When a company is experiencing serious financial difficulty, terms such as “receivership” and “liquidation” are often used interchangeably. To someone unfamiliar with insolvency law, both can sound as though they mean essentially the same thing: the company has failed and an insolvency practitioner has taken control.
In reality, receivership and liquidation are quite different processes.
The fundamental difference between receivership and liquidation is their purpose. A receiver is generally appointed by a secured creditor to take control of particular secured assets and realise them for the benefit of that creditor. A liquidator, on the other hand, is appointed to wind up the company’s affairs for the benefit of creditors generally.
Those different objectives affect who controls the company, whether its business continues trading, how its assets are sold and what ultimately happens to the company.
Understanding those differences is important for directors, employees and creditors when a business is approaching insolvency.
What is liquidation?
Liquidation is the process of winding up a company’s affairs.
A liquidator takes control of the company, identifies and realises its assets, investigates its financial affairs and, where funds permit, distributes the proceeds among creditors according to the priorities established by law.
Once the liquidation has been completed, the company will ordinarily be deregistered and cease to exist.
For an insolvent company, liquidation commonly begins in one of two ways.
In a creditors’ voluntary liquidation, the shareholders resolve to wind up the company, usually following a recommendation by the directors after they have concluded that the company cannot pay its debts.
Alternatively, a company can be wound up by the Court, commonly following an application by an unpaid creditor.
Once appointed, the liquidator assumes control of the company and the directors’ powers are effectively displaced.
The liquidator also has important investigative and recovery functions. These may include investigating the conduct of directors and other officers and examining transactions entered into before liquidation.
In appropriate circumstances, a liquidator may seek to recover voidable transactions, including unfair preference payments, unreasonable director-related transactions and certain transactions designed to defeat creditors. A liquidator may also investigate whether directors allowed the company to trade while insolvent.
These powers can make liquidation particularly important to unsecured creditors because recoveries made by the liquidator may increase the pool of assets ultimately available for distribution.
What is receivership?
Receivership has a different purpose.
A receiver is usually appointed by a secured creditor after the company defaults under a finance agreement.
For example, a bank or other lender may have advanced money to the company and obtained security over some or all of its assets under a General Security Agreement, or GSA. If an event of default occurs, the security documents may entitle the lender to appoint a receiver.
Depending upon the security and the terms of the appointment, the receiver may take control of particular assets or substantially the whole of the company’s business and property.
The receiver’s principal task is generally to take control of the secured assets, realise them and apply the proceeds in accordance with the relevant legal priorities and security arrangements.
This does not necessarily mean immediately closing the business.
Where the receiver considers that a better result can be achieved by continuing to trade, the receiver may operate the business while arranging a sale.
A going concern sale can sometimes produce a substantially better result than simply closing the doors and selling individual assets. It may preserve the value associated with the company’s employees, customers, contracts, intellectual property, goodwill and operating systems.
However, receivership should not be confused with a formal restructuring process designed primarily to rescue the company.
A receiver’s principal focus is the secured property and the debt owed to the appointing secured creditor. If preserving and selling the business as a going concern produces the best result, the business may continue. If it does not, the receiver may close the business and sell its assets.
Receivership vs liquidation: the key differences
Although both receivers and liquidators are external administrators who can assume substantial control over a company’s affairs, their appointments serve different purposes.
Issue | Receivership | Liquidation |
|---|---|---|
Who usually appoints? | A secured creditor exercising rights under its security documents | Shareholders in a creditors’ voluntary liquidation or the Court in a compulsory liquidation |
Primary objective | Realise secured property, generally to recover money owed to the secured creditor | Wind up the company’s affairs and realise assets for creditors |
Whose interests are involved? | The receiver has statutory and other legal duties, but is ordinarily appointed to enforce a secured creditor’s security | The liquidator acts for creditors generally and must administer the liquidation according to the statutory regime |
Will the business continue trading? | Possibly, particularly where trading may preserve value and facilitate a going concern sale | Sometimes, although insolvent businesses are frequently closed unless continued trading is expected to improve the outcome |
Does the company automatically cease to exist? | No | Ultimately, ordinarily yes, following completion of the liquidation and deregistration |
Investigation and recovery powers | More limited and directed principally towards the receivership and secured assets | Extensive statutory investigation and recovery powers |
Can the company survive? | Potentially | Liquidation ultimately results in the company being wound up |
These distinctions can have significant practical consequences for everyone involved.
Frequently Asked Questions
Can a company be in receivership and liquidation at the same time?
Yes.
This is an important point because receivership and liquidation are not mutually exclusive.
A secured creditor may appoint a receiver over company assets and the company may subsequently enter liquidation. Alternatively, a receiver may be appointed to a company that is already in liquidation if the secured creditor is entitled to enforce its security.
In that situation, both appointments may continue at the same time.
Broadly speaking, the receiver deals with the assets subject to the secured creditor’s security, while the liquidator remains responsible for the broader winding up of the company.
The respective powers and responsibilities can become complicated, particularly where there are competing claims over assets or questions about the scope and validity of security interests.
Which process is better for directors?
From a director’s perspective, neither receivership nor liquidation is an attractive outcome. However, their consequences are different.
When a receiver is appointed, the directors generally remain directors of the company, but their ability to exercise their powers is substantially restricted in relation to matters controlled by the receiver.
There may also be circumstances in which some or all of the underlying business survives.
For example, a receiver may continue operating the business while seeking a purchaser. A sale as a going concern may preserve the business operation, employment and relationships with customers and suppliers, even though ownership of the business itself may change.
In some cases, the secured creditor may be repaid and the receivership may eventually end without the company entering liquidation. Whether that is realistic depends heavily upon the company’s financial position, the value of the secured assets and the extent of its other liabilities.
Liquidation is more definitive. Once a company enters liquidation, the process is directed towards winding up its affairs rather than returning control of the company to its directors.
Which process is better for unsecured creditors?
For an unsecured creditor, liquidation will often provide greater involvement in the formal insolvency process.
A receiver is not appointed primarily to recover money for unsecured creditors. The receiver’s focus is generally upon the secured assets and repayment of the secured creditor.
If there is sufficient money after satisfying claims that rank ahead of unsecured creditors, there may ultimately be funds available elsewhere in the administration. However, unsecured creditors should not assume that a receivership will produce a distribution to them.
A liquidator, by contrast, represents the interests of creditors generally and has statutory powers to investigate the company’s affairs and pursue certain recoveries.
For example, a liquidator may investigate whether assets were improperly transferred before liquidation or whether certain creditors received payments that constitute unfair preferences.
Successful recoveries may increase the assets available for distribution to unsecured creditors.
Of course, liquidation does not guarantee that unsecured creditors will receive a dividend. In many insolvent companies there are simply insufficient assets to pay unsecured creditors in full, and sometimes there are insufficient assets to pay them anything at all.
What happens to employees during receivership?
The appointment of a receiver does not necessarily mean that employees will immediately lose their jobs.
If the receiver decides that continuing to operate the business is likely to preserve or increase its value, employees may continue working while the business is traded and offered for sale.
This can be one of the significant practical advantages of a successful going concern sale. A purchaser may acquire an operating business rather than simply buying its individual assets.
However, there is no guarantee that employment will continue.
If the receiver concludes that continued trading is not commercially justified, some or all employees may be terminated.
Employee entitlements have particular statutory priorities in insolvency administrations, although their treatment can depend upon the type of appointment, the assets available and the interaction between receivership and any subsequent liquidation.
Employees should therefore obtain advice about their particular circumstances rather than assuming that receivership and liquidation produce identical outcomes.
If a receiver is appointed, am I still a director?
Yes.
The appointment of a receiver does not itself remove a director from office.
However, the receiver assumes control over the property and business within the scope of the appointment. As a practical matter, this can leave directors with very limited powers while the receivership continues.
Directors also have obligations to cooperate with an external administrator and should obtain professional advice about their continuing duties.
Importantly, directors should not assume that the appointment of a receiver removes potential exposure arising from conduct before the appointment.
Can a receiver become the liquidator?
In most cases, no. There are questions of independence and conflicts of interest that need to be carefully considered.
Receivers and liquidators perform different roles and may represent materially different interests within the same insolvency.
A practitioner who has acted as receiver may therefore face restrictions or independence concerns about subsequently accepting appointment as liquidator.
For that reason, where a company in receivership subsequently enters liquidation, a different insolvency practitioner or firm will usually act as liquidator.
Does receivership mean the business can be saved?
Sometimes, but this requires an important qualification.
Receivership should not be viewed as a business rescue mechanism in the same sense as voluntary administration or small business restructuring.
The receiver’s role is principally concerned with realising secured property and achieving an appropriate outcome from that property. Continuing to trade may be part of that strategy.
If an operating business is worth substantially more than its assets would realise through a break-up sale, a receiver may continue trading while seeking a purchaser.
That can preserve the business itself, even if the company that previously owned it does not survive in its original form.
For employees, customers and suppliers, that distinction can be extremely important.
Receivership or liquidation: which is the right option?
In many cases, the directors do not actually have a free choice between receivership and liquidation.
Receivership is generally initiated by a secured creditor exercising rights under its security. Liquidation may be initiated voluntarily by the company or imposed by the Court.
The appropriate response therefore depends upon the company’s financial circumstances, its secured debt, available assets and whether there remains a viable underlying business.
For directors facing serious financial difficulty, the more important question is often not simply whether receivership or liquidation is preferable.
It is whether action can be taken before either becomes inevitable.
Early advice may reveal other alternatives, including refinancing, negotiating with creditors, selling assets or the business, voluntary administration, small business restructuring or, where the legal requirements are satisfied, relying upon the safe harbour protections while developing a course of action reasonably likely to lead to a better outcome for the company.
Once a secured creditor has decided to appoint a receiver, or a creditor has commenced winding-up proceedings, the available options can narrow considerably.
If your company is experiencing financial difficulty, obtaining advice early can provide considerably more options than waiting until an external administrator is appointed.
IRT Advisory assists directors, creditors and other stakeholders to understand their options when a business is experiencing financial distress. If you are concerned about your company’s financial position, contact us for a confidential discussion before the situation becomes more difficult to control.
