Liquidation is a critical event in the life of a company, signalling the end of its operations due to insolvency.
But what exactly happens when a company goes into liquidation? Who is affected, and in what way?
This comprehensive guide delves into the process of liquidation and its impact on various stakeholders, including shareholders, employees, and creditors.
We examine what happens to a company’s debts and assets during liquidation and how liquidation proceeds differ under voluntary and compulsory circumstances.
Lastly, we explore the payment hierarchy in the unfortunate event of company liquidation.
Let’s unravel the intricacies of this complex and transformative process, shedding light on each step and its implications.
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What Happens When a Company Goes into Liquidation?
When a company goes into liquidation, it means it’s unable to meet its financial obligations and has decided to cease operations.
Essentially, the company’s assets are sold off (liquidated) to repay as much of its debt as possible.
It’s a last resort scenario, taken when the company has exhausted all other avenues of debt recovery.
Company liquidation is a legal process overseen by an appointed insolvency practitioner (IP).
The IP ensures that the process is fair and transparent, selling the company’s assets, dealing with creditors, and following the statutory process set out in the Insolvency Act 1986.
Liquidation can either be voluntary (initiated by the company’s directors or shareholders) or compulsory (initiated by the company’s creditors).
The liquidation process involves systematically winding down company operations, selling off assets, paying off creditors, and distributing any leftover funds to shareholders in that order.
The immediate consequence is the cessation of business activities.
The company’s operations come to a halt. It loses control over its assets and typically loses the right to sell or dispose of assets on its own.
The IP takes over all decision-making and operations.
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What Happens to Shareholders When a Company Goes into Liquidation?
Shareholders stand last in line to receive any remaining funds from the liquidation process.
Once a company is in liquidation, any dividends or distributions to shareholders are usually halted.
Shareholders may even lose their entire investment if the company’s debts are more than its assets.
In some cases, shareholders may get a proportion of the proceeds from asset sales once the company’s debts have been paid.
However, this is often a small fraction of their initial investment.
In most instances, shareholders can only hope to regain their investment if the company successfully restructures and resumes operation, which is a rarity in the case of liquidation.
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What Happens to Employees When a Company Goes into Liquidation?
When a company goes into liquidation, employees are often one of the hardest-hit groups.
Initially, they may face job losses as the company ceases operation.
In some cases, employees are kept on temporarily to assist in the winding down of operations.
However, employees are classed as ‘preferential creditors’ under the UK Insolvency Act, meaning they have a right to certain payments before ordinary unsecured creditors.
These include arrears of pay, holiday pay, and certain pension contributions.
They may also be entitled to claim redundancy payments from the National Insurance Fund if the company cannot pay these.
What Happens to Creditors When a Company Goes into Liquidation?
Creditors are those who are owed money by the company.
A strict hierarchy determines how creditors are paid when a company enters liquidation.
‘Secured creditors’ (those who hold security over a company’s assets, like a mortgage) are paid first, followed by ‘preferential creditors’ (including employees), and finally ‘unsecured creditors’ (like suppliers).
The appointed IP will contact all known creditors and distribute a report outlining the company’s assets, liabilities, and prospects of a return.
Creditors also have the right to ask questions and vote on key decisions about the liquidation.
However, it’s often the case that there are not enough funds to repay all creditors in full.
Unsecured creditors may receive only a proportion of what they’re owed or, in some cases, nothing at all.
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What Happens to a Company’s Debt During Liquidation?
During liquidation, the IP handles a company’s debt in an orderly manner.
The aim is to pay off as much of the debt as possible.
The IP achieves this by selling off the company’s assets, including property, equipment, and inventory.
Creditors are then paid in order of priority. First, come the costs of the liquidation and the claims of secured creditors.
Then come preferential creditors, which include employees’ unpaid wages.
Finally, unsecured creditors are paid.
The debt may be written off if there are insufficient assets to repay the debt.
However, it’s important to note that directors can be held personally liable for company debt if they have given personal guarantees or if they’re found guilty of wrongful trading.
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What Happens to a Company’s Assets During Liquidation?
A company’s assets are turned into cash to pay off its debts in a liquidation.
The IP takes control of all assets, which may include tangible assets like property and equipment and intangible assets like intellectual property and customer lists.
The IP will value and sell these assets, typically through an auction or private sale.
The proceeds are used to pay the liquidation costs and repay creditors.
What Happens During a Voluntary Liquidation?
Voluntary liquidation is when the directors of a company decide to wind up the company.
There are two types of voluntary liquidation: members’ voluntary liquidation (MVL) and creditors’ voluntary liquidation (CVL).
In an MVL, the directors declare that the company is solvent and can fully pay its debts within 12 months.
The assets are sold, and after paying off creditors, the remaining funds are distributed among shareholders.
A CVL is used when the company is insolvent.
The process is similar, but the proceeds from selling assets go to creditors, and shareholders are unlikely to receive anything.
In both types of voluntary liquidation, the directors remain in control of the company until the IP is appointed.
They must also cooperate fully with the IP during the liquidation process.
What Happens During a Compulsory Liquidation?
Compulsory liquidation is a more severe form of liquidation initiated by creditors when a company can’t pay its debts.
The process begins when a creditor petitions the court for a winding-up order.
The court will consider the petition, and if it agrees, it will issue a winding-up order.
An IP is appointed as the liquidator, who takes control of the company’s assets and operations.
During compulsory liquidation, the directors immediately lose control of the company and may be investigated for wrongful trading.
It’s a more drastic and damaging form of liquidation, and companies typically seek to avoid it if possible.
Who Gets Paid First During a Company Liquidation?
In a company liquidation, creditors are paid in a specific order. First in line are the costs of the liquidation and the claims of secured creditors.
Banks or other financial institutions have typically lent money against the company’s assets.
Next are preferential creditors, which include employees owed wages and holiday pay.
They are followed by unsecured creditors, which include suppliers and customers who have paid for goods or services not yet received.
Finally, if there is any money left, it’s distributed among shareholders.
However, in many cases, there is little or nothing left by this point.
Final Notes On What Happens When You Liquidate a Company?
Liquidating a company is a serious and complex process with far-reaching implications for all stakeholders.
It should be viewed as a last resort when all other avenues to resolve a company’s financial difficulties have been exhausted.
While liquidation can provide a way to deal with insurmountable debt, the aftermath can be challenging.
Employees may lose their jobs, suppliers may go unpaid, and shareholders may lose their investments.
However, it’s also an opportunity for a fresh start.
Once a company is liquidated, the debt is typically written off, providing an opportunity for the directors to start anew.
The key is to seek advice early and take decisive action to address financial difficulties before they become unmanageable.