Grasping the Legal Issues When Liquidating a Small Business or Partnership
Liquidation is the process of gathering the assets of a business to settle the corporate debts. Once this process is completed, the business is then dissolved. One should not rush into this; it is important to take advice about whether this is the best route for your business. If it is insolvent with serious debts, there may be no choice—creditors can actually petition for its liquidation. However, where the business is solvent or when you as the owner can confidently expect to be able to pay off debts, then the potential options for voluntary dissolution should be explored. Partnerships offer special challenges, as this article reviews along with other kinds of liquidations.
As a partnership has no separate legal identity, it may be dissolved by an agreement between the partners or by notice of dissolution given by one partner to the others. Just as the partners agreed to join, they may agree to split. In some cases, the partnership agreement may provide for dissolution after a specified period of time or on other set terms.
Once an agreement has been reached, dissolution may proceed in the normal way—usually handled by the partners themselves. Partnership accounts are prepared and the dissolution should then be advertised. It is critical that all clients be given notice that the business has been wound up; issuing of this notice represents the end of the partners' authority to agree to contracts and transactions with clients.
Liquidation is a legal process resulting in a company ceasing to exist. Liquidation involves distributing a company's assets to pay off creditor debts. Following liquidation, the company literally ceases to exist. A company may be liquidated either voluntarily by its owners/shareholders or through the courts, by creditors who petition to recover funds or assets loaned or sold to a company.
As always, one needs to talk with legal counsel to determine the exact status and liabilities of your own partnership. In general, where a business is insolvent and partners cannot pay its debts, it may be treated as an unregistered company, much like a bankrupt company is treated. If the principle of unlimited liability can be invoked, however, once partnership assets have been exhausted in the payment of creditors, creditors may be able to lodge petitions against the partners' individual estates. Don't be surprised if the wealthier partners find that partnership creditors pursue their assets before those of their co-partners.
Often, when joint bankruptcy orders are made against partners, an official receiver immediately becomes trustee of the partners' separate estates and trustee of the partnership. The partnership is then liquidated—that is, assets will be gathered in and used to settle business debts, and then the partnership is dissolved.
Unlike sole owners (a sole proprietorship), whose personal and business assets are counted together for the purposes of creditors in bankruptcy, in a partnership, separate accounts must be kept of the joint (partnership) estate, and of each partner's individual estate. This is because, in fact, there are multiple owners. Once a partnership is dissolved, separate statements of affairs for joint and individual estates must be lodged with the court.
In any kind of liquidation, you cannot dispose of valuable assets before the bankruptcy, either by giving them away or selling them cheaply to relatives or friends, unless it can be solidly proven that the disposal was an innocent transaction.
Through unlimited liability, it's conceivable that a situation may arise where two sets of creditors are chasing payment of debts from partners—creditors owed money by the business along with personal creditors of individual partners. In such cases, partnership assets should be used to pay off partnership debts, while partners' individual estates are used to pay off their individual personal debts. Logic prevails in such cases: Any surplus in the joint estate then goes to the partners' estates in proportion to their share in the partnership, while any surplus from partners' estates goes to the joint estate to pay off partnership debts.
You should note that certain "secured creditors" may have direct claims on specific assets which will need to be satisfied first of all. Other creditors may be designated "preferred," "ordinary," or "deferred," and thus will be paid according to their status.
If a company is facing serious financial trouble, its members/directors may decide that liquidation is the only option for the business. This is a hard call, and you should discuss this option only if you are certain that future revenues cannot possibly cover the expenses (past and present) of the business. To guarantee that you are taking the right steps to improve your company's situation, check with appropriate legal counsels to see what options are available to you.
Compulsory liquidation occurs when a court orders a company into liquidation. This normally happens following a petition from a creditor or group of creditors. These would be capital providers (say, a bank) or suppliers (even subcontractors) who no longer believe that a company will pay its debts. Thus, these creditors move to seize what assets they can.
Following a court order, an official receiver will be appointed as liquidator by the court to handle the shutting down of the company and to investigate the possible causes of the liquidation.
In a liquidation, it is important to remember the individuals you hired to operate your company. You probably owe them some of the company's assets: An employer may owe debts to employees for wages, salary, or accrued holiday pay. If it is solvent when it ceases trading, employees may also be entitled to other compensations. Legal counsel should assess the priority of such claims on the limited assets of your business.
When forming a partnership, a formal agreement of partnership should be drafted and co-signed. It should specify preferred arrangements to be followed should an insolvency occur. Otherwise, the partnership will be subject to the relevant provisions of local, state, and/or federal law. Such standard provisions may not treat the partners as they would have wished.
In a liquidation, all information about the state of the business must be shared with those who have a claim on your company's assets. The court and any insolvency practitioners should be provided with all the information they require—omissions or false statements can result in criminal proceedings, as holding back information will be seen as duplicity or deception.
Branch, Ben, and Hugh Ray and Robin Russell.
Business Law Center: http://business-law.freeadvice.com
U.S. Bankruptcy Courts: www.uscourts.gov/bankruptcycourts.html