Demystifying the Liquidation Process

Background

In this third instalment of the Demystifying Insolvency series, we focus on the company liquidation process.

Commonly, although not always, a company goes into liquidation when it is insolvent (i.e. when it cannot pay its debts as and when they become due and payable). During the liquidation process, a company and its affairs are wound-up in a fair and orderly manner, and the company’s assets are utilised to pay money owing to creditors of the company, along with the costs associated with the winding-up. Prior to the company then being de-registered, any surplus funds are returned to shareholders, although this is rare.

A liquidator, being an independent third party, is appointed to oversee the winding-up process of the company aiming to maximise the possible returns to creditors.

In this bulletin, we discuss the types and various stages of the liquidation process, including what it means to place a company into provisional liquidation.

What are the Types of Liquidations?

Generally speaking, there are three different ways that a company can be placed into liquidation being:

1. Court Appointed Liquidation - when the Court orders that a company be wound up and a liquidator be appointed, usually on application by a creditor, director or shareholder of the company or the Australia Securities and Investments Commission (ASIC);

2. Creditor’s Voluntary Liquidation - which is usually initiated by:

(a) directors and shareholders who agree to place a company into liquidation on the basis that it is insolvent; or

(b) creditors after a company has been in Voluntary Administration or following the termination of a DOCA (Voluntary Administrations and DOCA’s are discussed in detail in our second instalment of the Demystifying Insolvency series which can be viewed here); and

3. Member’s Voluntary Liquidation - which is only available to solvent companies and is usually utilised to wind-up the company and return capital to shareholders. A common reason for doing this is when a company is part of a group of companies and a decision is made to wind-up an entity to simplify the group and lower administrative costs.

Ultimately, the decision as to what type of liquidation is required will depend on a number of factors including whether:

1. the company is solvent or insolvent;

2. there is a dispute between directors, shareholders and creditors as to whether a company should be wound-up; and

3. there is a risk that the assets of the company will dissipate (this is discussed in detail below).

This bulletin will explore the role of a liquidator in Court Liquidations and Creditor’s Voluntary Liquidations in detail below.

Provisional Liquidation

In circumstances where there is an application for a Court Appointed Liquidation, the moving party may seek orders that a provisional liquidator be appointed for the period between:

1. when the application is made to the Court; and

2. the winding up application is heard by the Court.

A provisional liquidator may be appointed to a company in circumstances where there is a dispute between shareholders, or a where company is insolvent and:

1. there is a real danger that the assets of the company will dissipate;

2. the applicant wishes to provide stability to the company while an application to wind-up the company is on foot; and

3. it is urgent that an independent third party be appointed to preserve and control the assets of the company while an application to wind-up a company is on foot.

The Court has the power to appoint a provisional liquidator to carry on the company’s business pursuant to sections 472(2) and 472(4) of the Corporations Act 2001 (Cth) (Corporations Act).

The appointment of a provisional liquidator is not permanent and can be reversed if the company is not wound up or the company is placed into liquidation and an alternative liquidator is appointed. During its appointment, a provisional liquidator may carry on the company’s business and is required to prepare a detailed report to the Court in relation to the solvency of the company.

How is a Liquidator Appointed?

The process of appointing a liquidator will ultimately depend on who wishes to place the company into liquidation.

If:

1. the directors and shareholders of a company agree to place the company into liquidation, the directors and shareholders simply need to pass a resolution appointing a liquidator. Prior to a liquidator being appointed, the directors of the company will need to contact the liquidator to obtain a Consent to Act from the liquidator and ensure that there is no conflict of interest with the liquidator being appointed to the company;

2. the creditors decide to place a company into liquidation after a company has been in Voluntary Administration or following the termination of a DOCA, the creditors decide who will be the liquidator. The administrator is often appointed as liquidator, given they are already aware of the affairs of the company. However, creditors may prefer an alternative liquidator in certain circumstances (For further commentary on this issue, see: Appointment from administrator to liquidator in a winding-up: guiding principles that the Court will consider); and

3. the company is placed into liquidation by an order of the Court, the Court will appoint the liquidator pursuant to section 472(1) of the Corporations Act. The applicant to the proceeding may suggest a liquidator and obtain a Consent to Act from the liquidator to provide to the Court. Generally speaking, the Court will appoint the suggested liquidator, unless there are circumstances where an alternative liquidator may be more suitable.

The Liquidation Process and the Role of a Liquidator

Once a liquidator has been appointed to an insolvent company, it owes a duty to the creditors of the company. It’s role during the liquidation process includes:

1. undertaking an investigation into the affairs of the company and reporting to creditors as to the findings of the investigations. This may include any recoverable unfair preference payments or possible claims against the directors of the company;

2. finding, collecting and protecting any assets of the company;

3. reporting to ASIC as required; and

4. distributing proceeds from the realisation of assets to creditors and potentially shareholders, after payment of the costs of the liquidation have been made.

Investigations and Reporting to Creditors

During the course of the liquidation, the liquidator will provide creditors with:

1. an Initial Report about their rights as creditors during the liquidation. This is usually done within 10 business days after the liquidator’s appointment in a creditors’ voluntary liquidation or within 20 business days following a court appointed liquidation;

2. a Statutory Report within 3 months after the appointment of the liquidator; and

3. any further reports required to provide creditors with an update in relation to the liquidation.

The Initial Report informs creditors of the appointment of the liquidator, their rights to request information, their rights to request that a meeting of creditors be held and their rights to provide directions to the liquidator.

The Statutory Report provides detail to creditors about the estimated value of the company’s liabilities and assets, provides an update as to the investigations undertaken by the liquidators including a summary of the affairs of the company and the likelihood that a dividend will be paid at the end of the liquidation.

Creditor’s Meetings and Approval of Liquidator Fees

During the course of the liquidation, a liquidator may call a meeting of creditors to provide them with an update on the liquidation, ascertain their position on particular matters during the liquidation process and seek approval regarding the liquidator’s fees. (See Insolvency Meetings - Casting a Shadow Over Voting Rights for further details about voting at creditors meetings including the liquidator’s ability to exercise a casting vote).

While the liquidator does not require creditor approval for all decisions made during the liquidation process, the liquidator’s fees (which are generally paid from the assets of the company) must be approved by creditors or the Court. Prior to voting on the liquidator’s fees, creditors must be provided with a report containing sufficient information to allow creditors to assess the reasonableness of the liquidator’s fees.

Payment of Dividends

After the realisation of the company’s assets, secured creditors will be paid in priority from the assets of the company. Generally speaking, funds will be distributed from the assets of the company as follows:

1. costs of the liquidation, including the liquidator’s fees;

2. wage, superannuation and leave payments to the company’s employees;

3. secured creditors;

4. unsecured creditors; and

5. shareholders.

Once each category is paid in full, the next category of creditors is paid. If sufficient funds are not available to pay out a certain category, the creditors within that category are paid on a pro-rata basis and the balance of the creditors are not paid anything.  It is rare that a dividend is payable to shareholders in an insolvent liquidation.

Unsecured creditors are required to lodge a proof of debt with the liquidator which provides sufficient information for the liquidator to be able to decide whether the debt from the company exists, and the amount of it.

Unsecured creditors generally will not know the exact amount of the dividend payable, if any, until the conclusion of the liquidation.

Finalisation of Liquidation

Once the assets of the company are realised, debts paid, payments are made as outlined above and liquidators report all things necessary to ASIC, the liquidation effectively comes to an end and the company will be de-registered.

Authors: Gavin Stuart, Adam Cutri and Max Mikha

See also: Demystifying Insolvency: what you need to know