Compulsory liquidation is the process of following court orders to dissolve a company and sell its assets to satisfy creditors.
This process often takes place with creditors appearing in court. However, other stakeholders like regulators and shareholders can also apply for it.
Let us discuss what is compulsory liquidation, how it works, and what are the important phases during this process.
What is Compulsory Liquidation?
Compulsory liquidation is a formal procedure followed by court orders to start a company liquidation if certain conditions are not satisfied.
The procedure may end up in a complete shutdown of the company as well. The most common reason for compulsory liquidation is a creditor filing due to unpaid debt.
The process begins with a winding up application and the court orders to repay the outstanding debt within seven days. If the company does not oblige or cannot repay within this time, it will enter the insolvency phase.
Compulsory liquidation is called compulsory winding up. The procedure is likely initiated by creditors and lenders. It affects every stakeholder of the company including shareholders, directors, employees, and creditors.
Compulsory liquidation is defined similarly in the UK and the US. However, the relevant codes of law apply in the respective jurisdictions of a company.
In the US, compulsory liquidation is defined by the Chapter 7 code, and in the UK, it is defined by the insolvency act 1986.
What is the Process of Compulsory Liquidation?
A company can face compulsory liquidation in the following scenarios:
- If the company fails to repay its debts and the court determines that the company must be liquidated to pay off its debt obligations.
- If the majority of the shareholders (75%) of the company vote for it after a court declaration.
- If the court determines the company liquidation is just and equitable under the present circumstances.
- Other situations where a company fails to meet regulatory requirements. For example, if a public company cannot obtain a trade certificate after one year of business inactivity.
Compulsory liquidation comes through a court order and the evidence can vary depending on the petition filer. The most common reason is the failure to repay debts.
The process follows the following steps.
- Filing a Petition
The first phase is to file a petition for the liquidation procedure. A creditor or any other petitioner approaches the court and files a petition against the company.
The court hears the petition and can decide on different outcomes. If the court issues a petition, the company has seven days to pay its debt.
- Issuing Windup Orders
Both parties can attend court proceedings after seven days if the dispute does not resolve. The court will hear the arguments and issue the decision.
If the court decides the company should be shut down, an official liquidator will be appointed.
- Control of Business
If the court issues winding up orders, the official liquidator officer will assume charge of the business. The company board of directors will be dissolved and company operations will be ceased.
- Liquidation of Company Assets
The liquidator will then start the liquidation of company assets including its tangible and intangible assets. Cash available will also be used to repay its debt obligations.
Company creditors and shareholders will be paid in priority order.
- Dissolving the Company
Depending on the court order, the next phase will be to dissolve the company. This is the phase where the company will be officially removed from the company’s registrar’s office.
- Investigation of BOD Role
In many cases, the creditors or shareholders may further appeal to investigate the role of the board of directors.
Depending on the evidence, the court may also issue investigation orders to assess the BOD’s role leading up to the insolvency stage of the company.
Who Applies for Compulsory Liquidation?
Several stakeholders of a company can apply for company liquidation. The procedure can take the voluntary or compulsory liquidation option.
One of the creditors can appeal for company liquidation. In fact, creditors appealing for the liquidation of company assets is the largest proportion of all petitions.
However, creditors would use this option as a last resort as it is an expensive route.
One of the regulatory authorities can file a petition against a company for financial misconduct or other reasons as well.
Community welfare societies and other bodies may also become petitioners against a company’s misconduct.
A company itself can apply for voluntary liquidation as well. The process can take place through the company’s shareholders with a majority vote or company directors.
Liquidation of Company Assets
Liquidation of company assets is a major phase during the whole process. The designated liquidation officer will start the process.
The liquidation officer will start disposing of company assets at their fair market values. The aim would be to get the best market prices for the company assets.
At the same time, creditors will be asked to present their debt agreements. Also, the liquidation officer will prioritize creditors according to debt type.
Once all assets of the company are converted into cash, they will be distributed among creditors in order. If there is any cash remaining, it will be distributed among shareholders in the last phase.
Creditors with secured debts will be paid first and then creditors with unsecured debts. Preferred shareholders and employees with unpaid balances will then be paid before common shareholders.
Dissolution of the Company
Once all assets of the company are liquidated, the next important phase is to dissolve the company formally.
During this phase, the liquidator will prepare the final notice for all stakeholders including creditors, shareholders, and regulators.
At this stage, the regulatory authorities may involve if any taxes or other financial obligations are due from the company. Usually, regulators remain a priority above creditors to receive due taxes.
Then, the liquidator will file for company dissolution in the company registrar’s office. The state authorities will formally record company liquidation.
Can the Compulsory Liquidation be Challenged?
Yes, company liquidation can be challenged in a few ways.
First of all, if all debt is paid within seven days of issuing the wind-up orders, the process of company liquidation will stop. If the petitioner is satisfied, the order can be reversed.
Then, if there are any legal grounds that one of the stakeholders of the company can argue against, they can challenge the compulsory liquidation orders in court.
In other cases, the company may negotiate new terms and conditions for debt restructuring or repayment.
Either way, the compulsory liquidation order can only be reversed or challenged if there is a solid reason legal or otherwise.
Post-Liquidation Situation of the Company Stakeholders
The company directors may not be personally liable for the insolvency of the company. However, their role continues during and after the liquidation of the company in different ways.
The directors will have to assist the liquidator in the whole process. This phase includes assessing the company’s financial affairs, debt prioritization, asset liquidation, and so on.
The role of creditors during and after the orders will be to resolve their debt issues. Once they’re paid, they must inform the court formally.
Shareholders of the company remain at the last in the case of compulsory liquidation. Usually, the stocks of an insolvent company fall and there is little left for shareholders after settling all debt obligations.
Depending on the company structure and personal guarantees for debt contracts, shareholders may be held personally liable for the company’s debt repayments during the liquidation process.
Compulsory Liquidation Vs Voluntary Liquidation
A creditor’s voluntary liquidation or simply voluntary liquidation is the same process but with the mutual consent of creditors and the company.
In this process, the company directors reach out to the creditors for liquidation of company assets if they cannot repay through company earnings.
If the creditors agree to the offer, they may enter into a voluntary liquidation agreement with the company.
Voluntary liquidation happens when directors feel they can repay debts through asset liquidation. Company employees also feel safer with this option.
Also, the directors put their efforts to get the maximum value for company assets. This process is also quicker and less expensive for all stakeholders as it does not involve legal fees.
Unlike compulsory liquidation, company directors will directly be involved and retain control of the whole process in voluntary liquidation.