Company Liquidation Meaning, Modes

Liquidation is the process in accounting by which a company is brought to an end in India, Canada, United Kingdom, Ireland, Australia, New Zealand, and Italy, and many other countries. The assets and property of the company are redistributed. Liquidation is also sometimes referred to as winding-up or dissolution, although dissolution technically refers to the last stage of liquidation. The process of liquidation also arises when customs, an authority or agency in a country responsible for collecting and safeguarding customs duties, determines the final computation or ascertainment of the duties or drawback accruing on an entry.

Liquidation may either be compulsory (sometimes referred to as a creditors’ liquidation or receivership following bankruptcy, which may result in the court creating a “liquidation trust“) or voluntary (sometimes referred to as a shareholders’ liquidation, although some voluntary liquidations are controlled by the creditors).

The term “liquidation” is also sometimes used informally to describe a company seeking to divest of some of its assets. For instance, a retail chain may wish to close some of its stores. For efficiency’s sake, it will often sell these at a discount to a company specializing in real estate liquidation instead of becoming involved in an area it may lack sufficient expertise in to operate with maximum profitability.

Liquidation is the process a debt-laden company initiates to wind up its operations and sell its assets in order to repay said liabilities and other obligations. A company is liquidated when it is ascertained that the business is not in any state to continue. This may be due to various reasons such as insolvency (usually the main reason), unwillingness to carry on with the operations, etc.

If the enterprise is bankrupt, the liquidator sells the company’s assets to repay all liabilities. The positive balance after repaying the creditors is then distributed among the company’s shareholders.

Turning assets into cash

As the term implies, liquidation relates to liquidating a company’s assets. In other terms, it means converting assets into cash. This cash allows the company to pay off its investors and other outside liabilities. Usually, this is the last resort for any insolvent company to repay its debts.

The liquidator

A liquidator is an individual who has been appointed to dissolve the company and terminate its operations. This person is responsible for selling the assets to repay the company’s internal and external liabilities.

Process of liquidation

The liquidator sells all assets that he deems necessary, except cash and bank balances.

The money raised in this manner is then distributed among various creditors. However, this repayment is undertaken based on a pre-established order. The first preference is given to the company’s secured creditors. The remaining money is then used to discharge preferential creditors, i.e., taxes due to the government, salaries of employees, etc.

Any outstanding amount is then used to compensate debenture-holders and other liabilities secured by a floating charge on all assets. Next, unsecured creditors and preference shareholders are paid off.

Finally, if there is a surplus of funds after all the payments mentioned above, they are distributed among shareholders. Meanwhile, in case of a deficit, shareholders are asked to pay up their unpaid share of capital.

Kinds of liquidation

There are three basic types of liquidation enumerated below:

(i) Voluntary liquidation

This type of liquidation is not forced by insolvency and is voluntarily decided by the owner(s)/member(s) of the company. This means that the company is still solvent and can make payments to creditors.

According to Sec. 484 of the Companies Act, a company can be wound-up voluntarily under the following circumstances:

(1) By an Ordinary Resolution (passed in a general meeting in the following cases):

(a) Where the duration of the company was fixed by the articles and the period has expired; and

(b) Where the articles provided for winding-up on the occurrence of any event and the specified event has occurred.

(2) By a Special Resolution (passed by the members in all other cases):

When a resolution is passed for voluntary winding-up it must be notified to the public by an advertisement in the Official Gazette and in a local newspaper (Sec. 485).

Types of Voluntary Winding-Up:

Voluntary winding-up is of two types:

(a) Members’ Voluntary Winding-up; and

(b) Creditors’ Voluntary Winding-up.

(a) Members’ Voluntary Winding-up:

If the company is, at the time of winding-up, a solvent company, i.e., able to pay its debts and the directors make a declaration to that effect; it is called a Members’ Voluntary Winding-up. The declaration must be verified by an affidavit.

The declaration must be:

(a) Made within the five weeks immediately preceding the date of passing of the resolution of winding-up by the company and delivered to the Registrar for registration before that date; and

(b) Accompanied by a copy of the report of the auditors of the company on the Profit and Loss Account of the company from the date of the last Profit and Loss Account to the latest practicable date immediately before the declaration of solvency, the Balance Sheet of the company; and a statement of the company’s assets and liabilities as on the last mentioned date.

The Members’ Voluntary Winding up is done by the following successive steps:

(i) Declaration of solvency;

(ii) Statutory Declaration to the Registrar;

(iii) A resolution in general meeting of the company within 5 weeks of declaration of solvency;

(iv) Appointment of Liquidator;

(v) Collecting the company’s assets, pay the liabilities of the company and pay the balance of the proceeds to the contributories.

(b) Creditors’ Voluntary Winding Up:

If the declaration of solvency is not made and filed with the Registrar, it may be presumed that the company is insolvent. In that case, the company must call a meeting of its creditors (for the day or the day next following the day fixed for the company’s general meeting) for passing the resolution for winding-up.

The Creditors’ Voluntary Winding-up is done by the following successive steps:

(i) A resolution for the winding up of the company in a general meeting of the company.

(ii) On the same day or the following day there must be a meeting of the creditors and a list of creditors must be furnished by the Directors.

(iii) A liquidator or liquidators are appointed by the meeting of members and the meeting of the creditors.

(iv) A committee of inspection.

(v) The work of winding-up according to statute.

(c) Voluntary Winding-up under the Supervision of Court:

At any time after a company has passed a resolution for voluntary winding-up, the Court may make an order that the voluntary winding-up shall continue but subject to the supervision of the court (Sec. 522). A supervision order is usually made for the protection of the creditors and contributories of the company. A petition for the continuance of a voluntary winding-up subject to the supervision of the Court is deemed to be a petition for winding-up by the Court (Sec. 523).

(ii) Creditors’ voluntary liquidation

This is brought about when the director/directors realize that the company will default on creditor payments. Shareholders are asked to vote; consequently, if 75% of the members agree to do so, the company is liquidated.

(iii) Compulsory liquidation

The court of law orders the business to terminate its operations and close down when the company is unable to repay its liabilities.

Grounds for Compulsory Winding-up (Sec. 433):

A company may be wound-up by the Court under the following cases:

(i) Special Resolution of the Company:

If the company has, by special resolution, resolved that the Company be wound-up by the Court;

(ii) Default:

If a default is made in delivering the statutory report of the Registrar of Companies or in holding the statutory meeting of the company, the court may make a winding-up order;

(iii) Not commencing or suspending the Company:

If the company does not commence its business within a year from its incorporation, or suspends its business for a whole year;

(iv) Reduction of Members:

If the number of members falls below seven in case of a public company or below two in case of a private company;

(v) Inability to pay Debts:

If the company is unable to pay its debts;

(vi) The Just and Equitable Clause:

If the Court is of opinion that it is just and equitable that the company should be wound-up.