Liquidation of a Company: Detailed Guide

The liquidation process of a company is a complex and often emotional event that occurs when a company can no longer pay its debts or decides to close its business.

The process involves appointing a liquidator, who takes control of the company’s assets, identifies and values the assets, sells the assets to pay off creditors, distributes the proceeds to creditors (with secured creditors having priority), distributes remaining funds to shareholders, and prepares a final report detailing the liquidation process.

The largest bankruptcy reported to date was Lehman Brothers, a U.S.-based company. Their declaration of the company becoming insolvent triggered a domino effect on the international banking sector resulting in the Great Recession.

In this blog, we will explore the meaning, types, and process of liquidation and the steps a company should take before entering the liquidation process. We will also discuss the appointment and role of liquidators in the liquidation process.

Understanding the Liquidation Process

The reason for the liquidation of a company can vary from company to company. A company enters liquidation when it can’t pay its debts. Or if the shareholders or directors decide to close the business. There can also be circumstances when the Court orders liquidation.

Regardless of the reason, the purpose of liquidation of a company is only one. The liquidation process helps the shareholders in paying back their debtors and creditors.

Types of Liquidation

The types of liquidation can be differentiated based on the following grounds:

Voluntary Liquidation

This type of liquidation is initiated by the shareholders or directors of the company. It occurs when they decide that the company should be wound up and its affairs settled.

Involuntary Liquidation

In this type of liquidation, the process is initiated by the creditors or regulatory bodies of the company. This occurs when the company fails to pay its debts or comply with regulations.

Members’ Voluntary Liquidation

This type of liquidation takes place when the company is solvent and the shareholders decide to wind up the company. It is also known as a solvent liquidation.

Creditors’ Voluntary Liquidation

This type of liquidation occurs when the company is insolvent, and the creditors agree to wind up the company. It is also known as an insolvent liquidation.

Compulsory Liquidation

In this type of liquidation, the court orders the liquidation of the company due to legal violations or insolvency.

Understanding these types of liquidation is essential for companies and stakeholders to make informed decisions regarding their financial affairs.

Preparing for Liquidation

Doing preparations for the liquidation of company is an important step. A well-planned process ensures that the process is carried out smoothly and efficiently. Hence, in the event of liquidation of a company, adequate preparation can-

• Minimise financial losses
• Prevent legal issues
• Meet all obligations
• Protect the company’s reputation and prevent damage to its brand image

Steps to Take Before Liquidation

Thus, a company should take steps before entering the liquidation process. These steps include the following –

• Assessing the company’s financial situation,
• Developing a liquidation plan,
• Notifying stakeholders,
• Appointing a liquidator,
• Protecting assets from any damage, and
• Ensuring that all legal requirements are met

Process of Liquidation

Further, here is a step-by-step process that a company must follow to liquidate itself-

Pass a Board Resolution

The first step is for the board of directors to pass a resolution for the liquidation of a company. The board must meet and pass a resolution to authorise the liquidation process.

Appoint a Liquidator

Once the resolution is passed by the board, the next step is to appoint a liquidator. A court-appointed liquidator or insolvency practitioner generally oversees the liquidation process. Even the board of directors appoints a licensed insolvency practitioner as the liquidator who is responsible for

• Taking control of the company’s assets
• Identifying and valuing the assets
• Selling the assets to pay off creditors
• Distributing the proceeds to creditors (secured creditors have priority),
• Distributing remaining funds to shareholders, and
• Preparing a final report detailing the liquidation process.

Notice to Creditors

Once a liquidator is appointed, the company gives notice to all its creditors. The notice informs the creditors about the liquidation decision. Moreover, it is ideal for providing the following to creditors –

• Details of the liquidator’s appointment
• The date of the liquidation, and
• The deadline for submitting claims

Sale of Assets

Once creditors are informed about the liquidation of the company, the liquidator can proceed with the next step. They can then sell the company’s assets. The sale of assets may occur through various methods, such as –

• Private sales, 
• Public auctions,
• Sales to a company’s directors or shareholders

It is worth noting here that these sale proceeds are used to pay the company’s creditors. Thus, the liquidator ensures that the assets are sold for the best possible price. This further ensures that enough amount is available to pay creditors.

Distribution of Funds

After the sale of assets, the liquidator distributes the proceeds among the creditors. The creditors are paid in order of priority, with secured creditors being paid first, followed by unsecured creditors. 

Final Report

The liquidator also submits a detailed final report to the Registrar of Companies. This final report provides details of the liquidation process, including the sale of assets and the distribution of funds to creditors.

Dissolution

With the submission of the Final Report by the liquidator, the liquidation of the company is done and it gets dissolved. The Registrar of Companies removes the company from the register of companies, and the company will cease to exist.

For instance, XYZ Company is a small manufacturing firm facing financial difficulties. The company decides to go through liquidation. So, for liquidation:

• The company’s board of directors passes a resolution to liquidate the company.
• A licensed insolvency practitioner is appointed as the liquidator. 
• The liquidator issues notice to all stakeholders, including creditors, shareholders, and employees, informing them of the liquidation process. 
• The company’s assets, including equipment and properties, are valued.
• The liquidator sells these assets to generate funds to pay off its debts. 
• The funds generated from the sale are then used to pay off creditors, with secured creditors being paid first. 
• If there are any remaining assets, they are distributed to shareholders. 
• Finally, the company is terminated and struck off the Companies Register. 

Appointment and Role of Liquidators

A liquidator is a licensed insolvency practitioner. Liquidators may be appointed by a court, the company’s shareholders or creditors, or the company itself. In some jurisdictions, only licensed insolvency practitioners may act as liquidators. He is appointed to oversee the process of liquidation of company. So, their role and duties include the following –

• Taking control of the company’s affairs,
• Investigating the company’s affair,
• Identifying and verifying creditors’ claims,
• Sell off the company’s assets, 
• Distributing the proceeds to creditors according to the priority of their claims,
• Preparing reports for creditors and the Court, and 
• Pursuing legal action against directors or shareholders if necessary.

Liquidation of Company and its Impact on Stakeholders

When a company undergoes liquidation, its assets are sold off. The amount received is utilised to repay its debts, and any remaining funds are distributed among the shareholders. Hence, liquidation significantly affects a company’s stakeholders, including employees, creditors, and shareholders.

Employees

• Liquidation of a company can lead to job loss for employees.
• Employees may not receive their total compensation. These can include wages, bonuses, and benefits owed to them.
• Some employees may lose their retirement benefits if the company cannot fund their pension plan.
• It can take time for employees to find new employment and regain financial stability.

Liquidation can significantly impact employees. The specific impact of liquidation on employees can vary depending on the liquidation circumstances. But here are some common impacts of the liquidation of a company on employees:

Creditors

Creditors are typically the first to be affected when a company is liquidated. They stand to lose significant money if the company can’t repay its debts. Creditors usually fall into two categories: secured and unsecured. 

 Secured Creditors

These creditors have a claim on specific assets of the company, which they can sell to recover their money. Secured creditors are assured of getting their debts paid.

Unsecured Creditors

These creditors don’t have a claim on any specific assets. Thus, they are at greater risk of losing their money. 

Shareholders

Shareholders are the owners of the company and are entitled to a share of the profits. But, in the case of liquidation, the priority changes. These shareholders are at the bottom of the priority list when it comes to repayment. 

So, they only receive any remaining funds after all the creditors have been paid in full. This means that shareholders may receive little money from the liquidation of a company. In some cases, shareholders may lose their entire investment, i.e., no money.

What Happens After Liquidation?

The liquidation process takes a significant amount of time and resources. Moreover, it can have long-term effects on the stakeholders involved. But, it is an important process. After all, it allows for the winding up of a company’s affairs and ensures that all parties receive their fair share of the remaining assets. 

After the liquidation process, the company ceases to exist as a legal entity. In other words, it means:

• The assets have been sold off to repay its debts and obligations to creditors,
• Any remaining funds have been distributed to shareholders,
• The company’s directors and officers no longer have any responsibilities or authority over the company. 
• Any contracts or agreements the company had in place are terminated, and 
• Employees are laid off or terminated

Overall, liquidation is a difficult and often emotional time for all involved. Yet, ensuring that the process is carried out properly and fairly is important. Regardless of the stage, the interests of all stakeholders are paramount.

Also Read: Understanding The Different Types Of Companies In India And Their Features

Liquidation of Company and Legal Advice

Liquidation can be a complicated and stressful process. Hence, seeking professional advice from experienced liquidators can be critical. Legal assistance can ensure a smooth and efficient liquidation of a company. 

A few such pieces of advice are:

• Be transparent with stakeholders and keep them informed of developments throughout the process. 
• The company should also prioritise the sale of assets to generate maximum value.
• Ensure that funds are distributed fairly to creditors. 
• Proper record-keeping and documentation are critical to avoiding legal issues and protecting the company’s reputation. 
• Work closely with liquidators and other professionals, such as lawyers and accountants, to ensure that all legal requirements are met, and
• Plan for the future and consider the options for restructuring or reorganising the business to minimise the impact on stakeholders.

Besides, a company can avoid the process of liquidating a company. Increasing revenue, monitoring debt levels, staying current on tax obligations, developing contingency plans, etc., are a few ways to escape liquidation circumstances.

The Liquidation of Company Process Explained

To summarise, liquidation is the process of closing down a company when it can no longer pay its debts or if the shareholders/directors decide to close the business. It involves appointing a liquidator who takes control of the company’s assets, identifies and values them, sells the assets to pay off creditors, distributes the proceeds to creditors, and shareholders, and prepares a final report.

The liquidation process can be voluntary, involuntary, members’ voluntary, creditors’ voluntary, or compulsory. Before entering the liquidation process, a company should take steps like assessing its financial situation, developing a liquidation plan, notifying stakeholders, appointing a liquidator, protecting assets, and ensuring that all legal requirements are met.

Finally, the company is dissolved, and the Registrar of Companies removes it from the register of companies.

Innovative, low-investment ideas for the hidden entrepreneur in you! Explore our guide on Business Ideas.

Frequently Asked Questions (FAQ’s)