Q&A: What is liquidation and what does it mean for your business?

by Grazia Zhou
19 June 2013

In brief - Your business can be affected if a customer has gone into liquidation due to insolvency

If a company goes into liquidation and owes you money, whether you get it back from the liquidator depends on a number of factors, including whether there is money available to make any payments at all.

I have just found out that one of my customers has gone into liquidation. What does that mean?

Liquidation, also referred to as "winding up", is the process by which a company’s assets are liquidated and the company closed, or deregistered.

There is one term that is crucial to understanding liquidation:"insolvent". A company is solvent if it can pay its debts when they fall due and insolvent if it can’t. The financial state of the company is important because it determines what kind of liquidation the company will enter, as well as the types of investigations that a liquidator will undertake.

A solvent company is brought to an end via a members' voluntary winding up. By contrast, an insolvent company can be wound up by the court or by a creditors' voluntary winding up. This last method is called a creditors' voluntary winding up because, while the company's members decide whether to appoint a liquidator, it is the creditors who decide whether a liquidator will stay involved in the company.

Your business will only be affected if your customer has gone into liquidation due to insolvency. In a members' voluntary winding up, the company's debts will all be paid. Where a company is insolvent, this doesn't always happen. This article focuses on the processes involved in court liquidation and in creditors’ voluntary wind-ups of insolvent companies.

What is the role of the liquidator?

The role of the liquidator in an insolvent liquidation is essentially to collect, and deal with, the company's assets, and, where possible, to make a distribution to the creditors and only then to the members.

The liquidator also conducts investigations into the failure of the company, the conduct of its directors and, sometimes, the conduct of third parties, like creditors.

What happens after the liquidator is appointed?

The liquidator must follow particular timeframes as set out by the relevant legislation.

Once the company is placed into liquidation, the liquidator will send out a notice to known creditors. The notices may include proof of debt forms and proxy forms for voting at meetings called by the liquidator, depending, in part, on whether there are funds available in the company.

If there are funds in the insolvent company, the proof of debt lets you tell the liquidator how much the company owes you and why. The liquidator will look at each proof of debt and decide whether the claim is valid. If the claim is rejected by the liquidator, either in whole or in part, no payment will be available to that creditor.

The liquidator may decide to take action against directors and/or third parties, including court proceedings. This will lengthen the process of the liquidation. It will also impact the amount, if any, that is available for distribution to creditors.

That company owes me money. Will I get it back from the liquidator?

Unfortunately, there is no absolute answer to that question. Assuming that your proof of debt is accepted by the liquidator, there are many factors which influence whether or not you will receive a payment, including:

• The company may not have enough money available to make any payments at all.

• If there is money available, there is a specific order of payment which a liquidator must follow. Depending on where your claim sits, you may not be entitled to a payment, or a full payment.

The situation is slightly different if your debt is secured. An example of a secured debt would be a debt secured by a retention of title clause and which has been properly registered under the new Personal Property Securities Act. If your debt is secured, you sit outside the liquidation and you can rely on the security to get your money back. However, sometimes a secured debt will be included in the liquidation process.

The liquidator is talking about unfair preferences. What does that mean?

A liquidator has the power to "claw back" certain transactions, including certain transactions involving a creditor. These transactions are known as "unfair preferences".

An unfair preference is a payment made to a creditor in the six months before the liquidation started (or the date that the application was filed in the case of a court ordered liquidation). The payment must have been received while the company was insolvent or it causes the company to become insolvent, and the creditor must have received more than it would have received in the liquidation.

Liquidators can claw back unfair preferences via an application to the court. If your business receives a preference claim, it's best to see a lawyer.