A company that is in debt initiates the process of liquidation to wind down and cease operations and transactions. To meet its liabilities and obligations, the company sells its assets. A company generally is liquidated when it’s inevitable that the business will not be profitable enough to continue. A company may be liquidated for various reasons, including insolvency, bankruptcy, an unwillingness to continue its activities and operations, among others.
The liquidation of a company is the process by which all of the company’s assets and property are distributed among creditors per the amount owed. If any surplus amount remains, it is distributed among members, shareholders, owners, and others as per their rights.
The board of directors must appoint an administrative person known as a liquidator to oversee all activities involved in liquidation. Following these procedures, the company’s name is removed from the register of companies.
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What is Liquidation of Company
The liquidation of a company is winding down a company’s finances and economics. Liquidation occurs when a company becomes insolvent and cannot pay its obligations. At this point, the property is distributed among its claimants. The general partners are the subjects of liquidation.
Therefore, liquidation is the process of ending the affairs of a company, business, or other entity by leveraging its assets to clear its liabilities.
A court, unsecured creditors, or the company’s shareholders typically appoint a liquidator. He is in charge of liquidating assets (in most cases). The liquidator is usually appointed when a company is insolvent or bankrupt. He assumes control of all the organisation’s assets, properties, and people following his appointment.
Functions of a Liquidator
A liquidator (i.e., a licensed insolvency practitioner) is required for liquidation, and they discharge several responsibilities. Following their appointment, these professionals have to act as an impartial third party to oversee the liquidation process from start to finish.
A liquidator’s role entails various responsibilities, including but are not limited to the following:
Distributing both realised assets and surplus funds to the appropriate parties determining any outstanding claims against the company and satisfying those claims in the legal order of priority.
Reasons for the Liquidation of Company
Liquidation of a company occurs when a limited company decides not to continue operations for one reason or another. In this case, a company can consider liquidation.
In general, it refers to converting a company’s or business’s assets into cash, which typically is done to pay off various debts such as creditor’s investment in the business or loans taken for the business’s growth.
The main reasons for the liquidation are insolvency and bankruptcy.
Insolvency is a state or phase when a company or a person cannot pay their debts and dues. Insolvency occurs when a company’s debts and obligations exceed its income and assets. Therefore, they cannot repay their debts and dues in the present and future.
A company can become insolvent even if its assets exceed its liabilities, and if its assets are not easily converted into the cash needed to make necessary payments.
A company becomes insolvent when it fails to maintain its quality or any other aspect to keep up with current market conditions, when its growth plan depletes its financial resources, or when there is a lack of bookkeeping, fraud, improper management.
When a person, company, or business declares bankruptcy, they are declared insolvent. This term is used to describe company employees who cannot repay their outstanding debts or dues.
When a company declares bankruptcy, then it has been released from its debts and can make a fresh start while ensuring that its assets are shared with the creditors to whom it owes money in proportion.
Forms of liquidation
Liquidation is classified into the following three types:
- Compulsory liquidation,
- Voluntary liquidation
- Creditors voluntary liquidation
Compulsory liquidation of company
Compulsory liquidation occurs when a person or company is unable to pay their debts or dues, and the creditor files a suit in a court of law to wind up the company.
If the company does not pay the debt by the date specified in the court’s successful application and order, the company’s or business’s accounts are frozen. During this process, assets are liquidated, and the proceeds are divided among creditors.
Voluntarily Liquidation of Company
When the directors, owners, and shareholders become aware that the company is failing to pay its debts, the liquidator takes control of the company and takes command of the liquidation process. It is the most commonly used liquidation.
Process of Liquidation of Company
The type of the liquidation process heavily influences the details of the process when voluntarily liquidating a limited company. However, all procedures include the following steps:
- An insolvency practitioner appoints the liquidator.
- Asset revaluation and realisation for the company (liquidated).
- Paying creditors (if any) in the order of their priority.
- Surplus cash is distributed to shareholders.
- Dissolution of the company, followed by removing its name from the registrar of companies.
As previously stated, the liquidation of a company begins when the company becomes insolvent and bankrupt due to unmanaged business affairs and transactions, failing to keep up with the trade market. When this situation arises, a company must either voluntarily or by order of the tribunal dissolve the company by going through the liquidation process
In liquidation, who is paid first?
Creditors are paid in liquidation based on the priority of their claims. In the descending order of priority, these include holders of fixed charges and creditors with a proprietary interest in assets (first); expenses of the insolvent estate (second) and creditors with a proprietary interest in assets (third) (second).
What exactly do liquidators do?
A liquidator is a person with the legal authority to sell a company's assets before it closes to generate cash for various reasons, including debt repayment.
Who chooses a liquidator?
Official liquidators are officers appointed by the Central Government under Section 448 of the Companies Act of 1956 and assigned to various high courts.
What exactly is a liquidator report?
The liquidator is required to provide creditors with the statutory report within 3 months of their appointment. This report will explain what happened to the company, what assets and liabilities it has, what inquiries the liquidator has made, and what the liquidator will do to recover money for creditors.