What Happens When a Company Goes Into Liquidation?

Company liquidation is the formal, legally governed process of bringing a business’s existence to a close. During this procedure, the company stops its normal operations, its assets are collected and sold, and the resulting funds are used to settle its outstanding liabilities. Whether initiated by the company’s owners or forced upon it by outside parties, the objective is to convert all company property into cash and distribute it to claimants in a specific order. Once liquidation is complete, the legal entity that was the company ceases to exist.

Initiating the Liquidation Process

The path to liquidation can begin voluntarily through a decision by a company’s directors and shareholders. For a solvent company, one whose assets are sufficient to cover its debts, this process is a state-level corporate dissolution. It starts with a formal resolution by the board of directors, which is then approved by the shareholders as dictated by company bylaws. Following approval, the company files “Articles of Dissolution” with the Secretary of State and notifies tax agencies like the IRS via Form 966, Corporate Dissolution or Liquidation, to begin the wind-down.

A company that is insolvent, meaning its debts exceed its assets, may also voluntarily enter liquidation by filing for Chapter 7 bankruptcy with federal courts. The board of directors authorizes this action when it recognizes the company can no longer meet its financial obligations. The process is initiated by filing a Petition for Non-Individuals Filing for Bankruptcy, which provides the court with a comprehensive overview of the company’s financial state and places it under the court’s jurisdiction.

Liquidation can also be forced upon a company by its creditors through an involuntary process. This occurs when unpaid creditors file a petition with the bankruptcy court to place the company into Chapter 7 bankruptcy. Under Section 303 of the U.S. Bankruptcy Code, if the company has twelve or more creditors, the petition must be filed by at least three of them whose undisputed claims total at least $21,050 in unsecured debt for cases filed in 2025.

Once an involuntary petition is filed, the company has a period of 21 days to respond. If the company does not contest the petition, or if it contests and the court finds in favor of the creditors, the court will enter an “order for relief.” This order officially places the company into Chapter 7 bankruptcy. The basis for granting such an order is a finding that the company is “generally not paying such debtor’s debts as such debts become due,” a standard focusing on current cash flow issues.

The Liquidator’s Role and Responsibilities

Once a company enters Chapter 7 liquidation, control passes from its directors to a court-appointed bankruptcy trustee. This individual, a private attorney or accountant appointed by the U.S. Trustee Program, acts as a neutral fiduciary. The trustee’s primary duty is to manage the bankruptcy estate and ensure compliance with the U.S. Bankruptcy Code for the benefit of all creditors.

The trustee’s first responsibility is to take complete control of all property of the estate. This involves securing all physical assets like real estate and inventory, as well as intangible assets like bank accounts and intellectual property. The trustee demands all books and records from management to gain a full understanding of the company’s financial affairs.

A significant part of the trustee’s duties involves investigating the debtor’s financial affairs. This includes scrutinizing past transactions to identify irregularities that can be unwound to recover money for the estate. The trustee has the power to sue to recover “preferential transfers,” which are payments made to certain creditors shortly before bankruptcy, and “fraudulent conveyances,” where assets were transferred for less than their value to hide them from creditors.

The trustee also presides over a mandatory proceeding called the 341 meeting of creditors. This is a formal meeting where the trustee and creditors can question the debtor’s representatives under oath about the company’s debts, assets, and financial conduct. The meeting allows the trustee to gather information, verify the accuracy of bankruptcy filings, and identify any assets that may not have been properly disclosed.

Converting Assets to Cash and Settling Debts

After securing the company’s assets, the trustee’s central task is to liquidate them, converting all property into cash for distribution to creditors. This process, known as realization, involves valuing and selling everything the company owns. The trustee may hire appraisers, auctioneers, or real estate brokers to ensure assets are sold for their maximum possible value through public auctions or private sales.

Once the assets are converted to cash, the trustee distributes the funds to creditors according to a strict hierarchy of payment established by the U.S. Bankruptcy Code. This payment waterfall ensures that certain types of claims are paid before others. No lower-ranking class of creditor receives any payment until all higher-ranking classes have been paid in full.

Secured Creditors

The first claims to be addressed are those of secured creditors. These are lenders who hold a specific security interest, or lien, on a particular asset of the company, such as a mortgage on a building. The secured creditor is entitled to be paid from the proceeds of the sale of their specific collateral. If the sale generates more cash than the debt, the excess funds flow back into the general bankruptcy estate, while a shortfall results in the remaining debt being reclassified as a general unsecured claim.

Priority Unsecured Creditors

After secured claims are satisfied, the next in line are priority unsecured claims. These are specific types of unsecured debts that Congress has deemed important enough to be paid ahead of other general debts. These include:

• Administrative expenses, which includes the costs of the bankruptcy itself, such as trustee and legal fees.
• Claims for employee wages and commissions earned within 180 days before the bankruptcy filing, up to $17,150 per employee for cases filed after April 1, 2025.
• Certain contributions to employee benefit plans.
• Customer deposits for goods or services not received, capped at $3,800 per individual.
• Certain tax obligations, such as recent income and payroll taxes owed to the IRS.

General Unsecured Creditors

Only after all secured and priority claims have been paid in full does the trustee distribute any remaining funds to the general unsecured creditors. This is the largest group, including suppliers, service providers, and landlords. In the vast majority of Chapter 7 liquidations, the funds are exhausted before this class can be paid in full, and it is common for these creditors to receive only a small percentage of what they are owed or nothing at all.

Final Outcomes for Shareholders and the Company

The final stage of the liquidation process addresses the interests of the company’s owners, the shareholders. The distribution of any remaining funds is governed by the “absolute priority rule,” a principle in bankruptcy law. This rule dictates that shareholders, as equity holders, are at the very bottom of the payment hierarchy. They are entitled to receive a distribution only if every class of creditor—secured, priority, and general unsecured—has been paid 100% of what they are owed.

In the context of an insolvent Chapter 7 liquidation, a distribution to shareholders is exceedingly rare. The nature of insolvency means the company’s debts already exceeded its assets before the process began. After administrative costs and priority claims are paid, there is seldom enough money to fully satisfy general unsecured creditors, leaving nothing for equity holders. For solvent dissolutions conducted outside of bankruptcy, however, paying shareholders from surplus funds is the primary objective.

Once the trustee has sold all assets and distributed all available proceeds, they complete the administration of the case by filing a Final Report and Account with the bankruptcy court. This document provides a detailed accounting of all money collected and how it was disbursed. After the court reviews and approves this final report, it will issue a final decree that formally closes the bankruptcy case.

With the closing of the case, the company’s liquidation is complete and its legal existence is terminated. The company is struck from the official register of companies in its state of incorporation. It can no longer conduct business, enter into contracts, or sue or be sued, and the business entity has legally and permanently ceased to exist.