What it means
Liquidation is the end of a company's life rather than a stage in it. Once it begins, control passes from the directors to a licensed liquidator whose duty is to creditors as a group, not to the owners or to any single creditor.
There are two broad flavours. A solvent liquidation, sometimes called a members' voluntary winding up, happens when a company can pay everything it owes and the owners want to close it and take out what is left; an insolvent liquidation happens when it cannot, and the process becomes about splitting up too little money fairly.
The order of payment is the heart of the process and is fixed by law rather than by negotiation. Liquidator fees and costs come first, then secured creditors against their security, then preferential claims such as certain employee entitlements, then unsecured creditors, and shareholders only if something remains.
That ordering explains why shareholders in an insolvent liquidation almost always receive nothing. Unsecured creditors typically recover a fraction of what they are owed, quoted as cents in the dollar, and equity sits behind all of them.
Liquidation is not the same as administration or restructuring, both of which try to keep a business trading. Liquidation accepts that the business is over and concentrates on turning what is left into cash and distributing it, which is why the recoveries are so much lower than in a rescue.
In practice
Real-world examples.
Example
A profitable consultancy whose two owners are retiring goes through a solvent liquidation, settles its final tax bill and distributes the remaining $640,000 to the owners as capital. Nobody is left unpaid, and the process is essentially an orderly closing of the books.
Example
A regional airline is placed into compulsory liquidation after a court petition from an unpaid fuel supplier. Aircraft leases are returned to their owners, ticket holders join the queue of unsecured creditors, and the eventual recovery is a few cents in the dollar.
Example
A manufacturer's liquidator sells the brand name and customer list separately from the machinery, because a competitor will pay more for the customer relationships than for the presses. Splitting the assets raises the total realised and improves the recovery for creditors.
Formula
Calculation
Amount available to a class of creditors = realised assets - liquidator costs - all higher ranking claims. Recovery rate = amount available to that class / total claims of that class.
Halloway Fabrication enters an insolvent liquidation. The liquidator sells the plant, vehicles and stock and collects the receivables, realising $3,000,000 in total. Liquidator fees and legal costs come to $250,000.
A bank holds a first charge over the equipment and is owed $1,200,000, which is paid next. Preferential claims for unpaid wages and holiday pay total $300,000 and rank after the secured lender. That leaves $3,000,000 - $250,000 - $1,200,000 - $300,000 = $1,250,000 for the unsecured creditors.
Unsecured trade creditors are owed $2,000,000 in total, so the recovery rate is $1,250,000 / $2,000,000 = 62.5%, or 62.5 cents in the dollar. A supplier owed $80,000 therefore receives 62.5% x $80,000 = $50,000, and the shareholders receive nothing because the money runs out before equity is reached.Case study
Seen in the real world.
Marlow Instrument Works is a fictional precision engineering firm used purely to illustrate how the waterfall plays out. After losing a defence contract it entered liquidation owing $1,800,000 to trade suppliers, $900,000 to its bank under a charge over machinery, and $210,000 in unpaid employee entitlements.
The liquidator realised $1,650,000, mostly from the machinery and a workshop lease assignment, and charged $180,000 in fees. The bank recovered its $900,000 in full because the machinery alone fetched more than that, employees were paid their $210,000 in full as preferential claimants, and $360,000 remained for suppliers owed $1,800,000.
Suppliers therefore received 20 cents in the dollar, and the two founders received nothing for shares they had held for eighteen years. This illustrative example shows how quickly the money runs out and why the ranking rules, which look dry on paper, decide who actually gets paid.
Watch out
Common mistakes.
- Using liquidation and bankruptcy interchangeably, when bankruptcy in most systems applies to individuals and liquidation to companies.
- Assuming a director can pay a favoured supplier just before liquidation, when such preferences can be reversed by the liquidator.
- Expecting shareholders to receive something in an insolvent liquidation, when equity ranks last and almost always receives nothing.
Questions
People also ask.
How long does a liquidation take?
Simple cases can finish within a year, but complex ones with disputed claims or litigation regularly run for several years.
Is liquidation the same as administration?
No, administration aims to rescue the business or get a better result than an immediate winding up, whereas liquidation ends the company.
Do employees lose everything if their employer is liquidated?
Not necessarily; certain wage and holiday entitlements rank as preferential claims ahead of unsecured creditors, and many countries also run a government safety net scheme.
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