Incompetence. Mismanagement. Bad luck. Some combination thereof. There are lots of reasons businesses experience catastrophic financial difficulties. There are also lots of consequences, including liquidation. Here’s what all business owners should know about liquidation, and how it differs from the other repercussions of crushing debt.
What is liquidation?
To understand liquidation, one most first understand the concept of insolvency. A business (usually a company) goes into insolvency or becomes insolvent when its debt is such that the company is incapable of meeting past, current or future financial obligations.
Depending on the circumstances, insolvency can lead to receivership, administration, bankruptcy (generally applicable to individuals/sole proprietors) and liquidation. Each of these includes different protocols and mechanisms for the resolution of debt, which we will discuss briefly here.
This happens when a secured creditor or creditors enlist the help of someone called a “receiver” to recover money owed.
The receiver’s job is to oversee the sale of any business assets and/or the business and the distribution of the proceeds to the secured creditors, followed by any unsecured creditors and other relevant parties in accordance with applicable rules. The receiver is also responsible for notifying the Australian Securities & Investment Commission (ASIC) about any related offences.
There are two things to keep in mind here. The first is that receivership can be implemented without a court order. The second is that receivership does not change the legal status of the company; your directors can carry on, but the scope of their power will be restricted.
Administration is similar to receivership, in that someone is recruited to put things right. This person is called an administrator, and he/she has two responsibilities. The first is to ensure that outstanding debts are paid and the second is to see that the sale of the business/business assets goes smoothly.
Depending on the situation, administration may result in liquidation or restoration of control to the company’s directors.
As we have noted, bankruptcy does not apply to companies. Instead, it applies only to individuals/sole proprietorships. Accordingly, it is carried out on a much smaller scale.
Instead of an administrator or receiver, a trustee is chosen to oversee the process. In this role, he or she may coordinate the sale of assets, secure your income for a given period for the repayment of debts, or secure property wrongfully given or ‘sold’ to someone else in an effort to prevent its sale for repayment of debts.
Another consequence of bankruptcy is placement of your name, along with a mark, on the National Personal Insolvency Index (NPII) for up to five years. The NPII is a widely accessible database that includes the individual/business names and addresses of anyone who has declared bankruptcy.
What happens when a business is ‘liquidated’?
Liquidation – the process whereby which the business is done away with and all of its assets are sold – usually applies only in the most dire situations. It includes the following steps:
- The conversion of the company’s assets to cash (through sales).
- Distribution of the proceeds to creditors.
- Distribution of any remaining funds to shareholders.
- Formal request to ASIC to remove the company from the register, thereby ending its legal existence.
You should also be aware that this process is carried out by someone called a liquidator and that it can happen after the business has gone through receivership and/or administration.
How to tell when liquidation is forthcoming
Insolvency – particularly liquidation – may be warranted when a business:
- Cannot meet its monthly expenses;
- cannot sustain fair market salaries for its employees;
- can no longer afford to pay its taxes or make required contributions to employee superannuation;
- cannot recoup sufficient funds from its debtors or ongoing work to meet the cash flow demands.
There are other warning signs that should also be taken into consideration. For example, liquidation may be imminent if your business is hemorrhaging so much money that the bank secures a mortgage on your home to ensure it can recover the amount owed. It may also be forthcoming if growing business debt prompts a creditor or creditors to obtain personal guarantees. Liquidation may be on the cards if your business continues to incur debt after it is declared insolvent and goes through receivership or administration. Finally, liquidation is likely inevitable if you (or any other director) receives a Director Penalty Notice from the Australian Tax Office that the company is incapable of paying.
Ignorance is not bliss
One of the more unfortunate aspects of human nature is our tendency to ignore unpleasant situations. But as we all know, wishing something away doesn’t work. If your business is facing financial difficulties, the best thing to do is seek advice from qualified legal and financial professionals as soon as possible. Our legal team is here to help so contact us by phone on (02) 4365 4249 or through our website, today.