Liquidation Law: Everything You Need to Know
Liquidation law deals with the process of selling or dissolving a business. The term liquidation refers to the process of ending a company's existence.3 min read
Liquidation law deals with the process of selling or dissolving a business. The term liquidation refers to the process of ending a company's existence. The process involves selling the business's assets or converting them into monetary funds, which are distributed to shareholders, company members, and any outside creditors who are owed money after the company is liquidated. In other words, liquidation occurs when a business turns fixed assets into cash.
Businesses don't need to be insolvent to liquidate; liquidation can be voluntary or involuntarily. An owner may decide to close his or her business. In other instances, a business owner may find themselves forced into liquidation to pay off a loan in foreclosure. If the business's assets are not adequate to cover its debts, the business must be liquidated by Chapter 7 bankruptcy.
Certain types of businesses, like a bank, are required to post a bond to assure there is a proper distribution of assets to creditors. A receiver may be appointed to oversee the distribution as well. The receiver might be required to file a final statement with the receivership court, detailing what was liquidated, what assets are left, and what are the liquidation expenses, in order to obtain the final settlement order.
The Use of a Liquidator
A liquidator may be appointed by the shareholders or the court, and he or she has to answer to the shareholders or creditors. The liquidator represents all creditors' interests. This individual supervises the liquidation, which involves turning the company's assets into cash, discharging the business's liabilities, and then distributing any leftover money to the shareholders in the manner set forth in the company's constitution. Once all these steps are completed, the company has been formally dissolved.
Sometimes a company determines liquidation is necessary, but there needs to be a court order to enforce it. A court order is required if:
- A company was never issued a valid trading certificate within a year of its registration.
- The business is an "old public company," which means it has not re-registered or become a privately-owned company under specific state laws.
- It did not begin operations within the allotted time frame, which is usually within a year of incorporation.
- The company doesn't have enough members to meet statutory requirements.
The Liquidation Process
Once a company has decided to liquidate, the business must be closed, employees let go, and all company assets secured and inventoried. With larger companies, the owner needs to help manage the liquidation. The business owner should select one or more trustworthy employees to help with the process prior to announcing any implementing layoffs. It's not uncommon for unusual behavior to develop once the closure is announced. Some employees may feel cheated, while others believe the sale of the company constitutes a "free-for-all," so it's prudent to watch for sabotage and wholesale theft. This is why having assets secured prior to layoffs is important. Make sure to have valuable goods stored and locks changed.
Once assets are secured and layoffs completed, customers and vendors need to be notified. The owner should then conduct another inventory before involving any third parties in the process.
What Happens to Corporate Assets in Regard to the Liquidation?
Proceeds from the liquidation are required to be distributed to parties in a particular order, which is known as the "priority of claims." There is a specific order of distribution that must be followed:
- Debt security owners
- Preferred stockholders
- Common stockowners
This is one area where the majority of legal claims and lawsuits arise from. For example, if several creditors are vying for priority, the court may need to intervene.
If the business owner feels he or she needs to stop operating the company, but doesn't wish to liquidate its assets, they can sell the company instead. This is only an option if the owner makes the decision early on — before the business fails. Profits may be dwindling or sales slipping, but as long as there is still some value in the business, it's possible to sell it. For a business that's failing, it may be best to let the new owner pay off the purchase cost over time and share the risk with them in the interim.
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