Understanding Company Liquidation: Causes and Process Explained

Company liquidation is a formal process of closing down a business by selling off all of its assets to settle any outstanding debts. It involves appointing a liquidator to oversee the sale of assets with any surplus funds distributed to shareholders. Company liquidation is an important process that allows for the proper closure of a business, ensuring no unresolved obligations or liabilities remain. A sincere thank you to the company secretarial team for their invaluable contributions to this informative piece

Reasons for Company Liquidation

Several common reasons can lead to company liquidation:

• Starting a Business for the Wrong Reasons: Sometimes, businesses are initiated out of necessity rather than a well-defined, profitable opportunity. This lack of a strong foundation can lead to stagnation and eventual closure.

• Lack of Capital: Miscalculations regarding the required finances to operate efficiently can significantly impact the business. Insufficient capital can lead to a shortage of resources, hindering growth and ultimately forcing liquidation.

• Inadequate Marketing: A successful business requires a well-planned marketing strategy to grow and engage with its target audience. Without a proper strategy, a business may struggle to reach potential customers and achieve financial sustainability.

• Unexplored Opportunities: Optimistic but misguided business setups often overlook the actual potential of their offerings. This might involve choosing an incorrect location or service that doesn’t resonate with the market, leading to failure.

The Liquidation Process

The specific liquidation process depends on the type of business and the circumstances prompting it:

• Strike Off Procedure: Businesses eligible for a “Strike Off” must prepare documents and accounts as required by the Accounting and Corporate Regulatory Authority (ACRA). Closure of all relevant bank accounts is mandatory during this phase.

• Compulsory Liquidation: Court-ordered liquidation occurs when creditors petition for it due to the company’s inability to pay its debts. The court appoints a Liquidator to oversee the process, including valuing and selling assets to settle outstanding debts. Seeking guidance from an Insolvency Practitioner can be beneficial in navigating this complex situation and mitigating any potential negative consequences.

• Outcome: Directors of limited liability companies are typically not personally liable for the company’s debts. However, accusations of wrongful trading could lead to legal obligations to repay the company if directors are found to have acted negligently.

Voluntary Liquidation

Voluntary Liquidation offers a more controlled approach to closing a business and comes in two primary forms, each catered to specific circumstances:

• Members’ Voluntary Liquidation (MVL): In MVL, shareholders proactively choose to dissolve a solvent business. They appoint a liquidator who is responsible for realizing the company’s assets and distributing the proceeds equitably among the members. MVL offers the advantage of converting the business’s value into cash for shareholders. Additionally, there might be potential tax savings, as the taxation framework could shift from Income Tax to the more favorable Capital Gains Tax.

• Creditors’ Voluntary Liquidation (CVL): Similar to MVL, Creditors’ Voluntary Liquidation involves the voluntary closure of a company. However, the crucial distinction lies in the company’s financial health. In a CVL scenario, the company is insolvent, meaning it cannot meet its financial obligations. Consequently, all assets are directed towards satisfying the claims of creditors, with no distribution to members.

Following the completion of the liquidation process, the Registrar of Companies in Sri Lanka issues a Certificate officially confirming the company’s closure and dissolution. This Certificate serves a dual purpose:

• It acts as a formal confirmation of the company’s closure, preventing any further business activities under its name.

• It protects the community by reducing the risk of potential fraudulent activities associated with the dissolved entity.

By adhering to established legal procedures, transparency and accountability are ensured, upholding the overall integrity of the business closure process in Sri Lanka.