When an organisation is no longer able to pay its obligations, it may be forced to begin the process of liquidating its assets to pay off the debts that have been incurred.
An organisation is declared bankrupt when it cannot pay its obligations in a full and timely fashion. The company’s assets are then auctioned to satisfy its creditors, shareholders, and other claims, thereby dissolving the organisation. Liquidation can occur willingly or involuntarily.
Liquidation is a legal process that may be used by both small enterprises and large publicly traded corporations. It can be used as an exit plan for a company that has become bankrupt and no longer lucrative, while it can also be used to liquidate a profitable company.
A Closer Look at the Definition of Liquidation
In the financial world, liquidation occurs when a firm becomes bankrupt, which means that it cannot pay its debts and obligations. Liquidation is often carried out voluntarily by the shareholders or because of a court decision mandating that creditors carry out the procedure.
A voluntary liquidation happens when all of the firm’s shareholders come to an agreement to wind up the business. The shareholders have a referendum in which they vote on whether to proceed with the liquidation.
The corporation then liquidates its assets to free up capital to pay off any outstanding obligations. Voluntary liquidation can also occur due to the departure of the majority shareholder from a company. It is, therefore, possible for the remaining shareholders to decide not to continue with the company’s activities, thereby opening the path for its liquidation.
It is necessary to file for forced liquidation when a court directs that a firm’s assets be realised and subsequently divided among the company’s creditors. The procedure begins with filing a petition in the appropriate court of law.
Finally, the judge who is assigned to handle the petition considers and decides whether it is reasonable to order a liquidation. When the liquidation procedure is completed, the firm will begin the process of terminating its operations.
A creditor frequently submits a petition during a forced liquidation. Companies can be forced into compulsory liquidation for a variety of reasons, including by their directors, shareholders, or even the firm itself.
Different Types of Liquidation
Several different forms of liquidation may be used for a variety of various things. Voluntary liquidation, forced liquidation, and creditors’ voluntary liquidation are the three forms of liquidation most commonly seen in business.
Voluntary liquidation: In some situations, the owner of a solvent firm who wishes to depart the company may choose to volunteer to liquidate the business. For a company to be liquidated, at least 75% of its members must vote in favour of doing so. A liquidator is appointed to resolve the firm’s debts and legal challenges. The remaining monies are dispersed to the company’s shareholders and board of directors.
Forced liquidation: The compulsory liquidation process happens when creditors or lenders file a petition to liquidate a firm because their debts have not been paid within a certain period. This requires the business to sell its assets to pay its creditors back their money. If you own an insolvent company, which means that your firm cannot pay its obligations, you may be obliged to liquidate your business if you have failed to repay your debts in a reasonable amount of time.
Creditor’s Voluntary Liquidation: A creditors’ voluntary liquidation happens when the directors of a firm understand that they can no longer pay their obligations on time or that their liabilities have grown to outweigh the value of their assets. When a liquidator resolves a company’s legal challenges or debts, the directors must assist with the liquidation process to recover their losses.
How Are Assets Distributed
Securing their money with collateral or a contract allows secured bondholders and other secured creditors to get their money first before any other creditors. Unsecured creditors are paid after secured creditors.
People who are entitled to receive money from the corporation but do not have secured or guaranteed claims fall into the first category. These creditors include bank lenders, workers, the government if any taxes are owed, suppliers, and investors who have purchased unsecured bonds from the company.
A group of creditors known as general creditors is the final group to be paid, and this group is mostly investors. If there is anything left after the other creditors have been paid in full, they will be paid out of that remaining money.
General creditors are separated into two categories: creditors who own preferred stock and creditors who own ordinary stock. Shareholders who possess preferred stock receive their dividends before owners of ordinary stock.
Preferred shareholders are given first preference for reimbursement in the event of a bankruptcy. If there is no money left over after the preferred shareholders have been paid, the common stockholders will receive no compensation.
Example of How a Liquidation Works
It is possible to get numerous benefits from the liquidation of a business and the closure of a firm. Previously incurred debts are wiped off, giving the company the option to continue forward rather than having the entire investment eaten up by previous obligations.
If creditors have begun legal proceedings against the firm, the process of liquidation stops them, thus ending all legal proceedings against the company. It is also possible to cancel leases and purchase agreements, which is significant. Companies that file such claims may be able to recoup their investments from insolvency practitioners and other creditors in the process.
Liquidation is the selling off of all of a company’s assets to pay off its obligations. This means that there are no assets left over to use to launch a new company. As a result, all employees will need to seek alternative jobs.
In addition, if a new business proposal is submitted, a new hiring procedure will need to be begun to hire new employees. This is a time-consuming and expensive procedure since the organisation will have to start from the ground up.