Being a company director during liquidation is a tough job. You’re no longer in control of the company, but you are obliged to help.

The process of liquidation can be a long and complex one, and directors often find themselves in the firing line. When a company goes into liquidation, the liquidator may investigate the company’s historical affairs. The liquidator may then take action against the directors if they were involved in insolvent trading, uncommercial transactions, or have loans due and owing to the company. The recovery proceedings against the directors can result in personal bankruptcy.

If you’re the director of a company in liquidation, you need to understand your rights and responsibilities. In this article, our specialist insolvency lawyers take a look at what happens to directors of companies in liquidation. You’ll find advice on how to protect yourself if your firm enters into process.

What does liquidating a company mean?

When a company can’t pay its debts, it needs to be restructured (find a way out of trouble by getting in new capital or reducing its debt to a manageable level). Alternatively, the company can be wound up (dismantled, with anything of worth sold to pay debts and then shareholders).

Companies can be wound up voluntarily, which might involve going into administration. Going into administration involves appointing an administrator to conduct investigations on the company. The administrator will then report their findings to the creditors and recommend the next steps. At the second meeting in a voluntary administration, the creditors will vote to either:

• Hand the company back to the directors;
• Appoint a liquidator; or
• Enter into a deed of company arrangement.

Companies can also be wound up by court order. When this happens, the company goes into liquidation. When a company is in liquidation, a liquidator is appointed. The liquidator takes control of the company and is responsible for extracting as much value as possible to pay creditors. This includes selling any assets the company has. (More information here on winding up orders)

Why do companies liquidate?

There are a number of reasons why a company might be wound up. Some common reasons are:

• The company is insolvent (its assets are not enough to cover its liabilities and debts to creditors). This means that the company is unable to pay its debts as and when they fall due. In this case, the company must stop trading.
• The company’s shareholders agree that it’s in the company’s best interest to be wound up.

What are the different types of liquidation?

The three most common forms of liquidation in Australia are creditors’ voluntary liquidation (CVL), members’ voluntary liquidation (MVL) and court liquidation. A less common form of liquidation is provisional liquidation, which takes place when the court foresees the need to appoint a temporary liquidator.

What is creditors’ voluntary liquidation?
A creditors’ voluntary liquidation is when an insolvent company has creditors and the shareholders of the company propose to liquidate the company because the company can’t pay the debts. A liquidator is appointed to manage the process, and the liquidator is required to act independently to ensure the law is followed.

What is members’ voluntary liquidation?
Members’ voluntary liquidation is an option when the company is solvent, but the directors propose liquidation to the shareholders for other reasons. First, the company directors make a declaration of solvency. Then the members (shareholders) vote on whether to accept the proposal. If the proposal is accepted, a liquidator is appointed to wind up the company’s affairs.

What is a court-ordered liquidation?
A court-ordered liquidation is when the court orders the winding up of a company. This is done on the application of a creditor, the directors or the shareholders of the company. A court-ordered liquidation commonly begins with a statutory demand from a creditor pursuing a debt.
If the debt is not paid, or the company does not reach an agreement with the creditor, the creditor who issued the statutory demand may apply to have the company wound up. The court will appoint a liquidator to manage the process.

What happens to a dissolved company’s debts?

When a company goes into liquidation, its assets are sold off and the proceeds are used to pay off its debts.

The company directors are not personally responsible for paying back debts that can’t be paid by the company. However, directors will be personally liable if:

1. The director has given a personal guarantee on the company debt, they will be held personally liable for that debt.
2. A company director allowed the company to trade while insolvent, the director may be held personally liable for the company’s debts. (Insolvent trading is also a crime in Australia.)

If you are a director of a company in liquidation, you need to seek legal advice. An experienced lawyer can advise you on your rights and obligations. The earlier you seek advice, the more options are likely to be available to you.

Who gets paid first when a company is liquidated?

The priority for payments in a court-ordered liquidation under Section 556 of the Corporations Act 2001 (Cth) is as follows:

1. The liquidator’s fees and expenses.
2. The petitioning creditor’s expenses.
3. Priority employee entitlements (as defined in Section 561 of the Corporations Act).
4. Secured creditors.
5. Non-priority employee entitlements.
6. Shareholders, who are last in line as the owners of the company. They will receive whatever is left, if anything, after everyone else has been paid.

Are directors liable for debts in liquidation?

The priority for payments in a court-ordered liquidation under Section 556 of the Corporations Act 2001 (Cth) is as follows:

1. The liquidator’s fees and expenses.
2. The petitioning creditor’s expenses.
3. Priority employee entitlements (as defined in Section 561 of the Corporations Act).
4. Secured creditors.
5. Non-priority employee entitlements.
6. Shareholders, who are last in line as the owners of the company. They will receive whatever is left, if anything, after everyone else has been paid.

Are directors liable for debts in liquidation?

The general rule during a company liquidation (either voluntary or compulsory) is the directors are not liable for company debts. However, there are a few exceptions to this rule. Directors can be held liable for debts in certain circumstances.

Some of the situations where directors may be held liable for debts include:

• If the director has given a personal guarantee to a company debt.
• If the director has been found to have engaged in insolvent trading because they knew (or should have known) the company was insolvent.
• If the director has breached their duties owed to the business or its creditors.

If you are a director of a company that is being liquidated, it is important to seek professional advice to ensure you are not exposed to personal liability.

What happens to directors of a liquidated company?

When a company is liquidated, its assets are sold off and the proceeds are used to pay off its debts. The company directors are (usually) not personally liable for the company’s debts, unless they allowed the company to trade while insolvent or otherwise broken the law.

Removal of directors’ powers during liquidation

The directors of a company in liquidation lose their powers and authority over the company. They can no longer make decisions about company affairs or control its assets. They are, however, required to assist the liquidator.

Personal liability for company debts

Directors may be personally liable if they have a personal guarantee over the company debt. They may also be held responsible if they were found to be involved in:

• Allowing the company to trade while the director knew (or should have known) the company was insolvent.
• Misusing business funds.

What are the directors’ duties during liquidation?

Once a company is placed into liquidation, the directors’ powers are removed. They cannot make business decisions or access the company’s finances. Their role becomes one of assisting the liquidator in winding up the company’s affairs. This typically involves helping to locate and sell off assets, as well as liaising with creditors.

The company is no longer trading, so directors will usually not receive any further pay or benefits from the company. However, they may be able to claim some expenses incurred during the liquidation process.

Once the liquidation is complete, the directors’ role with the firm will end.

Directors of companies in liquidation should seek legal advice to ensure they understand their rights and obligations during the liquidation process.

What are the benefits of liquidating a company?

Companies are liquidated to divide their assets fairly between creditors, which might include employees and shareholders. When a company is liquidated, all of its assets are sold off and the proceeds are used to pay off creditors. Any funds left over are divided among the shareholders.

One benefit of liquidating a company is that it can help a business avoid the cost of restructuring and lay-offs. If a business is facing financial challenges, liquidating can be a cheaper and simpler alternative to undertaking a major restructuring.

Finally, liquidating a company can also be a good step towards a fresh start. It can allow owners and managers to start anew with a clean slate. This can be especially helpful if the business is facing serious financial distress.

What are the disadvantages of liquidating a company?

The potential disadvantages associated with liquidating a company mostly relate to companies that don’t have enough assets to cover their liabilities or to return anything to shareholders. If a company cannot pay its debts, there is no choice but to liquidate if the directors can’t secure financing or an agreement to reduce the debt to a level the company can service.

Creditors may not be paid in full

There is a hierarchy of creditors that dictates who will be paid first in the event of a liquidation. Secured creditors, often banks and other financial institutions, are typically at the top of the list. They are followed by employees, then unsecured creditors (However, certain employee entitlements may trump that of secured creditors in priority).

This means if the proceeds from the asset sales aren’t sufficient to cover all debts, some creditors may not be paid in full (or at all).

Shareholders may receive nothing for their investment in the company
Once the company debt has been paid, any remaining assets are distributed to shareholders. In some cases, however, there will be no assets left after the liquidation process is complete. This means that shareholders may receive nothing for their investment.

The liquidation process can be lengthy and expensive
The process of liquidating a company can be complex and time-consuming. Especially if the business has a large number of assets and creditors. The costs associated with liquidating a company can also be significant. Those costs will eat away at the proceeds from the asset sales.

The company’s directors may be held liable for the debts of the company
Directors can be held personally liable for the company debt if, for example, it is found that they have engaged in insolvent trading. This means that directors may be required to pay back debts owed to creditors out of their own pockets.

As an asset protection measure, directors may be advised to place their assets in someone else’s name, like their spouse. However, liquidators can ask the court to investigate the legitimacy of such arrangements, so directors should always take advice from an experienced lawyer.

Will liquidation affect a director’s credit rating?

When your company goes into liquidation, it may be listed in credit rating agencies along with the names of the directors. If someone does a name search at a credit rating agency, they will have access to the last seven years’ information about companies that were liquidated.

If you’re applying for credit in a personal capacity, these details are unlikely to be brought up. Unlike personal bankruptcy, a firm is considered a separate entity from its directors. That means directors do not need to automatically assume a company’s debts.

If you’re a director of a company that entered into a members’ voluntary liquidation, your credit rating won’t be affected at all.

Can directors start a new business after liquidation?

The short answer to this question is yes. Company directors can start a new business after liquidation. However, there are a few things you’ll need to consider if you’re thinking of starting a new business venture after your firm has been through liquidation.

For one, the Australian Securities and Investments Commission (ASIC) will be keeping a close eye on you. If you’ve been a director of two or more companies that have been liquidated in the past seven years, ASIC has the power to disqualify you from being a director.

With all of that said, there’s no reason why you can’t start a new business after your company has been through liquidation. Just be sure to understand the risks and challenges involved before moving forward.

Know your options during the liquidation process

The end of one business can be hard for all involved. But it is important to know the options available to company directors. As a director of a company in liquidation, you have responsibilities to fulfil. By understanding your role and the process that will happen, you can ensure that the company is wound up fairly and in accordance with the law.

If you are facing liquidation or need help winding up a company, our team at Twomey Dispute Lawyers are here to assist. We can provide you with the support and legal guidance you need to navigate this difficult time. Call us for a confidential chat on 1300 286 578 or email us at info@tdllaw.com.au

Important note on this article

This article discusses the general state of affairs, which could change at any time because the law can change at any time. Also, your situation is unique, so an article like this one can’t give you all your options, and some of the options discussed here might not apply to you. For those reasons and others, you mustn’t treat what you’ve read here as legal advice for you. What you should do as soon as possible is get legal advice specific to you if you are affected by anything discussed above.

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