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written by | April 18, 2022

Liquidation of a Company and the Causes for Insolvency

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What is the liquidation of a company? The success of a business depends upon its constant innovation and expansion. Some commercial enterprises reach a stage where they are unable to settle the financial obligations of their creditors, and this forces them to make a sale of all their assets to settle those dues. If a company is in very heavy debt, it liquidates its entire stocks before shutting shop.

In some cases, a company can manage to repay its debtors by selling a certain portion of its stocks. The remaining assets or stocks are then divided practically among the shareholders of the company. This is often dependent on their individual stakes in the organisation.

A person who is legally authorised to dispose of the stocks of an organisation that is in a state of heavy debts is referred to as a liquidator. Such a person sells the assets of the said company in order to obtain cash for the organisation to settle all its dues before it shuts down permanently. A court of law appoints liquidators to complete such formalities. In some cases, the shareholders of the organisation appoint a liquidator to do the needful.

Did you know?

That Varun Industries was the first big-ticket Indian corporate that went into liquidation on charges of the inability towards the repayment of debts amounting to ₹2,000 crores?

Why do Some Organisations Become Insolvent?

There are multiple reasons for an organisation to become insolvent. When it does, it goes into liquidation. Let us understand some of the reasons behind this state of affairs.

  • Poor vision and lack of innovation
  • Market competition and inability to face the challenges
  • Decrease in demand leading to losses
  • Reduced cash flow and piling of debts
  • Inability to pay settle loan payments

Also Read: Definition of Liquidity Ratio and Formula With Examples

Types of Liquidation

Compulsory

In most cases, this involves one of the creditors filing a petition in court. However, the shareholders, as well as the board of directors, can also file for compulsory liquidation if they so choose to. In a compulsory liquidation, the court demands the sale of assets to settle the debts of the firm in order to make the payments to the creditors. Before the actual liquidation, it is the appointed judge who makes the final decision on the necessity of a liquidation.

Voluntary

This occurs with the mutual consent of all the stakeholders of the organisation. There are some cases where the primary shareholder parts ways with the organisation. In such a situation, the other shareholders decide whether to continue with the firm's functioning or call for liquidation.

Understanding the Insolvency & Bankruptcy Code (IBC)

The President of India sanctioned the Insolvency & Bankruptcy Code (IBC) on May 28th, 2016. It was introduced to address the various inadequacies of the insolvency laws in India, which seemed to take too long to come into effect. In the United Kingdom, the insolvency resolution takes only 365 days, whereas it takes about 18 months in the USA. The insolvency resolution takes 24 months in South Africa, whereas, in India, there is no timeframe. India was ranked towards the bottom of the hierarchy ladder when it came to resolving insolvency cases. This code has impacted positively and has helped ease the various processes of conducting commerce in India.

Earlier, there were unnecessary delays in arriving at a resolution. The Insolvency & Bankruptcy Code (IBC) helped to consolidate and also revise the laws pertaining to the insolvency resolution and re-organising of a partnership organisation, individuals, or the concerned personnel in a corporate in a timely manner. This was purely to boost entrepreneurship, credit availability, and maintain the interests of the shareholders. This new code ensures a seamless process that will help to re-organise the organisation's dues, a faster liquidation, and an effective recovery of the investments made by the creditors.

The framework of the new code includes the following details:

  • The regulating authority will be the Insolvency & Bankruptcy Board of India, referred to as IBBI.
  • Specific personnel - Will act as mediators to assist finance institutes, sick units, and banks to manage the takeover of the insolvent businesses and the process of liquidation.
  • The establishment of a timeframe for the processes of liquidation, if need be, and the insolvency resolution. 

This will be the responsibility of the:

  • Adjudicatory mechanisms
  • Information utilities

The above two act as repositories of all crucial information of debtors. This would help to speed up the process of insolvency resolution.

The Insolvency & Bankruptcy Code (IBC) authorises the following entities, namely:

  • The National Company Law Tribunal (NCLT) – To manage all issues pertaining to Companies and Limited Liability Partnership
  • Debt Recovery Tribunal – (DRT) – To manage issues for individuals as well as partnership firms

In brief, this IBC code is responsible for creating a specific time frame of approximately 180 days to enforce the said laws towards the settlement of insolvency of a business. It also aims to increase the said value of stocks of the interested individuals, increase the amount of available credit, and maintain a healthy balance of the interests of the shareholders.

Also Read: Everything you need to know about Contingent Liabilities

Liquidation Order

A liquidator is a specific individual appointed to take stock of all the assets of an organisation that has gone into a state of liquidation. The liquidator collects the assets in order to fulfil the payment obligations of the creditors. A liquidation order is passed by adjudicating authority. This is in accordance with Section 33 of the insolvency code. The order states that the concerned debtor will be dissolved from the date mentioned in the order as per Section 59 (8) of the insolvency and bankruptcy code 2016. When it comes to financing, liquidation meaning in accounting implies the procedure of bringing the commercial activities of a business to an end. After that, the assets are distributed to the said stakeholders.

Conclusion

The various details help you understand the meaning of liquidation and the responsibilities of a liquidator. It clearly outlines the difference brought about by the introduction of the insolvency and bankruptcy code 2016.

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FAQs

Q: Who are the first beneficiaries when a commercial business gets liquidated?

Ans:

The first beneficiaries are the secured creditors. The next beneficiaries include the unsecured creditors and employees to whom payments have not been paid. The last in the line of beneficiaries are the shareholders.

Q: What is liquidation meaning?

Ans:

When an organisation’s debts exceed its earnings, and it is unable to sustain its operations, it goes into liquidation. Its stocks are sold to settle its dues, and the business shutters come down.

Q: Who is a liquidator in company law?

Ans:

As per the company law, a Liquidator is authorised to take action on behalf of a firm, settle all its pending liabilities, and generate cash to repay all its creditors.

Q: How do you define liquidation?

Ans:

Liquidation involves a procedure of ending the operations of a business by the sale of its assets to pay the creditors. The remaining stocks, if any, are distributed amongst the shareholders.

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The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.
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Disclaimer :
The information, product and services provided on this website are provided on an “as is” and “as available” basis without any warranty or representation, express or implied. Khatabook Blogs are meant purely for educational discussion of financial products and services. Khatabook does not make a guarantee that the service will meet your requirements, or that it will be uninterrupted, timely and secure, and that errors, if any, will be corrected. The material and information contained herein is for general information purposes only. Consult a professional before relying on the information to make any legal, financial or business decisions. Use this information strictly at your own risk. Khatabook will not be liable for any false, inaccurate or incomplete information present on the website. Although every effort is made to ensure that the information contained in this website is updated, relevant and accurate, Khatabook makes no guarantees about the completeness, reliability, accuracy, suitability or availability with respect to the website or the information, product, services or related graphics contained on the website for any purpose. Khatabook will not be liable for the website being temporarily unavailable, due to any technical issues or otherwise, beyond its control and for any loss or damage suffered as a result of the use of or access to, or inability to use or access to this website whatsoever.