What is the Impact of Liquidation on a Company?

In Short

• Liquidation results in the winding up of a company, with a liquidator overseeing the process.
• Directors lose decision-making control and must cooperate with the liquidator.
• Creditors are paid in order of priority, with secured creditors and employees usually first in line.

Tips for Businesses
If your business is facing liquidation, ensure you fully understand your obligations as a director. Cooperate with the liquidator, maintain accurate records, and be prepared for creditor claims. Seeking professional advice early can help minimise risks and personal liability during the liquidation process.

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Table of Contents

• Impact on the Company
• Impact on Directors 
• Impact on Creditors 
• Distribution of Funds
• Conclusion of Liquidation 
• Key Takeaways 
• Frequently Asked Questions 

Liquidation can occur when a company is insolvent, deemed insolvent or is unable to meet its financial obligations. Liquidation is a form of external administration involving an independent third party, the liquidator, taking control of the company to facilitate the winding up of its affairs and the realisation of its assets. As liquidation mostly correlates to the closure of a company and a cessation of business activities, it has a severe impact and, as a director, you may lose your decision-making capabilities. This article explains the impact of liquidation on your company, as well as on creditors and shareholders. 

Impact on the Company

Liquidation is one of the most serious issues a company will face and, as such, has a severe impact on the business. Firstly, it dictates the end of the company’s operations and, in many cases, leads to the:

• sale of assets;
• closure of business activities; and 
• termination of employment contracts. 

If your business is facing liquidation, a liquidator will be appointed to oversee the realisation process, involving the conversion of your assets into cash. When a liquidator is appointed, the company’s directors lose their decision-making authority. The liquidator will, therefore, act as an agent of your business. 

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Impact on Directors 

Once a company enters liquidation, the directors are bound by specific obligations under the Corporations Act 2001 (Cth) (the Act) to assist the liquidator in carrying out their duties effectively. These obligations include:

• Reporting on Company Activities and Property: The directors must submit a Report on Company Activities and Property (commonly referred to as a ROCAP) to the liquidator within 10 business days of the court making the winding-up order. This report is a detailed statement of the company’s assets and liabilities. 
• Cooperation: Directors must cooperate with the liquidator’s requests and attend meetings if required. Legally, they must provide insights into the company’s operations, financial history, and any potential causes of insolvency. 
• Duty of Care: Directors are expected to exercise their duty of care to act in the best interests of the company’s creditors during the liquidation process. 

Additionally, the Act imposes a requirement for directors to provide the liquidator with all relevant information about the company’s affairs, including financial records, contracts, and assets. Specifically, the Act outlines: 

• Section 530A: Directors must deliver to the liquidator all company books in their possession. 
• Section 483: Directors must disclose the whereabouts of all of the company property and records not in their possession, and provide the liquidator with access to them.  
• Section 530A(2): If the liquidator organises a meeting, the directors must attend where reasonable. 
• Section 530A(5): If the address or contact details of any of the directors changes, they must notify the liquidator. 

As a company director, if you fail to comply with these obligations, you may face legal consequences including personal liability for the company’s debts. 

Impact on Creditors 

Creditors are significantly affected by the liquidation process and are often the party who commenced the winding-up proceedings against the company. However, contracts between a creditor and the company are not automatically terminated once a liquidator is appointed. This means that you can expect a creditor to continue with the contract despite the company being in liquidation. 

However, it is common practice for contracts to include a default clause that states the contract is no longer on foot if an insolvency event occurs. This means that once your business becomes insolvent, you have effectively breached the contract. Therefore, the creditor is free to terminate the contract. 

Creditors’ Rights 

Creditors have rights that are defined under the Insolvency Practice Schedule (Corporations) (IPS). Specifically, creditors have rights to:

• request information, reports and documents from the liquidator, where reasonable;
• direct that a meeting of creditors be held; 
• give directions to the liquidator, although they do not have to comply; 
• appoint a reviewing liquidator to review either remuneration or the incurred by the external administrator; and 
• remove and replace the external administrator. 

Creditor’s Obligations 

Creditors have the primary obligation of providing proof of debt in order to receive payment from the liquidator. The liquidator will initially call for formal proofs of debt to be submitted and will then assess each proof for validity. If a proof of debt is rejected, the liquidator is required to notify the relevant creditor and provide their reasons. Creditors then have the option of appealing to the court against the liquidator’s decision. 

Debt Recovery Prospects

Creditors assess their chances of recovering their debts based on: 

• your business’ asset realisation; 
• your business’ total liabilities; and 
• the priority of their claims. 

The ranking of creditors is important as it is very unlikely that the total funds realised from the liquidation will be enough to repay all the creditors. However, secured creditors, or those who hold a charge over specific assets, have a higher chance of recovery compared to unsecured creditors. This is because they can repossess their assets.

Distribution of Funds

The distribution of funds in a liquidation follows a specific hierarchy of payment priorities,  determined by relevant insolvency laws. 

The payment priorities dictate that creditors are to be paid in the following order:

1. Secured Creditors: Secured creditors, holding valid security interests, such as a mortgage over specific assets, are given first priority in the distribution. This is because they have a legal claim to the secured assets or proceeds from their sale. 
2. Costs and Expenses of Liquidation: The costs incurred in conducting the liquidation, including the liquidator’s fees, legal expenses and administrative costs, are paid next from the available funds. 
3. Preferential Creditors: Certain creditors, such as employees and government agencies,, are entitled to be paid before unsecured creditors. Examples include employee entitlements such as unpaid wages and superannuation contributions.
4. Unsecured Creditors: Unsecured creditors who do not have a security interest, including trade creditors and suppliers, are next in line for payment. However, their recovery rate may be significantly lower than secured and preferential creditors.
5. Shareholders: Shareholders typically receive payments only after all creditors’ claims have been satisfied. In many cases, shareholders may not receive any payment due to insufficient funds. 

Preference Payments 

Preferential payments are payments or asset transfers to creditors that give them an advantage over other creditors. The liquidator will examine pre-liquidation company transactions to identify any potentially unlawful preferential payments or transactions. If they find that your business has engaged in this form of conduct, the creditors you paid may be required to return the funds for equitable distribution. This is because the payments will be considered voidable transactions. 

Conclusion of Liquidation 

The conclusion of the liquidation is the final stage of the winding-up process. This occurs after your company’s assets have been realised and funds have been distributed. At this point, the liquidator can apply to: 

• the court for an order for the company’s dissolution; or 
• ASIC for the company to be struck off the register. 

Finally, the liquidator must lodge their End of Administration Return within one month of finalisation. Once all these steps are taken, the company ceases to exist.  

Key Takeaways 

In conclusion, liquidation marks the end of a company’s existence, as its assets are realised and affairs are wound up. As a director, you may lose control of decision-making, and the liquidator will distribute the company’s funds to creditors and shareholders. Secured creditors and employees often receive priority in the distribution of funds, but unsecured creditors and shareholders may face limited recovery. Directors must comply with strict legal obligations throughout liquidation, and failure to do so can result in personal liability. The company is formally dissolved once the liquidator completes their duties and lodges the necessary returns.

If your company is facing liquidation, our experienced disputes lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 1300 544 755 or visit our membership page.

Frequently Asked Questions