Liquidation Meaning Process Types Examples Consequences

Liquidation Meaning

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).

Key Takeaways

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 Explained

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 expensesBusiness ExpensesBusiness expenses are those incurred in order to successfully run, operate, and maintain a business. Travel & conveyance, salaries, rent, entertainment, telephone and internet expenses are all examples of business expenses.read more, the business is liquidated. Winding up is done to cut the losses.

A liquidator or an insolvencyInsolvencyInsolvency is when the company fails to fulfill its financial obligations like debt repayment or inability to pay off the current liabilities. Such financial distress usually occurs when the entity runs into a loss or cannot generate sufficient cash flow.read more 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.

Liquidation Process

The standard steps involved in the process of business liquidation are stated below:

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The directors decide to voluntarily liquidate a business due to inadequate cash flowCash FlowCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more. 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 shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company’s total shares.read more, 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 creditorsCreditorsA creditor refers to a party involving an individual, institution, or the government that extends credit or lends goods, property, services, or money to another party known as a debtor. The credit made through a legal contract guarantees repayment within a specified period as mutually agreed upon by both parties. read more 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 restructuringRestructuringRestructuring is defined as actions an organization takes when facing difficulties due to wrong management decisions or changes in demographic conditions. Therefore, tries to align its business with the current profitable trend by a) restructuring its finances by debt issuance/closures, issuance of new equities, selling assets, or b) organizational restructuring, which includes shifting locations, layoffs, etc.read more.

#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.

Consequences

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.

Liquidation Examples

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 subsidiariesCompany’s SubsidiariesA subsidiary company is controlled by another company, better known as a parent or holding company. The control is exerted through ownership of more than 50% of the voting stock of the subsidiary. Subsidiaries are either set up or acquired by the controlling company.read more as well. The court-appointed bankruptcy trusteeTrusteeA trustee is an individual or institution with legal authority to manage the trust property and assets on behalf of the settlor to benefit the beneficiary. They have complete control over the trust assets until they get transferred to the beneficiary. The administration of assets goes as per the directions of the trust. read more asked the directors to hand over all the documents, assets, and funds.

Also, the court ordered the board of directorsBoard Of DirectorsBoard of Directors (BOD) refers to a corporate body comprising a group of elected people who represent the interest of a company’s stockholders. The board forms the top layer of the hierarchy and focuses on ensuring that the company efficiently achieves its goals. read more 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 informationFinancial InformationFinancial Information refers to the summarized data of monetary transactions that is helpful to investors in understanding company’s profitability, their assets, and growth prospects. Financial Data about individuals like past Months Bank Statement, Tax return receipts helps banks to understand customer’s credit quality, repayment capacity etc.read more.

#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.