Effects of Company Liquidation in South Africa

What happens when a Company undergoes Liquidation in South Africa?

Before we understand the effects of company liquidation in South Africa, let’s understand the concept in brief.

What is Liquidation?

Liquidation is the legal process of winding up a company’s affairs when it cannot pay its debts. The company’s assets are sold, proceeds are used to pay creditors in order of priority (ranking of creditors), and any surplus is distributed to shareholders. However, when a company in liquidation has no assets and therefore no proceeds from the sale of assets (or insufficient proceeds after paying administration costs), creditors will not get their money back. The outstanding debts are essentially written off, and the creditors bear the loss. 

While liquidation is primarily a route for insolvent companies, even solvent companies can choose this route. For example, if a business owner wants to retire and there’s no one else in line to take over the business, they may consider liquidation.

Now, if you are interested in the whole process of Company Liquidation in South Africa, we highly recommend giving this article a read. In this article, however, we will discuss the major effects of company liquidation in South Africa.

Effect on Company

Once a company initiates the winding-up process, it must stop trading. Thus, the company cannot enter into new contracts or carry on business as usual. The main purpose of the liquidation is winding up, realisation of assets, and paying off the creditors. The company must not trade beyond the activities that benefit the process.

During liquidation, the board of directors loses all control over the company’s affairs and assets. A liquidator appointed by the Master of the High Court takes control of the assets. The directors must cooperate with the liquidator to ensure a smooth procedure. Although the directors’ powers and duties effectively end during liquidation, they remain liable for any wrongdoing prior to liquidation.

Effect on Creditors

In the event of a company liquidation, creditors are compensated according to a defined legal order of priority, where each level must be fully paid before the subsequent one can receive any payments. This procedure adheres to a "waterfall" distribution method, indicating that creditors in a lower tier will only obtain payment once all claims from the tiers above them have been completely fulfilled.

The general hierarchy is as follows:

Costs and Expenses of Liquidation: The fees of the liquidator and the expenses related to the winding-up process (for instance, legal fees and costs for asset realisation) are prioritised and paid from the company's general assets.

Secured Creditors: These creditors possess a claim that is secured by specific assets of the company (collateral), which may include a mortgage on property or a lien on business assets. They receive payment from the proceeds generated by the sale of their specific secured asset. Should the sale proceeds fall short of covering the debt, the outstanding amount is classified as an unsecured claim.

Preferential Unsecured Creditors: This group of creditors lacks specific security but is granted legal priority over general unsecured creditors. Typically, this category encompasses employee wages and entitlements generally up to a defined statutory limit as well as tax liabilities owed to the government. (South African Revenue Services).

Unsecured/Concurrent Creditors: This represents the largest category of creditors, which includes suppliers, trade creditors, and general lenders who do not possess any collateral or preferential status. They are compensated from any remaining funds on a pro-rata basis if there are insufficient resources to fully satisfy all claims.

Shareholders/Members: Shareholders are positioned last in the hierarchy of priority. Preferred shareholders may have a superior claim compared to common shareholders; however, in most cases of insolvency, there are seldom any funds available for distribution to shareholders.

Effect on Employees

When the liquidation process begins, employee contracts are automatically terminated (as per the terms in Section 38 of the Insolvency Act). Employees are classified as preferent creditors, meaning their claims for certain unpaid amounts rank above ordinary unsecured creditors.

Employees can lodge claims with the liquidator for unpaid wages and salaries (up to a maximum of three months' remuneration, subject to a statutory cap). Accrued leave pay. Notice pay (if applicable).

Severance pay (typically one week's remuneration for each completed year of service).

These preferential claims are capped at certain monetary limits. Any amounts owed above these limits are treated as "concurrent claims," which rank lower in priority and are often only partially paid out, depending on the available funds from the sale of assets.

Once employment is formally terminated, affected employees are entitled to apply for Unemployment Insurance Fund (UIF) benefits

Related: Effects of Company Liquidation on Employees in South Africa

Effect on Shareholders

Last in Line: Shareholders will only receive any distribution if there is a surplus remaining after all creditors have been completely compensated.

Minimal or No Return: In the majority of insolvent liquidations, all available funds are depleted prior to reaching the shareholders' level, rendering their shares nearly worthless.

Share Type Priority: Preferred shareholders possess a superior claim to any residual assets compared to common shareholders; however, both categories rank below all creditors.

Tax and Regulatory Effects

As mentioned earlier, SARS becomes a preferential creditor during the liquidation process, as the company may have some outstanding taxes. Taxes are paid from the proceeds of the sale of assets. If no assets exist then SARS are not able to recuperate taxes owing by the company. SARS can pursue a personal liability claim against the company representatives but can also only do so if it is proven that the company did not pay taxes due to unethical or fraudulent behaviour. Apart from that, the company’s bank accounts are frozen and are under inspection for any misconduct.

The CIPC (Companies and Intellectual Property Commission) is also a part of this process, as the entity maintains the records of your company’s existence and status.

Effect on Legal Proceedings

Any legal actions against the company are suspended when liquidation begins. From this point onwards, creditors cannot continue or initiate court proceedings without the liquidator’s or the court’s permission. On the other hand, the company also cannot institute new legal actions except through the liquidator. 

In short, the liquidator is the ultimate decision-maker throughout the process.

Conclusion on the effects of Company Liquidation in South Africa

When a company undergoes liquidation, a plethora of entities and people are legally affected and involved to get their piece of the pie. To ensure a smooth process and no future troubles, a company must decide to hire a knowledgeable, competent team of lawyers.

At Solvendi, we focus on delivering prompt legal services and assistance as per our clients’ needs. Whether it is sequestration or liquidation, our team at Solvendi can help you out. Contact us today for more information.

Disclaimer: This article is intended for general informational purposes only and should not be interpreted as legal advice. Any actions taken based on the information provided are done so at your own discretion. Solvendi cannot be held liable for any outcomes resulting from such actions. We encourage you to consult with us directly before making decisions solely based on the content of this article.

Would like to discuss the effects of liquidation with regards to your specific company? We have legal experts with 20 years experience that can guide you through the process. Our main aim is to be as informative as possible. Let's Chat.

If you require advice with regards to Sequestration, Business Liquidations, Insolvency, Bankruptcy or Credit Rehabilitation kindly contact SOLVENDI as follows:

National: 087 220 0710

Head Office: 010 880 7589

Email: consultations@solvendi.co.za 

Website: www.solvendi.co.za