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Concept Version 9
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Liquidation Preference

The main purpose of a liquidation where the company is insolvent is to satisfy claims in the manner and order prescribed by law.

Learning Objective

  • Summarize how the liquidation preference determines which claims will be paid if a company becomes insolvent


Key Points

    • The main purpose of a liquidation where the company is insolvent is to collect in the company's assets, determine the outstanding claims against the company, and satisfy those claims in the manner and order prescribed by law.
    • Before the claims are met, secured creditors are entitled to enforce their claims against the assets of the company to the extent that they are subject to a valid security interest. In most legal systems, only fixed security takes precedence over all claims.
    • Claimants with non-monetary claims against the company may be able to enforce their rights against the company. For example, a party who had a valid contract for the purchase of land against the company may be able to obtain an order for specific performance.
    • Most preferred stocks are preferred as to assets in the event of liquidation of the corporation.

Terms

  • creditor

    A person to whom a debt is owed.

  • Preferred Stock

    Stock with a dividend, usually fixed, that is paid out of profits before any dividend can be paid on common stock, and that has priority to common stock in liquidation.

  • liquidation

    The selling of the assets of a business as part of the process of dissolving it.


Example

    • A party who had a valid contract for the purchase of land against the company may be able to obtain an order for specific performance and compel the liquidator to transfer title to the land to them, upon tender of the purchase price. After the removal of all assets which are subject to retention of title arrangements, fixed security, or are otherwise subject to proprietary claims of others, the liquidator will pay the claims against the company's assets.

Full Text

Liquidation Preference

The main purpose of a liquidation where the company is insolvent is to collect in the company's assets, determine the outstanding claims against the company, and satisfy those claims in the manner and order prescribed by law. The liquidator must determine the company's title to property in its possession. Property which is in the possession of the company, but which was supplied under a valid retention of title clause will generally have to be returned to the supplier. Property which is held by the company on trust for third parties will not form part of the company's assets available to pay creditors.

Before the claims are met, secured creditors are entitled to enforce their claims against the assets of the company to the extent that they are subject to a valid security interest. In most legal systems, only fixed security takes precedence over all claims. Security by way of floating charge may be postponed to the preferential creditors.

Claimants with non-monetary claims against the company may be able to enforce their rights against the company. For example, a party who had a valid contract for the purchase of land against the company may be able to obtain an order for specific performance and compel the liquidator to transfer title to the land to them, upon tender of the purchase price. After the removal of all assets which are subject to retention of title arrangements, fixed security, or are otherwise subject to proprietary claims of others, the liquidator will pay the claims against the company's assets.

Plane Liquidation

Planes are an example of liquidated items when companies "go under. " They are generally auctioned off to the highest bidder.

Priority of Claims

Generally, the priority of claims on the company's assets will be determined in the following order:

  • Liquidators costs
  • Creditors with fixed charge over assets
  • Costs incurred by an administrator
  • Amounts owed to employees for wages/superannuation (director limit $2,000)
  • Payments owed in respect of workers' injuries
  • Amounts owed to employees for leave (director limit $1,500)
  • Retrenchment payments owing to employees
  • Creditors with floating charge over assets
  • Creditors without security over assets
  • Shareholders (Liquidating distribution) - Most preferred stocks are preferred as to assets in the event of liquidation of the corporation. Stock preferred as to assets is preferred stock that receives special treatment in liquidation. Preferred stockholders receive the par value (or a larger stipulated liquidation value) per share before any assets are distributed to common stockholders. A corporation's cumulative preferred dividends in arrears at liquidation are payable even if there are not enough accumulated earnings to cover the dividends. Also, the cumulative dividend for the current year is payable. Stock may be preferred as to assets, dividends, or both.
  • Unclaimed assets will usually vest in the state as bona vacantia.
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