Liquidation

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In law, liquidation refers to the process by which a company (or part of a company) is brought to an end, and the assets and property of the company redistributed. Liquidation can also be referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation.

Liquidation may either be compulsory (sometimes referred to as a creditors' liquidation) or voluntary (sometimes referred to as a shareholders' liquidation, although some voluntary liquidations are controlled by the creditors, see below).

In finance, liquidation is also sometimes used as convenient shorthand for converting an asset to cash.

Contents

[edit] Compulsory liquidation

The parties who are entitled by law to petition for the compulsory liquidation of a company vary from jurisdiction to jurisdiction, but generally, a petition may be lodged with the court for the compulsory liquidation of a company by:

  1. the company itself
  2. any creditor who establishes a prima facie case
  3. contributories[1]
  4. the Secretary of State (or equivalent)
  5. the Official Receiver

[edit] Grounds

The grounds upon which one can apply for a compulsory liquidation also vary between jurisdictions, but the normal grounds to enable an application to the court for an order compulsorily wind-up the company are:

  1. the company has so resolved
  2. the company was incorporated as a public company, and has not been issued with a trading certificate (or equivalent) within 12 months of registration
  3. it is an "old public company" (ie. one that has not re-registered as a public company or become a private company under more recent companies legislation requiring this)
  4. it has not commenced business within the statutorily prescribed time (normally one year) of its incorporation, or has not carried on business for a statutorily prescribed amount of time
  5. the number of members has fallen below the minimum prescribed by statute
  6. the company is unable to pay its debts as they fall due
  7. it is just and equitable to wind up the company[2]

In practice, the vast majority of compulsory winding-up applications are made under one of the last two grounds.

An order will not generally be made if the real purpose of the application is other than for a winding-up, eg. the application is made just to enforce a debt.[3]

A "just and equitable" winding-up enable the ground to subject the strict legal rights of the shareholders to equitable considerations. It can take account of personal relationships of mutual trust and confidence in small parties, particularly, for example, where there is a breach of an understanding that all of the members may participate in the business,[4] or of an implied obligation to participate in management.[5] An order might be made where the majority shareholders deprive the minority of their right to appoint and remove their own director.[6]

[edit] The order

Once liquidation commences (which depends upon applicable law, but will generally be when the petition was originally presented, and not when the court makes the order[7]), dispositions of the company's property are generally void,[8] and litigation involving the company is generally restrained.[9]

Upon hearing the application, the court may either dismiss the petition, or make the order for winding-up. The court may dismiss the application if the petitioner unreasonably refrains from an alternative course of action.[10]

The court may appoint an official receiver, and one or more liquidators, and has general powers to enable rights and liabilities of claimants and contributories to be settled. Separate meetings of creditors and contributories may decide to nominate a person for the appointment of liquidator and possibly of supervisory liquidation committee.

[edit] Voluntary liquidation

Voluntary liquidation occurs when the members of the company resolve to voluntarily wind-up the affairs of the company and dissolve. Voluntary liquidation begins when the company passes the resolution, and the company will generally cease to carry on business at that time (if it has not done so already). If the company is solvent, and the members have made a statutory declaration of solvency, the liquidation will proceed as a members' voluntary winding-up. In such case, the general meeting will appoint the liquidator(s). If not, the liquidation will proceed as a creditor's voluntary winding-up, and a meeting of creditors will be called, to which the directors must report on the company's affairs. Where a voluntary liquidation proceeds by way of creditor's voluntary liquidation, a liquidation committee may be appointed.

Where a voluntary winding-up of a company has begun, a compulsory liquidation order is still possible, but the petitioning contributory would need to satisfy the court that a voluntary liquidation would prejudice the contributories.

In addition, the term liquidation is sometimes used when a company wishes to divest itself of some of its assets. This is used, for instance, when a retail establishment wishes to close stores. They will sell to a company that specializes in store liquidation instead of attempting to run a store closure sale themselves.

[edit] Misconduct

Main articles: Fraudulent trading, Undervalue transaction, Unfair preference and Wrongful trading

The liquidator will normally have a duty to ascertain whether any misconduct has been conducted by those in control of the company which has caused prejudice to the general body of creditors. In some legal systems, in appropriate cases, the liquidator may be able to bring an action against errant directors or shadow directors for either wrongful trading or fraudulent trading.

The liquidator may also have to determine whether any payments made by the company or transactions entered into may be voidable as a transaction at an undervalue or an unfair preference.

[edit] Priority of claims

The main purpose of a liquidation where the company is insolvent is to collect in the company's assets, determine the outstanding claims against the company, and satisfy those claims in the manner and order prescribed by law.

The liquidator must determine the company's title to property in its possession. Property which is in the possession of the company, but which was supplied under a valid retention of title clause will generally have to be returned to the supplier. Property which is held by the company on trust for third parties will not form part of the company's assets available to pay creditors.[11]

Before the claims are met, secured creditors are entitled to enforce their claims against the assets of the company to the extent that they are subject to a valid security interest. In most legal systems, only fixed security takes precedence over all claims; security by way of floating charge may be postponed to the preferred creditors.

Claimants with non-monetary claims against the company may be able to enforce their rights against the company. For example, a party who had a valid contract for the purchase of land against the company may be able to obtain an order for specific performance, and compel the liquidator to transfer title to the land to him, upon tender of the purchase price.[12]

After the removal of all assets which are subject to retention of title arrangements, fixed security, or are otherwise subject to proprietary claims of others, the liquidator will pay the claims against the company's assets. Generally, the priority of claims on the company's assets will be determined in the following order:

  1. Firstly, the costs of the liquidation are met out of the company's remaining assets
  2. Secondly, the preferred creditors under applicable law are paid
  3. Thirdly, in many legal systems, the claims of the holders of a floating charge will be paid; other claims may also fit into this layer[13]
  4. Fourthly, if there is anything left, the unsecured creditors are paid out pari passu in accordance with their claims. In many jurisdictions, a portion of the assets which would otherwise be caught by a floating charge are reserved for the unsecured creditors.[14]
  5. In the very rare instances where the unsecured creditors are repaid in full, any surplus assets are distributed between the members in accordance with their entitlements.

Unclaimed assets will usually vest in the state as bona vacantia.

See also: Secured creditor, Preferred creditor and Unsecured creditor

[edit] Dissolution

Having wound-up the company's affairs, the liquidator must call a final meeting of the members (if it is a members' voluntary winding-up), creditors (if it is a compulsory winding-up) or both (if it is a creditors' voluntary winding-up). The liquidator is then usually required to send final accounts to the Registrar and to notify the court. The company is then dissolved.

However, in most jurisdictions, the court has a discretion for a period of time after dissolution to declare the dissolution void to enable the completion of any unfinished business.[15]

See also: Dissolution (law)

[edit] Striking off the Register

In some jurisdictions, the company may elect to simply be struck off the Register as a cheaper alternative to a formal winding-up and dissolution. In such cases an application is made to the Registrar, and they may strike off the company if there is reasonable cause to believe that the company is not carrying on business or has been wound-up and, after enquiry, no case is shown why the company should not be struck off.[16]

However, in such cases the company may be restored to the Register if it is just and equitable so to do (for example, if the rights of any creditors or members have been prejudiced).[17]

[edit] See also

[edit] Footnotes

  1. ^ Those shareholders who may be required to contribute to the company's assets on liquidation, for example, in the United Kingdom, see sections 74 and 75 of the Insolvency Act 1986
  2. ^ In the United Kingdom, see section 122 of the Insolvency Act 1986
  3. ^ See Stonegate Securities Ltd v Gregory [1980] Ch 576
  4. ^ Ebrahimi v Westbourne Galleries [1972] 2 AER 492
  5. ^ Tay Bok Choon v Tahansan Sdn Bhd [1987] BCLC 472
  6. ^ Re A & BC Chewing Gum Ltd [1975] 1 WLR 579
  7. ^ In the United Kingdom, see section 129 of the Insolvency Act 1986
  8. ^ In the United Kingdom, see section 127 of the Insolvency Act 1986
  9. ^ In the United Kingdom, see section 130 of the Insolvency Act 1986
  10. ^ Re A Company (No 001573 of 1983) [1983] Com LR 202
  11. ^ See for example, Barclays Bank v Quistclose [1970] AC 56
  12. ^ Re Coregrange Ltd [1984] BCLC 453
  13. ^ For example, in the United Kingdom, the claims of persons who have distrained goods within the preceding three months are postponed to the preferred creditors, see section 176 of the Insolvency Act 1986
  14. ^ In the United Kingdom, 50% of the property up to £10,000 and 20% of further property, up to an aggregate maximum of £600,000 - The Insolvency Act 1986 (Prescribed Part) Order (No 2097 of 2003)
  15. ^ In the United Kingdom, see section 651 of the Companies Act 1986
  16. ^ In the United Kingdom, see section 652 and 653 of the Companies Act 1986
  17. ^ Re Priceland Limited [1997] 1 BCLC 467