Distributions upon liquidation: Overview, definition, and example
What are distributions upon liquidation?
Distributions upon liquidation refer to the process of allocating a company’s remaining assets to its shareholders, creditors, or other stakeholders after it has been liquidated, meaning it has ceased operations and is dissolving. When a business is liquidated, its assets are sold off, and the proceeds are used to pay off any outstanding debts. Any remaining funds after debts and liabilities are settled are then distributed to the owners or shareholders according to their shareholding or ownership interests.
For example, if a company goes out of business, its assets such as cash, property, and inventory are liquidated to pay off creditors, and any remaining money is then distributed to the company’s shareholders.
Why are distributions upon liquidation important?
Distributions upon liquidation are important because they represent the final step in a company’s life cycle. For shareholders and creditors, it determines how much they will receive from the sale of the company’s assets. The order and priority in which distributions are made—such as paying creditors before shareholders—are crucial in ensuring a fair and legal distribution of remaining assets. For businesses, understanding how distributions work helps in making informed decisions during financial difficulties and in structuring the liquidation process properly.
For creditors, the liquidation process ensures they are repaid as much as possible based on the available assets, while for shareholders, it offers a chance to recover part of their investment in the event of the company’s dissolution.
Understanding distributions upon liquidation through an example
Imagine a company that has failed to remain solvent and decides to liquidate its assets. The company’s remaining assets, after paying off its liabilities and creditors, amount to $500,000. The company has two classes of stakeholders: creditors, who are owed $300,000, and shareholders, who own 100% of the company’s equity.
First, the creditors are paid the $300,000 they are owed. After the creditors are fully paid, the remaining $200,000 is distributed to the shareholders based on their ownership percentages. If there is one shareholder with 50% ownership, they would receive $100,000, while the other shareholder with 50% ownership would also receive $100,000.
In another case, if the company has secured and unsecured creditors, the secured creditors would typically be paid first before any unsecured creditors or shareholders receive a distribution.
An example of a distributions upon liquidation clause
Here’s how a distributions upon liquidation clause might appear in a shareholder agreement:
“Upon the liquidation of the Company, the assets shall first be distributed to settle all outstanding liabilities, including debts to creditors. Any remaining assets shall then be distributed to the shareholders based on their ownership percentages in the Company, subject to the terms outlined in this Agreement.”
Conclusion
Distributions upon liquidation are a critical aspect of the dissolution process, ensuring that the assets of a company are fairly distributed to creditors and shareholders according to their priority and ownership interests. For businesses and their stakeholders, understanding how distributions work during liquidation is essential for navigating the closure of a company in an organized and legally compliant manner.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.