DEFINITION of 'Forced Selling (Forced Liquidation)'
The involuntary sale of assets or securities to create liquidity in the event of an uncontrollable situation. Forced selling is normally carried out in reaction to an economic event, personal life change, company regulation, or legal order.
Also known as Forced Liquidation.
BREAKING DOWN 'Forced Selling (Forced Liquidation)'
In the realm of security investments, forced selling can occur within an investor’s margin account if the investor fails to bring her/his account above the minimum requirements after being issued a margin call. Forced liquidations generally occur after warnings have been issued by the broker regarding the under-margin situation of an account. Should the account holder choose not to meet the margin requirements, the broker has the right to sell off the positions. The following two examples serve as an illustration of forced selling within a margin account:
- If Broker XYZ changes its minimum margin requirement from $1,000 to $2,000, Mary’s margin account with a stock value of $1,500 now falls below the new requirement. Broker XYZ would issue a margin call to Mary to either deposit some money or sell some of her stocks to bring her account value up to the required amount. If Mary fails to respond to the margin call, Broker XYZ has the right to force sell $500 worth of her stocks.
- Mary’s margin account net value is $1,500 which is above her broker’s minimum margin requirement of $1,000. If her stocks start performing badly and her net value drops $800, her broker would issue a margin call. If Mary fails to respond to the margin call by bringing her delinquent account up to good standing, the broker would force sell her shares in order to reduce its leverage risk exposure.
The opposite of forced selling in margin accounts is a forced buy-in which occurs in a short seller’s account when the original lender of the shares recalls them or when the broker is no longer able to borrow shares for the shorted position. When a forced buy-in is triggered, shares are bought back to close the short position. The account holder might not be given any notice prior to the act.
In the event of a crisis, portfolio managers are forced to sell certain assets so as to mitigate their losses. Case in point is Valeant Pharmaceuticals International, which saw its stock value slump to about 90% in May 2016 from its 2015 peak. Hedge funds who had invested hundreds of millions of dollars in the pharmaceutical company exited their long positions and forced sold, thereby protecting themselves from further declining losses.
Forced selling is normally done when the events of a person’s life change significantly. When a family member dies, the estate may be forced to sell the deceased’s assets and properties to pay for debt. One may be forced to sell his/her assets when faced with a health condition that requires high medical bills. In divorce proceedings, assets are sold and the proceeds divided between both parties involved.
When joint owners of a property are in disagreement over how to manage a property or whether to sell a property, the Partition of Property Act, provides the court with the authority to force sell the property and distribute the sale earnings appropriately among all joint owners.
Creditors, under the authority of a court’s writ of execution, can usually force sell a debtor’s assets by auctioning them. The Forced Liquidation Value (FLV) or Forced Sale Value (FSV) is the proceeds received from the sale of these distressed assets and used to pay off debt.