Businesses often aim to grow, maximise their profitability and prosper. However, in some cases, they might be forced to wind up operations. This process is referred to as liquidation.
It involves selling off assets to pay off debts or stakeholders. But why do companies liquidate their assets? In this blog, we will delve deeper into the term – Liquidation and also explain in detail the process of liquidation and different types of liquidation process in India.
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What is liquidation?
In simple terms, liquidation is the process of winding up a business. It is an activity wherein the assets of the business are sold to generate funds. These funds are then used to settle existing debts and pay off creditors.
In some cases, the liquidation definition can also involve selling off or divesting some of the business’s assets to cut losses. In such cases, liquidation would not mean a full closure. For instance, if a business closes its operation in certain cities or countries, it would also fall under liquidation.
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Liquidation – Important Points To Note
- Liquidation is the winding up of a business and sell business assets to pay off liabilities.
- Liquidation can be forced or voluntary.
- There is a specific liquidation process wherein expert liquidators are appointed to conduct the necessary protocol.
Types of liquidation
There are different types of liquidation that a business can undergo. These are as follows –
- Forced or compulsory liquidation
A forced or compulsory liquidation happens when the creditors of a business lose faith in the business’s repayment capacity. They appeal to the court to get the business dissolved, and the court may pass the liquidation order.
- Members voluntary liquidation
Liquidation not only happens when the business becomes insolvent or bankrupt. In some cases, the owners might decide to wind up the business even if it is solvent. In such cases, the members would opt for voluntary liquidation.
- Creditors voluntary liquidation
This type of liquidation happens when the business becomes insolvent and fears legal intervention or compulsory liquidation. As such, the Board decides to liquidate voluntarily since it is not financially feasible to continue operations.
Insolvency and Bankruptcy Code (IBC)
The Insolvency and Bankruptcy Code, or IBC, is a tool for resolving business insolvency.
It is a code to help businesses take care of their insolvency issues. Under the code, debtors and creditors start their recovery process when the business is still continuing. All possible steps are taken to ensure business continuity and solvency. However, if every measure fails, liquidation may serve as the last resort.
Liquidation process
The liquidation process under the IBC code can be listed in the following order –
- The liquidation starts after the AA passes a liquidation order
- A liquidator is appointed, and his fee is negotiated and determined
- The liquidator consults with stakeholders and collects the debts the company is yet to receive
- The liquidator forms a liquidation estate wherein the assets of the business are listed with their values
- The creditors are paid off
- Unsold assets are distributed among the stakeholders
What are assets?
Assets are the different types of investments, property and other things that a business owns which can generate revenue. In liquidation, the assets are sold off to realise funds which are then distributed among the creditors and shareholders.
Assets of a business include the following –
- Plant and equipment
- Investments
- Inventory
- Furniture and fixtures
- Land, building and property
- Vehicles
- Any outstanding income that the business is supposed to receive
- Accounts receivable
- Cash in hand or at the bank
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Paying off creditors
The funds realised from selling assets are used to pay off creditors. The priority of payment, however, depends on the type of creditors that a business has. Given below are the types of creditors listed in order of their priority –
- Secured creditors
Debts that are secured against an asset are paid first. For instance, a loan against property is a secured loan. If the business sells off the property, the loan needs to be settled first.
- Unsecured creditors
After the secured creditors are paid off, the unsecured creditors take precedence.
- Shareholders
After all the creditors are paid off, the remaining funds are distributed among shareholders. In this case, also, preference shareholders are paid first, followed by equity shareholders.
Liquidation specialists
Liquidation is a complicated process. That is why specialised businesses conduct the liquidation process on behalf of companies. Businesses can hire liquidation specialists to buy their assets, sell them off, generate funds and then pay off creditors.
Liquidation order
A liquidation order is an order to liquidate a business. Only the Adjudicating Authority (AA) can pass the liquidation order, and that too under the following instances –
- When a business resolution plan is not submitted on time
- If the resolution plan is rejected by the National Company Law Tribunal (NCLT), which is the AA
- If the Committee of Creditors (CoC) approve the liquidation
- If the corporate debtor contradicts or opposes the approved plan of resolution
Liquidator
Once the AA has passed the liquidation order, the authority appointed for making a resolution plan can become the liquidator.
The AA can also replace the liquidator if needed. The IBC code specifies the eligibility of a liquidator. Moreover, the liquidator would be duty-bound to oversee and complete the whole liquidation process.
Consequences of liquidation
Once the liquidation proceedings start, the rights of shareholders and owners are lost. The appointed liquidator determines the manner of liquidating the assets.
If the company winds up, employees might end up losing jobs. Moreover, the name of the company is also removed from the Registrar.
Costs and fees of liquidating a company
The costs and fees for liquidating a company are specified under the Insolvency and Bankruptcy Board of India (Liquidation Process) Regulations, 2016. It is calculated as a percentage of the amount realised by selling off the assets. Moreover, the percentage reduces with time.
Examples of liquidation
Some businesses in India that underwent liquidation include the following –
- DHFL
- Essar Steel
- Bhushan Steel
- Jet Airways
- Bhushan Power and Steel
What happens when a company goes into liquidation?
When a company goes into liquidation, its name is removed from the Registrar. The employees also lose their jobs, and shareholders might suffer a loss of capital if their stocks do not fetch the right price.
Timeframe
The Insolvency and Bankruptcy Board of India has specified the timeframe for completing the liquidation. It is as follows –
- If claims from creditors have been received – the liquidation process should be completed within 270 days from the date of initiation of the process.
- If claims from creditors have not been received – the liquidation process should complete within 90 days.
Do employees get paid?
Payment to employees is usually made in full during the liquidation of a company if employees were working when the resolution professional was appointed (to manage the company as a going concern). In other cases, employees might not get paid.
What happens to the directors?
Directors lose their managerial and decision-making powers when the company goes into liquidation.
Conclusion
Companies may voluntarily or, due to several reasons, wind up their business. This process is termed liquidation. The assets of a company are sold off during the liquidation process to pay off creditors. IBC in India resolves liquidation and bankruptcy issues for companies. Understand the liquidation process to read businesses and their activities better and to analyse good investment options.
