Liquidation of a company: Definition
If a company or association becomes insolvent or holds too much debt, there are two possible options: insolvency or liquidation.
The decision all depends on what you want to happen to the company or association next. If you are still able to see a future for the organization, then you should consider insolvency. On the other hand, if you’re sure that the fate of your company is sealed, you should consider liquidating your assets as your final act as an owner, shareholder or member of the board of directors.
Liquidation is suitable for both companies and associations. In this article, we will focus on liquidating a company.
The liquidation process is always the same in principle, regardless of a company’s legal form.
What is liquidation? Definition and meaning of the term
Liquidation is appropriate if a corporation or partnership becomes insolvent and therefore needs to be dissolved. The aim is to make the company’s remaining assets (e.g. buildings, machinery, vehicles) liquid in order to meet all your liabilities – i.e. to convert them completely into cash or other funds that can easily be exchanged into cash.
In a business and legal context, “liquidation” (which comes from the Latin liquidaries or “liquefaction”) means the sale of all of a company’s assets with the end result being that the company is terminated.
The remaining assets are also called “liquidation proceeds”. They are intended to:
- Firstly, cover creditor’s claims
- Secondly, be distributed to shareholders or passed to the owner.
Liquidating a sole proprietorship is relatively straightforward, unlike dissolving companies where several shareholders are involved. The decision to liquidate is made by the owner alone. Assets do not have to be divided between multiple individuals and no liquidator needs to be appointed. However, this article describes the liquidation of partnerships involving several shareholders and corporations.
The liquidation process cannot begin until the company has been dissolved according to the legal framework. The dissolution marks the end of the business and initiates the liquidation phase during which all remaining assets are revalued.
Different kinds of liquidation
- Compulsory liquidation: occurs where a business entity is forced to close down by order from a court of law. In order to interfere with the company’s operations, the court needs to have a petition by someone who is connected to the company, such as the company director or any creditor who has not been paid.
- Voluntary liquidation: when the organization’s management team including the directors, members and shareholders, decide to dissolve the company due to the fact that it is unable to carry on functioning. This is mainly because there are not enough funds to perform its operations effectively.
Liquidation: The same as insolvency?
When a company defaults, it usually has two options: either liquidate its remaining assets, or file for bankruptcy.
Liquidation is only possible if a company is either terminated regularly (e.g. because it was only invested for a certain period of time) or if insolvency is rejected due to a lack of assets.
Insolvency proceedings may be initiated if the company is insolvent, is in danger of insolvency or if over-indebtedness is emerging. The insolvency court then provides the company with an insolvency administrator. This ensures that the company is either shut down or resolved in accordance with legal provisions, i.e. closed or rehabilitated to resume normal business operations.
Similarly to liquidation, the company loses all their assets in the event of liquidation as part of insolvency proceedings. However, it stays in its current legal form. Therefore, insolvency makes sense whenever a company needs to be rehabilitated after going bankrupt. On the other hand, liquidation is an option if terminating a company is a matter that has already been decided, or if an application for insolvency was rejected by the court because there wasn’t sufficient money to pay the cost of the court proceedings.
Complete liquidation of a company: Responsibility and implementation
Before a company is brought to a close, if first needs to be properly dissolved. This requires the shareholder’s decision, which must have been made by a three-quarter majority (unless otherwise stipulated in the articles of association). Next, you must file for dissolution with the relevant state and federal authorities and the IRS. The company then becomes a resolution company.
From that point on, a liquidator takes over the settlement process. They must strictly comply with the applicable laws and should therefore be an expert in the field. A board member or the managing director is usually a good pick for this role. It is also possible to designate an external legal or natural person as the liquidator through a clause in the partnership agreement or a resolution in the Annual General Meeting. This individual would then act on behalf of management and represent them in the outside world, and in court. However, regardless of who takes on this task, the Department of Justice will also appoint a trustee to oversee the proceedings to ensure that all legal requirements are being met.
The main objective of a liquidator is to generate as many assets as possible in order to benefit creditors and shareholders. To this end, they are given full power of action and may also close new contracts if necessary.
You can learn more about the rights and obligations of a liquidator in our article on the topic.
A number of laws regulates exactly how the resolution process should be carried out. Certain special regulations apply to some legal forms e.g., for a general partnership, or a limited company.
However, the basic procedure for liquidating a company is the same for all of them:
- Creating a balance sheet: One of the liquidator’s tasks is to obey the rules of proper accounting. This means, for example, that they must draw up a balance sheet on the resolution’s threshold date. They also are responsible for creating a new invoice section for resolving the company.
- Reaching out to creditors: For creditors to be able to bill any outstanding claims against the company, they first need to be informed of the company’s impending closure. To do this, the liquidator must publish a corresponding notice in the company’s relevant bulletins. This could include physical pamphlets, electronic newsletters or business magazines. They must also notify the relevant creditors by mail.
- Settlements: In addition to terminating all ongoing company business, the actual settlement procedure also includes recovering outstanding claims. Similarly, all the company’s outstanding debts must be paid. The liquidator can convert the remaining assets into money if the company’s debts cannot be settled any other way.
- Interim balance sheets: If the settlement process drags on for more than one year, the liquidator must prepare an interim balance sheet including a management report for each financial year. The latter is intended to provide any legal authorities with an insight into the company’s current legal situation and to document that the interests of creditors and shareholders have been safeguarded.
- Final balance sheet: In order to complete the detailed accounts, a final balance sheet should be made at the end of the process.
In fact, the liquidation process itself no longer includes de-registering the business with the Secretary of State. This can only take place once there are no longer any company assets, meaning that a material liquidation has finally been completed. Once this can be confirmed by the Department of Justice, then the company can officially be removed from all registers. Once the formal liquidation is complete, either the liquidator or a third party must keep the company books and documents on file for an additional 10 years in order to make them available should the local or federal tax authorities care to begin a retroactive inspection of the books.
The final step is distributing the assets among the company shareholders – provided that there are any remaining once the outstanding creditors have been paid. However, this step can only take place at the end of a blocking year, which begins when the dissolution announcement is published, and creditors are notified. The way money is distributed among shareholders depends on their nominal shares.
Example: Liquidating a company
Liquidation does not necessarily have to happen only as a result of your company going bankrupt. Sometimes there are other reasons to do so, which might have nothing to do with insolvency. These could include:
Sixty-seven year old Charlie is the head of a craft enterprise and plans to retire after decades of successful work. His greatest wish is that one of his children should take over the family business and continue to run it. However, none of them seem to be interested in this, but Charlie still doesn’t want to see his life’s work in the hands of an external buyer. Instead, he decides to liquidate his company. As the sole shareholder, he can decide to dissolve the company of his own initiative, and start filing for liquidation whenever he sees fit.
Somewhat frustrated that his family business is coming to an end, Charlie is reluctant to deal with the settlement details himself. So, he hires his old friend Carl, a person he trusts and who has the necessary professional skills, and appoints him the official liquidator. From now on, Carl will take care of anything associated with liquidating Charlie’s company – including the public dissolution announcement and informing creditors, as well as handling the accounting aspects.
Within the financial year, Carl is able to sell all the company machines, resulting in a considerable sum of liquidation proceeds. Charlie does not have to include the land his company is located on in the procedure, since he wants to keep it. Once all the creditor claims have been satisfied and all necessary liquidation measures have been taken, Carl officially dissolves the company and removes it from the Secretary of State’s register. Charlie takes responsibility for the business books and documents with the intention of safeguarding them for the next decade. Now, he just has to wait until the end of the mandatory blocking year to start withdrawing from the company’s assets.
In the 1&1 IONOS Startup Guide, you can also find out more information about the exact procedures for dissolving a limited company and other legal forms.