For most people, there is no difference between liquidation, bankruptcy, and insolvency. The terms amount to the same thing – the inability of a person or business to pay their debts.
However, there are important differences to understand – especially if you or your business are facing financial difficulty.
Below is a breakdown of the differences between liquidation, bankruptcy, and insolvency.
Insolvency describes the financial status of a person or business in financial trouble, and the inability to pay their debts when they fall due.
This state generally precedes bankruptcy or liquidation. Both an individual (who may become bankrupt) or a business (which may enter liquidation) can be insolvent.
The causes of insolvency are numerous, often causing significant stress. If you suspect insolvency, acting early to understand your options is best. Common early indicators of insolvency include late payment of superannuation or tax debts, struggling to pay suppliers when due or getting knocked back for extra finance when cash is tight. Leaving it too late to act or seek help may mean bankruptcy or liquidation become inevitable.
When a person or business suspects that they may be insolvent, there are various duties upon them to act in the best interests of their creditors (the people they owe debts to). It is therefore recommended that they seek professional help.
To help work out if your company may be insolvent, further information about possible indicators is here.
In Australia, bankruptcy is a legal process for an individual (not a company) who is unable to pay their outstanding debts.
An independent person known as a bankruptcy trustee, or alternatively the Australian Financial Securities Authority (AFSA – the Government bankruptcy authority) is appointed to manage a person’s financial affairs.
This official will determine whether a bankrupt person owns any assets that may be sold or has disposed of any property which may be recovered. They will assess the individual’s liability for income contributions and also provide information and, (if sufficient funds are realised) pay dividends to their creditors.
The bankruptcy process generally lasts three years and can be initiated in one of two ways.
A person can apply to become bankrupt voluntarily by filing a Debtor’s Petition and Statement of Affairs with AFSA. Either AFSA or a bankruptcy trustee at an insolvency firm will be their trustee. Alternatively, a creditor whose debt is at least $5,000 can file a creditor’s petition at court for an order that the debtor be made bankrupt.
Liquidation is the process of winding up a company’s business: selling its assets, investigating its affairs, recovering any legal claims, and distributing the funds received to creditors and/or shareholders.
A liquidator, registered with the Australian Securities & Investments Commission (ASIC), will be appointed to the company to carry out the liquidation.
There are several different types of liquidation, as follows:
A court-ordered liquidation occurs when a creditor applies to the court to wind up a company that owes it an outstanding debt. To begin the court liquidation process, a creditor can issue a statutory demand on a company to pay a debt pursuant to section 459E of the Corporations Act. This requires the company to pay its debt within 21 days.
Should the company not comply with this demand, the creditor can apply to court to have the company wound up (placed in liquidation).
If successful, a liquidator will be appointed to the company. Upon the liquidator’s appointment, the directors’ powers cease and the liquidator takes control of the company to carry out the above steps.
Creditors voluntary liquidation
Creditors voluntary liquidation (CVL) is similar to a court-ordered liquidation. However, it is commenced voluntarily by a company’s shareholders. No court application is required; it simply requires a shareholders’ resolution.
Directors have a duty not to trade a company while it is insolvent. Accordingly, this option is appropriate where a company has outstanding debts that it cannot pay, and its business has ceased, or it cannot continue to trade viably.
Members voluntary liquidations
This type of liquidation is only available to solvent companies. It is a procedure initiated by the company’s shareholders and involves the winding up of the company’s affairs. Usually, its business has ceased, its assets sold, and perhaps a small amount of funds or loan account balances remain.
The liquidator appointed will use the available funds to pay any remaining creditors and distribute any surplus assets to shareholders.
Various tax benefits are made available through this process and it may be preferable to have an independent person review and finalise the company’s affairs.
Further information about liquidation is available here.
Understanding the difference between liquidation, bankruptcy, and insolvency allows people and businesses to better identify their situation when problems arise. It also helps them understand how they can get assistance with their financial matters in order to avoid bankruptcy or liquidation.
If you suspect your business is insolvent or you can’t pay your debts, get help early to avoid liquidation and bankruptcy.