, allowing the management of risk and the collective efforts of individuals to be harnessed to a joint and more significant economic force. Given the risk involved, the failure of companies is inevitable and the need for their orderly disposition is necessary. Given the privilege of limited liability, there needs to be some investigation of their failure in order to determine if their corporate form has been abused, to the disadvantage of creditors. Insolvent trading, the continued incurring of debts to creditors for services supplied or goods delivered given the company has no capacity to pay them, is one such abuse.
An economic purpose of corporate insolvency is to ensure assets of a failing business are cut to better use with the least transaction costs, either by way of restructuring the entity or releasing its assets with the least loss of value and purpose. An insolvency regime supports ending and entrepreneurial business conduct.
Overview of an insolvent liquidation
If a company is insolvent it may be wound up in one of two ways:
either a creditor will force a liquidation of the company through a court order (known as
compulsory liquidation); or
the members of the company will resolve to wind up their company under the scrutiny of
the creditors (known as a creditors’ voluntary winding up) .
If a creditor initiates an application for a compulsory winding up, it usually relies upon the ground that the company is insolvent through its failure to comply with a statutory demand for payment (s 459E), although, as with bankruptcy, the creditor may prove insolvency in a number of other ways. There is no real equivalent to the act of bankruptcy that applies in
personal insolvency under s 40 of the Bankruptcy Act, which is relevant to the date of commencement of the bankruptcy and which predates the date of the actual bankruptcy.
If a creditors’ voluntary winding up is initiated, the court is not involved and it may never be solved in the liquidation at any stage. Even in a court-appointed liquidation, the court may not be further involved after the winding up order is made.
This is comparable to personal bankruptcy. One difference is that the court appoints the official liquidator, under s 472 of the Corporations Act; in contrast, a trustee is appointed by operation of the law when a sequestration order is made by the court: s 156A(3) Bankruptcy Act Whichever procedure is initiated, a liquidator will be appointed to administer the winding up
of the affairs of the company. Unlike a trustee in bankruptcy, there is no vesting of the property in the liquidator; the company continues to own the property 13 and the liquidator becomes the company’s agent.
Apart from such differences, the task of a liquidator is comparable to that of a trustee in bankruptcy. The liquidator possesses wide powers of investigation and inquiry into the dealings of the company, and powers to recover and gather in and secure the company’s property. The liquidator is then required to realise that property and distribute any proceeds
amongst the creditors, according to the provisions of the Corporations Act.
Any proceeds of the company’s realised property are distributed rateably and equally amongst all creditors who succeed in proving that they are owed money by the company in respect of a legally recoverable debt. As in bankruptcy, such debts are known as provable debts. Creditors who have proved their debt are paid dividends from the realised property.