Winding up is the process through which the life of a company is ended and the company assets administered for the benefit of the creditors and the company members.
It can also be defined as the process of selling off companies’ assets with a view of paying off the creditors and distributing any residue there from to the members and eventually dissolve the company.
Liquidation on the other hand is the process through which an insolvent company distributes its assets to its creditors and/or members with the objective of bringing its life to an end.
From the above definition, you will realize that where as winding up may be caused by many reasons, liquidation is only caused by inability to pay debts otherwise called insolvency. It is for these reasons that unlike in the repealed companies act, where both winding up and liquidation were treated to almost to mean the same thing, and were both regulated under the same companies act, the position is now quite different. Winding up is now provided for under the companies’ act 2012, while liquidation is separately provided for under the insolvency act 2011.
However notwithstanding the above position, different literature and scholars use the liquidation and winding up phrases interchangeably meaning the same thing which is ending the company’s existence.
Types of winding up/liquidation of a company
a)Voluntary Winding up of a solvent company
This is the type of winding up where a company voluntarily agrees to close down business not because of incapacity to pay debts /insolvency but because of totally different reasons. In other words this company should still have the ability to pay its own debts(it must be solvent).
Under this type, a company may by special resolution resolve to be wound up voluntarily. And in this instance, a voluntary winding up shall be taken to commence at the time of the passing of the resolution under subsection 1.
However before a company can pass a resolution to voluntarily wind up, the company directors must prepare a declaration of solvency wherein they must state and show that they are of the opinion that the company is in a position to pay all its liabilities within twelve months from the date of passing the resolution.
A declaration of solvency is supposed to be delivered to the Registrar of companies atleast 30 days before the date when the resolution to voluntarily wind up is intended to be passed and it must be accompanied with a full report on the assets and liabilities of the company.
The following are some of the reasons why a company may resolve to voluntarily wind up;
i) Where the company accomplishes its objectives. This happens for companies that are set up for particular reasons
ii) Where the companies’ lifetime as per the articles ends. Members may, right from incorporation agree that the company shall be wound up after a specified time for example after 30 years. After 30 years the members may decide to go by their earlier plan and accordingly resolve to wind up.
iii) Fear of business risks. Some times members of a company may, for different reasons , fear to assume any further risks. This could happen because of the changes in the regulatory regime in the country of operation for instance where they were motivated to engage in a particular sector because of subsidies or tax exemptions. If the subsidies or tax exemptions are withdrawn by the government, the share holders may fear to incur losses due to the changes, and hence decide to wind up.
iv) Incase of disagreements. where the owners of the company have irreconcilable protracted differences to the extent that they can no longer be able to work together, it may be resolved that the company be wound up to avoid further differences and problems from cropping up.
After the company has duly passed a special resolution to wind up voluntarily, it will be required to publish the notice in the gazette and thereafter proceed to appoint a liquidator to take over the final steps of selling the company assets and distributing the proceeds there from to the creditors and residue to the members. Once all the processes are done, the company life will finally be ended three months after the final meeting for dissolution of the company is held.
LIQUIDATION
As discussed herein above liquidation applies to companies that are insolvent, that is to say companies that are unable to pay their debts. This is strictly regulated by the insolvency act 2011, which came into effect on the 1st day of July 2013, by virtue of the insolvency act 2011 (commencement ) instrument S.I No.25 of 2013.
The circumstances that amount to Inability to pay debts are laid down under section 3 of the insolvency act as herein below;
that a debtor is presumed to be unable to pay debts if:
(a)The debtor has failed to comply with a statutory demand.
(b)The execution issued against the debtor in respect of a judgment debt has been returned unsatisfied in whole or in part
(c)All or substantially all the property of the debtor is in the possession or control of a receiver or some other person enforcing the charge over that property.
It is further provided that nothing in the section above can limit some one from proving a debtor’s inability to pay debts though other means than the above.
Section 57 of the insolvency act provides for three modes of winding up which are liquidation by court, voluntary liquidation and liquidation subject to the supervision of court. Lets briefly look at each of the aforesaid modes of liquidation.
VOLUNTARY LIQUIDATION
According to section 58 of the insolvency act, a company may be liquidated voluntarily if the company resolves by special resolution , that it can not by reason of its liabilities continue business and that it is advisable to liquidate. This usually becomes necessary where a company finds itself in a rather desperate financial position, so much that the members find themselves with no better exit strategy than to liquidate/ sell the remaining assets, pay off the debts to the extent possible and finally dissolve.
Depending on the circumstances of a particular company, the decision to liquidate may not actually be as bad as it might sound. Liquidation is often referred to by financial analysts as a safe way to get born again, because it relieves the company, the directors and share holders of the stress and risk of running a financially sick entity.
Voluntary liquidation may either be a members’ voluntary liquidation or a creditor’s voluntary liquidation.
(i) Members’ voluntary liquidation .This is the kind of liquidation where the decision to liquidate originates from the members. This could happen after the members realizing the risks of continuing in operation with so many debts. Section 62 of the insolvency act empowers the members, including the directors or any other person authorized in the articles through a special resolution to appoint one or more people to act as a liquidator (s) for the purposes of liquidating the affairs and distributing the assets of the company and, on the appointment of liquidator, all the powers of the directors shall cease, except where the company in a general meeting or the liquidator sanctions the continuance of those powers.
The liquidator so appointed shall assume the management of the company, and after reviewing the financial status of the company , if the liquidator realizes that the company is indeed unable to pay all its liabilities, the liquidator will, in accordance with section 65 of the insolvency act , be required to call a creditor’s meeting. The purpose of this meeting is to enable the liquidator to explain to the creditors the situation at hand and also be able to gather and verify the nature of the respective creditors’ claims.
(a)Creditor’s voluntary winding up
Liquidation is said to be a creditor’s voluntary liquidation where, before the company passes a resolution to liquidate, it notifies the creditors and meets them on the day when the resolution is sought to be passed or on the day following the passing of the resolution to liquidate voluntarily , and inform them of the company’s financial challenges and of the member’s position to have the company liquidated.
The procedure to be followed is to the effect that creditors are supposed to be given prior notice of the companies’ intention to pass the resolution to liquidate. The company’s directors are required to nominate one of the directors to preside over the creditor’s meeting, lay before them a full report on the affairs of the company and clearly inform them that owing to the companies’ inability to settle all its debts, the members propose to liquidate it .
The creditors’ meeting may or may not be held in the same place or time with the creditors, and in their respective meetings, they may respectively propose a liquidator to take over the liquidation process, and where there is a disagreement as to who the liquidator should be, then the one nominated by the creditors will take charge.
At the end of it all, the liquidator will distribute the proceeds of sale of the assets to the creditors and upon completion of all the requisite steps, he or she will call for a final dissolution meeting, after which the company will be finally resolved.
LIQUIDATION SUBJECT TO THE SUPERVISION OF COURT
This is the type of liquidation which arises where, after the commencement of a voluntary liquidation, in circumstances where one of the Stake holders moves to court and petitions it that it should be court to supervise the liquidation process.
Section 87 of the insolvency act clearly provides that where a company passes a resolution for voluntary liquidation, the court may make an order that the voluntary liquidation shall continue subject to the supervision of court. This is usually triggered off by an application to court by any creditor, contributory or any other interested person. This could happen where such creditor feels suspicious of the liquidation process in the hands of the liquidator appointed by the members.
If court grants the prayer to supervise liquidation, it may make such orders as the circumstances may require, including demanding that the liquidator makes periodical reports to court about the manner in which the liquidation is carried out. This, in a way, makes the liquidator to be more accountable to the concerned stake holders, which generally ensures transparency and arguably, fairness in the sales and distribution of the proceeds of the liquidation process.
LIQUIDATION BY COURT
This type of liquidation occurs where it is the court that appoints a liquidator in circumstances where court has been satisfied that a company is unable to pay its debts. The application may be made by the company itself, a director of the company, creditor, shareholder, contributory or the official receiver.
This is quite different from the position under the repealed companies act where the grounds of liquidation by court were many, under the current law, this can only happen where the company is unable to pay its debts. Interestingly inability to pay debts is defined under section 3 of the insolvency act as earlier on discussed herein.
In this particular type of liquidation, any of the persons authorized to move court may petition court for an order to appoint a liquidator, and once this is done, the liquidation will be said to have been done by court.
PRIORITY IN DISTRIBUTION OF PROPERTY OF A COMPANY DURING WINDING UP/LIQUIDATION OF A COMPANY IN SATISFACTION OF ITS DEBTS/LIABILITIES.
The general position about distribution of property of a company during winding up/ liquidation is provided for under section 79 of the insolvency act in so far as it provides that subject to the provisions of the act on preferential payments, the assets of the a company shall, on its liquidation, be applied in satisfaction of its liabilities simultaneously and equally, and subject to that application, shall unless the articles of association otherwise provide, be distributed among the members according to their rights and interests in the company.
And from the above analogy, we get to understand that in satisfying the company’s liabilities , the first priority is given to preferential debts and then to non-preferential debts and lastly to the stake holders as hereunder discussed.
Under section 12 (1) of the insolvency act, it is provided that subject to section 11 and subsection 2, the liquidator shall apply the assets to the preferential debts listed in subsection 4, 5, and 6 which debts shall be paid in priority to other debts.
Under section 12 (4), first to be paid shall be;
(a)Remuneration and expenses properly incurred by the liquidator
(b)Any receiver’s or provisional administrator’s indemnity under section 159 or section 187 and any remuneration and expenses properly incurred by any receiver, liquidator, provisional liquidator, administrator, proposed supervisor or supervisor and
(c) The reasonable costs of any person who petitioned court for a liquidation order including the reasonable costs of any person appearing on the petition whose costs are allowed by court.
Under subsection 5, it is provided that after making the payments listed in subsection 4, next to be paid shall be
(a )All wages or basic salary, wholly earned or earned in part by way of commission for four months,
(b)All amounts due in respect of any compensation or liability for compensation under the workers’ compensation act which accrued before the commencement of the liquidation not exceeding the prescribed amount.
(c )All amounts that are preferential debts under section 105.
In furtherance of( c) above, section 105 (4) of the insolvency act provides that a person shall not enforce a lien over any document of the company in respect of a debt for services rendered to the company before the commencement of the liquidation.
Whereas it is further provided that the debt referred to in subsection 4 shall be a preferential claim against the company under section 12 to the extent of twenty currency points or a greater amount as maybe prescribed by the regulations.
Still on priority of debts, it is provided that after paying the sums referred to in section 12(5) of the insolvency act, the liquidator shall then pay ,
(a)The amount of any tax withheld and not paid over to the Uganda Revenue authority for twelve months prior to the commencement of the insolvency and
(b)Contributions payable under the national social security fund act .
It is further provided that section 12 shall apply not withstanding any other law.
Under section 13(1) of the insolvency act, it is provided that after paying preferential debts in accordance with section 12, the liquidator shall apply the assets in satisfaction of all other claims which are referred to as the non-preferential debts.
It is further provided for that the claims referred to in subsection 1 shall rank equally among themselves and shall be paid in full unless the assets are insufficient to meet them, in which case they abate in equal proportion.
And in considering non-preferential debts, the first people to be paid are the secured creditors depending on their line of priority.
Under section 11 (1) of the insolvency act 2011, a secured creditor shall, as soon as practicable after public notice has been given of the liquidation , deliver to the liquidator written notice of any debt secured by a charge over any asset subject to the charge and the amount secured.
After the secured creditors being paid, the next in line shall be the unsecured creditors.
After paying up all the aforesaid debts in section 13 of the insolvency act,, incase there is any surplus during the process of liquidation, the liquidator shall distribute the company’s surplus assets in accordance with the memorandum and articles of association of the company and the companies act to the share holders.
This order of priority of payment of debts is very controversial since the owners of the company are paid last meaning that there are chances that they could lose out on their entire investment and go back home with nothing.
The other critical point inherent in the priority of payment is that the creditors who extended credit facilities to the company also are paid at a far later stage after satisfying a number of ‘preferential debts’ which is likely to scare people from extending credit facilities to companies given the fact that in case the companies run broke, they are likely to lose out and not get enough of what they deserve.
SOLUTIONS TO THE CHALLENGES THAT MAY ARISE AS A RESULT OF A COMPANY GOING OUT OF BUSINESS
CORPORATE RESCUE
When the business of a company is closed down , many challenges arise which include loss of employment and source of income to employees, the share holders lose out on the opportunity of getting any further dividends , government loses out on a tax payer, the host community of the company also loses out on the numerous opportunities that are associated with having a business within their community and creditors who have extended credit facilities to the company, their chances of getting paid become more slim and lean.
Therefore owing to that background , biggest solution that can help to cure the aforesaid challenges lies in the idea of corporate rescue. Corporate rescue can be defined as the process whereby a company can be saved from going out of business. This essentially entails proceedings to facilitate the rehabilitation of a company that is financially distressed by providing for the temporary supervision of the corporation , a temporary moratorium on the rights of claimants against the corporation or in respect of property in its possession as well as development of a corporate rescue plan which requires the restructuring of a corporation’s affairs, business , property , debt and other liabilities and equities in a manner that maximizes the likelihood of the corporation continuing in existence on a solvent basis.
Corporate rescue has a number of advantages which include but are not limited to that there is almost likely to be a better return for the creditors and shareholders than if the corporation went into liquidation since corporate rescue enables the corporation to undergo restructuring, formal and informal employees plus managers are likely to retain their jobs and their contractual and statutory rights which would not be the case in case a company is wound up, thirdly it also promotes social and economic stability of the country at large since government loses a tax payer whenever there is liquidation.
There are a number of types of corporate rescue and they include the following;
1.Negotiation: in this the company individually negotiates with the creditors on an informal basis seeking either more time or compromise or some form of arrangement to avoid the company being wound up unceremoniously just like that to the major disadvantage of all the interest holders of the company at large. This is normally on a party to party basis.
2. Government bail out. This may be direct through an express cash bail out or through tax favors. A number of companies have benefitted from the same, for example Business Man Hassan Bassajabalaba’s Hides and Skin business.
3.Putting a company under provisional administration pursuant to section 139 of the insolvency act. Essentially the purpose of putting a company under administration is to provide a breathing space, a short term intensive care operation , free from the pressure of the creditor’s claims. The administrator can consider whether the business can profitably be rescued or whether it should be broken in a more organized way and can as well negotiate with creditors regarding any possible arrangement . The biggest advantage of administration or an administrative order is that it would have the effect of putting a moratorium (a stay) which will freeze the enforcement of rights against the company whether by secured creditors or unsecured creditors . The rationale for this is to re-organize the company so as to restore it to profitable trading and enable it to avoid liquidation and in circumstances where this can not be achieved to restore the company to a condition which can be sold off as a going concern or at least dispose off its assets in terms more advantageous than would be obtained by the liquidator. The aforesaid can only be achieved after a company passing a special resolution to appoint a provisional administrator and getting an interim protective order as provided for under section 139 of the insolvency act. An example in point in our Jurisdiction is Uganda Telecom Limited (UTL) which was heavily sinking in debt and only making losses and was only rescued from going out of business when a provisional administrator was appointed to restructure it back into a going concern (normal operations/profitability) and in this case the provisional administrator who was appointed was the registrar general of the Uganda Registration Services Bureau .
4. The other mode of corporate rescue is provided for is a compromise and arrangement provided for under section 234 of the companies act
5.The other example of corporate rescue can be through mergers or amalgamation of companies as provided for under section 237 of the companies act where in two or more companies can merge together to become one company for example when Mango telecommunication company merged with Uganda telecom to become one. (look for notes on mergers/amalgamation from our earlier classes in order to be able to understand the aforesaid)
By Mukama Sanyu Jamil
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