8/26/2008. Chapter 20 Liquidation of companies. What is a winding-up? Winding-up by the court. Process whereby a company is dissolved

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1 Chapter 20 Liquidation of companies Prepared by Emma Holmes What is a winding-up? Process whereby a company is dissolved Company ceases to be a legal entity Also referred to as a liquidation Legal requirements contained in chapter 5 of Corporations Act Two modes: Winding-up in insolvency by the court Voluntary winding-up by members or creditors Accounting method the same in both cases Winding-up by the court Where a company is insolvent, application may be made to the court for winding-up Insolvency is presumed to exist under a number of circumstances set out in the Corporations Act. These include where: A creditor serves a demand for unpaid debts over $2,000 and the debt remains unpaid after 3 months A receiver has been appointed under a floating charge on property Insolvency is the most common reason for liquidation therefore the major accounting problem is the apportionment of limited assets between creditors and shareholders 1

2 Winding-up by the court Corporations Act also contains general grounds for winding-up. These include: The company has resolved by special resolution that it be wound-up The company does not commence business within a year of incorporation or suspends business for more than a year ASIC or APRA issue a request for the company to be wound up Winding-up by the court Liquidator is appointed to oversee the liquidation. The task of the liquidator is to: Take possession of the company s assets Realise the assets or carry on the business as necessary for the beneficial disposal of the assets Determine the creditors and order of priority of payment Pay the creditors Distribute the balance of funds (if any) to shareholders Bring about the dissolution of the company Winding-up by the court The directors must prepare and submit a Statement of Affairs to the liquidator within 14 days of the making of the order for winding-up The Statement of Affairs includes: Summary of assets and liabilities Details of charges over assets and secured liabilities Within 2 months of receipt of the Statement of Affairs the liquidator must lodge a report with ASIC outlining: Estimated assets and liabilities of the company The causes of failure 2

3 Voluntary winding-up A company may be wound-up voluntarily at the instance of either the members or the creditors Members voluntary winding-up Can only occur if the company is solvent Declaration of solvency must be made by the directors and attached to the statement of affairs Voluntary winding-up Creditor s voluntary winding-up Occurs where there is no declaration of solvency. In such cases the winding-up is under the control of both members and creditors Company must provide creditors with a summary of affairs Creditors can nominate a liquidator. Where this is different to the member appointed liquidator the creditors liquidator will be appointed as a replacement Powers of the liquidator Liquidator has wide ranging powers under the Corporations Act. Powers depend on whether the liquidation had been ordered by the court or is voluntary. In both cases liquidators must: Not make any concessions on any debts owing to the company of $20,000 or more Keep proper records in which entries and details of proceedings of meetings must be made Every 6 months during the liquidation appointment, the liquidator must prepare a statement of receipts and payments 3

4 Powers of the liquidator In the case of a court ordered liquidation key powers under s 477(1) include: Carry on the business of the company so far as is necessary for beneficial disposal or winding-up Pay any class of creditors in full Make arrangements with parties claiming to be creditors Come to agreements regarding calls, liabilities and claims existing Other powers are contained in s 477(2) and include everything that is necessary to wind up the affairs of the company and distribute the property Powers of the liquidator In the case of a voluntary liquidation powers are specified under s 506 They include all the powers given under s 477 to court appointed liquidators s 506 also confers some additional powers in relation to performing roles that are performed by the courts in court appointed liquidations (eg. fixing a time when debts and claims must be proved) Priority of payment of debts The general principle under the Act is that all debts and claims rank equally Many expectations to this rule. Four different categories of creditors Secured Preferential unsecured Ordinary unsecured Deferred A summary of priority of payment of creditors (assuming insolvency) is set out on the following slide 4

5 Priority of creditors 1. Secured creditors a) Secured by a specific charge Any excess is returned to the liquidator Any shortfall is classified as an unsecured creditor b) Secured by a floating charge Where there are limited funds available, debts mentioned in items 12, 14 and 15 receive priority 2. Expenses incurred by a liquidator or other relevant authority in preserving, realising, to getting in property of the company, or in carrying on the company s business 3. Costs relating to court ordered applications Priority of creditors 4. Debts relating to the indemnification of the administrator 5. Debts incurred by an official manager (where the management ceased < 2 months prior to the appointment of the liquidator) 6. Costs associated with the preparation of a report as to the affairs of the company in the case of a court ordered liquidation 7. Costs of the audit of the liquidators accounts 8. Auditors fees related to the period of official management referred to in 5 above 9. Any other expenses properly incurred by a liquidator or other relevant authority Priority of creditors 10. Liquidator s remuneration 11. Expenses incurred by members of a committee of inspection 12. Wages and super contributions payable to employees Limited to $2,000 for directors 13. Workers compensation payable 14. Employees leave entitlements Limited to $1,500 for directors 15. Retrenchment payments to employees (excluding directors) 5

6 Priority of creditors 16. Unsecured creditors Includes shortfalls of secured debts and salary & wages, employee entitlements and retrenchment payment to directors Includes all debts payable to the government eg PAYG tax, GST Although utility companies (electricity, telcos etc) are unsecured they commonly receive preferential treatment by threatening to withdraw services 17. Deferred creditors Rights of contributories Contributories are defined as members or past members of a company In certain circumstance past shareholders may be required to contribute in the winding-up Three possible situations may arise Insufficient funds for creditors Sufficient funds to pay creditors, but not to repay share capital A surplus of funds Insufficient funds for creditors Where partly paid shares exist an order may be made to make calls on all or any of the contributories to the extent of their liability Once all shares have been paid in full, and deficiency is borne by creditors Most common scenario in practice 6

7 Sufficient funds to pay creditors, but not to repay share capital Distributions made in accordance with the company s constitution For example, preference shareholders may received preferential treatment over ordinary shareholders Distributions proposed by the liquidator are approved by a special resolution of members It is common for company s constitutions to specify that distributions are made on the basis of the number of shares held, regardless of the issue price of the shares Uncommon in practice Surplus of funds The rights of contributories to participate in a surplus should be specified in the constitution Note that a preference shareholders claim to preferential return of capital does not necessarily give them a right for preferential treatment with regard to a surplus Rare in practice Five main tasks 1. Prepare relevant forms Statement of Affairs Summary of Affairs (creditors voluntary winding-up only) Declaration of solvency (members voluntary winding-up only) 2. Realisation of assets 3. Possession of assets by secured creditors 4. Payment to the creditors in order of priority 5. Return of capital and surplus (if any) to shareholders 7

8 Realisation of assets Realisation of assets accounted for in the company s records using a liquidation account All assets (incl contra account but excl cash) are transferred to this account On realisation of the assets the cash account is debited and the liquidation account is credited Possession of assets by secured creditors Assets over which a specific security is held are commonly taken into possessions by the secured creditor and sold Any net proceeds are handed to the liquidator, with any gain or loss credited to the liquidation account Payment of creditors in order of priority The remaining creditors are paid in order of priority Unrecorded liabilities (such as liquidation expenses) are accounted for by debiting the liquidation account and crediting the appropriate liability On settlement, the liability account is debited and cash credited Where creditors accept an amount lower than the carrying amount of the debt, this represents a discount given to the company and is accounted for by crediting the liquidation account Return of capital to contributories Accounting procedures are: Calculate the distribution for each class of shareholder Make any necessary calls on unpaid capital Transfer share capital to a shareholders distribution account Transfer reserve accounts to the liquidation account Pay distributions by crediting the cash account and debiting the shareholders distribution account Transfer the balance of the liquidation account to the shareholders distribution account 8

9 A summary of movements through the liquidation account is as follows: 9