What is Liquidation?

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Definition:

Liquidation is the sale of all property when a business is shutting down and the company needs cash to settle all of its debts.

🤔 Understanding liquidation

Liquidation is the process of turning all company assets into cash to pay creditors. Any cash left after paying creditors goes back to owners. Typically, a company liquidation takes place when a company closes due to lacking solvency — a company’s capacity to pay off its long-term debts and financial obligations. The U.S. Bankruptcy Code provides liquidation guidelines to sell all assets and totally erase all eligible debts. Other reasons for a company to go through a liquidation include the retirement of company owners, departures of investors, or reorganization of the company. Liquidation can also refer to the liquidation of assets in a trade or investment. For example, if you own a house and want to sell that house to buy a new one, you need to liquidate your home.

Example

Pier 1 Imports filed for Chapter 11 bankruptcy in February 2020 to begin the liquidation process of assets across its 450 stores in North America. The company had declining sales over the last few years and experienced close to $200M in losses in 2019. It had accumulated $400M in debt at the time of its bankruptcy filing.

Chapter 11 bankruptcy allows Pier 1 Imports to come up with a plan to repay its debts while it continues to operate. As part of its strategy, the company received $256M in financing to support operations during the liquidation.

Takeaway

Liquidation is like an estate sale…

When a person dies and leaves behind personal effects, like jewelry and furniture, these are often converted into cash through an estate sale. The cash from the sale may be used to pay creditors, if the deceased left behind any debts. Likewise, when a company “dies,” or goes out of business, its property will be liquidated to pay creditors.

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What is liquidation?

Liquidation is the process of turning assets into cash. While any asset or investment can be liquidated, this type of sale often refers to the process of disposing of all assets of a company that has filed for bankruptcy — a legal process in which the company declares it can’t pay its debts and works to settle with its creditors.

Bankruptcy is related to a company’s ability to meet its short-term debts (liquidity) and long-term debts (solvency). Solvency and liquidity are both measures of a firm’s financial health.

A company needs to maintain liquidity to keep sustainable operations. When a company has liquidity issues over a long period, it may no longer have solvency. When a company becomes insolvent, it may file for bankruptcy and liquidate all assets to pay its creditors.

When a company files for bankruptcy, it goes through liquidation according to the guidelines from the U.S. Bankruptcy Code. The most common types are Chapter 7, Chapter 11, and Chapter 13 bankruptcy. Chapter 7 bankruptcy is the most streamlined liquidation process, while Chapter 11 and Chapter 13 bankruptcies have more options for negotiations among parties.

Additional reasons for liquidation include the retirement or exit of some or all company owners and/or investors or the reorganization of a company. A company going through liquidation for reasons other than bankruptcy may liquidate just some assets (like those directly related to an investment or a department).

What are the types of liquidation?

Liquidation can be voluntary or compulsory.

Voluntary liquidation

  • A liquidation that takes place when both the buyer(s) and the seller(s) of the asset(s) perform the transaction voluntarily.
  • In the case of a company, a voluntary liquidation takes place when the company leadership decides to dissolve the company (also referred to as winding-up the company) and obtains shareholder approval if needed.
  • If a company filed for bankruptcy on its own, then it is performing a voluntary liquidation to pay eligible creditors.

Compulsory liquidation

  • A compulsory liquidation takes place when creditors force a company to sell its assets through legal action.
  • It often results from a court order from a bankruptcy court, forcing a debtor into bankruptcy and having to sell assets to pay off creditors.

How does liquidation work?

The steps to carry out a liquidation depend on several factors.

One factor that stands above all is whether the liquidation is voluntary or compulsory. In a voluntary liquidation, a buyer and seller need to agree on price and terms. It may also involve a broker as required, depending on the assets being sold (e.g., real estate, large blocks of securities). Alternatively, a compulsory liquidation typically involves court proceedings, one or more trustees, and several rounds of negotiations that need to be court approved.

Another factor determining how a liquidation is carried out is whether a company files for bankruptcy. While liquidation is often linked with bankruptcy, specifically Chapter 7 bankruptcy, it can take place without bankruptcy.

Some instances of non-bankruptcy liquidations are when a company decides to sell off a division to streamline operations or when a partner exits a joint venture — a legal entity that two or more people, businesses, or organizations form to work together toward a common goal.

Regardless of the factors, all types of liquidation share the same objective: turning assets into cash to pay creditors and provide any remaining money to the owners.

What is the liquidation process?

The liquidation process is typically affected by the type of bankruptcy governing the process. The two types of bankruptcies available for company liquidations are Chapter 7 and Chapter 11 bankruptcies.

  • Chapter 7 bankruptcy: In a Chapter 7 bankruptcy, the court appoints a trustee who oversees the sale of the debtor’s assets into cash for paying among creditors.
  • Chapter 11 bankruptcy: A Chapter 11 bankruptcy allows the debtor more flexibility than a Chapter 7 bankruptcy. The debtor can reorganize and set a plan, instead of going straight into liquidation.

A Chapter 11 bankruptcy often offers the debtor better economic conditions for the compulsory liquidation than those from a Chapter 7 bankruptcy. Additionally, creditors may play a more active role in the liquidation in a Chapter 11 bankruptcy than in a Chapter 7 bankruptcy.

Regardless of being governed by a Chapter 7 or Chapter 11 bankruptcy, the liquidation process involves filing several forms, paying applicable court fees, and following bankruptcy court guidelines.

If no bankruptcy is involved, the liquidation process is closer to a standard sale, in which the buyer and seller have to agree on the sale terms.

How long does a company liquidation take?

The length of a company liquidation can vary from weeks to months, depending on several factors.

Typically, a Chapter 7 bankruptcy liquidation takes from four to six months. However, court proceedings, requests for additional documentation, title issues (a potential problem with a real estate property), and terms negotiations may extend the length of a liquidation up to one year.

When a liquidation doesn’t involve bankruptcy, the process may be shorter, as long as both buyer and seller can agree on transaction terms quickly. One principal factor affecting the length of a non-bankruptcy liquidation is the buyer’s price flexibility.

How are assets distributed during liquidation?

Assets are distributed during liquidation according to the terms agreed between a creditor and a debtor.

In the case of a Chapter 7 bankruptcy company liquidation, secured creditors — those creditors with a claim to company assets used as collateral for a loan — have priority over unsecured creditors to receive payment.

Bankruptcy courts generally provide unsecured creditors the opportunity to file proofs of claim to demonstrate a claim to the debtor’s assets (typically within 90 days after first meeting with creditors).

The court-appointed case trustee typically seeks to distribute all assets in an equitable way to all secured creditors, maximizing the remaining portion for unsecured creditors. Company owners receive any leftover money after all creditors have been paid in full.

What is a liquidation sale?

A liquidation sale is a process to sell a company’s assets for cash. While a court dictates the terms of the overall bankruptcy process, the court-appointed trustee generally oversees the liquidation sale.

Depending on the number and nature of the company assets, the trustee may outsource all or part of the process to a third-party specializing in liquidating assets. Some liquidators handle general merchandise or specialized in specific asset classes.

In a non-bankruptcy liquidation, an owner needs to demonstrate due diligence to prevent potential legal issues so it’s common for an owner to also outsource the liquidation process to professionals specializing in liquidation sales.

Where can you find liquidation sales?

You can often find liquidation sales by looking online for estate liquidators and auction houses. Due to advances in technology, most estate liquidators and auction houses run online portals in which you can bid on items from liquidation sales. If you’d like to see the items in person, you may need to make an appointment or attend specific dates for viewings.

Some firms may run their own liquidation sales in-store at existing retail locations or warehouses using pallets and announce their liquidation sales on their own websites.

You should verify all claims of liquidation sales with your state’s Attorney General Office to avoid falling for a sale claiming to be a liquidation and offering goods at full retail price.

What are the advantages and disadvantages of liquidation?

The main advantage of liquidation is the potential for obtaining a discharge releasing the debtor from liability from most debts and from receiving further collection claims.

Some secured creditors (those with a claim to a company’s asset used as collateral for a loan) may have a claim even when a company receives a discharge. Still, a discharge generally provides protection against all other creditors, particularly unsecured ones.

There is the potential that a discharge may not be approved. The U.S. Courts recommend filing for bankruptcy with an attorney who can advise you on how to process the necessary paperwork and prevent any potential mistakes.

Alternatively, the main disadvantage of liquidation is that it may hurt a company’s ability to secure financing in the future.

Chapter 11 bankruptcy and other types of company liquidation processes have long-lasting effects on company finances. Like individuals, companies have a credit score — a score based on credit history to rate a company’s trustworthiness as a borrower. In the event of complete company liquidation, the business credit score goes down to one (business credit scores are different from personal credit scores, generally ranging from 1 to 100).

Another disadvantage of liquidation is that the assets are often not sold at original retail price. Instead, the assets are usually priced lower for a quick sale, so creditors can receive payment sooner. Company owners may experience distress seeing their hard work be undervalued.

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