Frequently Asked Questions
As a director, you may feel that the company does not have enough cash coming in to pay its debts and want to test if it is really insolvent.
If there is a real chance that the company will 'go broke' (be fatally insolvent) then you need to tread carefully.
It's all about the date when you knew (or should have known) that the company would go under, and should have gone into voluntary administration or liquidation.
Technically, the legal tests for when a company becomes insolvent are:
- It has insufficient cash pay its debts as and when they fall due, or
- When the company's current (or short-term) liabilities exceed its current assets, or
- When its net assets are negative.
There are many ways to become insolvent, to inadvertently engage in insolvent trading, and for a director to put their personal assets on the line.
The best test is when cash or access to cash doesn’t cover debts as they are payable.
If this occurs, contact me, a Licenced Insolvency Practitioner and Chartered Accountant.
All business owners naturally fear the terms 'receivership' and 'liquidation'. Oftentimes, these terms are used interchangeably to describe the downfall of a company - a misleading comparison.
While it's true that appointing either a Receiver or a Liquidator indicates that a company is in serious financial trouble, there are crucial differences between these two processes.
Receivership offers an insolvent company the opportunity to recover and resume business operations.
Once the Receiver has fulfilled their appointed role, the company can oftentimes be handed back to its Directors and Shareholders.
Receivership is sometimes a debt restructuring process, in all cases, it mainly involves the recovery of a secured debt.
Generally, a Receiver is only acting for the secured Creditor, while a Liquidator is effectively acting for all the unsecured Creditors.
Unless you are the appointed secured Creditor, or you are a preferential Creditor (an employee), you are unlikely to receive any payments from a Receiver.
Liquidation ends in the termination of the business and its removal from the registrar of companies.
Also known as 'winding up', the liquidation process involves a Liquidator collecting and selling the company's assets and then distributing the proceeds among the Creditors to pay off debts owed. Once the interests of the Creditors are met, the company is officially dissolved.
What Do Receivership & Liquidation Have in Common?
- Management Relinquishes Control. The company's management will need to step down and hand over legal control of their business operations and its assets to either the Receiver or the Liquidator.
- Repaying Debt is the Primary Objective. The ultimate goal of both court-appointed receivership and liquidation is to pay off accrued debts to all of the company's Creditors, according to their priority.
- Each Process is Well-Documented. The appointed professional, whether a Receiver or a Liquidator, is responsible for regularly filing reports to document the company's progress in repaying debts.
What Sets Them Apart?
- The Outcomes. Receivership offers an insolvent company the opportunity to recover and resume business operations, while liquidation always ends in the termination of the business and its removal from the registrar of companies.
- Whose Interests are Represented. A Receiver acts for the secured Creditor that appoints them. A Liquidator, on the other hand, purely represents the interests of the unsecured Creditors and Shareholders.
- Management's Involvement. In receivership, the Owner of a company maintains a limited role in the debt restructuring process. Liquidation completely eliminates the roles of the Owner and Directors and operates without their input.
It’s easy to get confused between the terms 'Bankruptcy' and 'Liquidation'.
In other countries around the world they are interchangeable, and in some languages, mean the same thing. In some countries, an application must be made to the Court for the appointment of a Trustee in the Bankruptcy of either a company or an Individual.
In New Zealand, the term bankruptcy refers to a person who becomes or is declared bankrupt, while the term liquidation refers to a company that becomes insolvent.
In New Zealand, all personal bankruptcies are handled by the Insolvency and Trustee Service who are part of the Ministry of Business Innovation & Employment. Free-phone them on 0508 INSOLVENCY (0508 467 658).
Remember only Licensed Insolvency Practitioners can act as a Liquidator, Receiver, or Compromise Trustee for a company.
If you have a potential corporate insolvency problem, or would like to negotiate a creditor compromise, contact me.
If your company can't pay its debts, you must decide how the assets of the company should be realised and the Creditors repaid.
There are strict rules set out in the Companies Act 1993 as to who gets paid and in what order.
In New Zealand, only a Licenced Insolvency Practitioner is legally allowed to act as a Liquidator of an insolvent company. They are experts in dealing with companies that fail.
If you think your company can’t pay its debts, contact me, a Licenced Insolvency Practitioner and Chartered Accountant.
If a company Director knows (or ought to know) that their company is insolvent, and continues to trade, the company's Creditors are considered to have been misinformed and suffered a loss. This is what is known as 'reckless trading'.
Your Obligations as a Director:
All Directors need to be aware of the statutory duty they owe to their company to not trade whilst insolvent.
The company Director must agree to and allow the business of the company to be carried on in a manner likely to create a substantial risk of serious loss to the company’s Creditors.
There have been lots of cases where Director’s believed they were doing the right thing when they should have known the company was insolvent, and have been held to be personally liable for the debts of the company.
A ‘sleeping Director’ (one who has no hands-on role in the business) can be held liable for reckless trading. Wilful blindness to what is happening around them does not excuse them.
Often, Directors think that when they set up a 'limited liability company', it's limited, not personal. This is usually the case. However, more and more, the Courts look at what company Director's did (or didn't do) and when they did it, and hold them personally responsible for the debts of the company.
Avoid trading whilst insolvent, contact me to discuss your options.
What is a Shareholder Current Account?
During the life of the company, a Shareholder Current Account is a record of the net balance of funds introduced and withdrawn by the Shareholder. This moving balance is recorded on the balance sheet and may fluctuate from being an asset of the company to a liability of the company.
Overdrawn Current Accounts
An Overdrawn Current Account is recorded as an asset in the balance sheet of the company. An overdrawn current account is where the Shareholders have taken more out of the company than they have put into the company and therefore owe the company. This balance if recorded as an asset is recoverable by the company from the Shareholder upon liquidation.
Overdrawn Current Accounts in Liquidation
The principle duty of a Liquidator is to take possession of, protect, realise, and distribute the assets (or the proceeds of the realisation of a company's assets) to the company's Creditors.
Upon liquidation, an Overdrawn Current Account will be called up by a Liquidator, and Shareholders are obliged to refund the net drawings taken.
This may lead to an agreed repayment arrangement; a settlement for a lesser sum subject to a statement of financial position; or in the worst case, proceedings being filed.
If your company cannot pay its debts, and your current account is overdrawn, contact me to discuss your options.
What is a personal guarantee?
In strict legal terms, this is where an individual (“the Guarantor”) has agreed to ensure that a person or entity (“the Debtor”) will perform its contractual obligations to a third party (“the Guaranteed Party”). If the Debtor does not perform its obligations, the Guarantor will step in and perform those obligations.
When is a personal guarantee required?
If a company Director originally signed an agreement to acquire either an asset or a service for the company establishment or its operation, a personal guarantee is often attached to this document.
A common example is when a company enters into a supply contract under which the company is provided with credit. A company’s liability is limited to its assets, meaning that if the company is unable to fulfil its obligations under the contract and goes into liquidation, an unsecured Creditor will stand in line with all other unsecured Creditors and there is a risk that it won’t get paid. In this situation, the Supplier may require the Directors and Shareholders to provide personal guarantees so that they can make a claim of them personally.
Other common examples of when a personal guarantee is required include:
- A company entering into a lease as a tenant
- A company obtaining funding from a third party – e.g. a bank
- A company entering into a franchise agreement as a franchisee
- A sale and purchase agreement where the purchaser is a company
What are the consequences?
The Creditor can make a claim of you personally under this kind of guarantee – they don’t need to wait until the liquidation is over!
If your company cannot pay its debts, you need to consider the personal guarantees you have signed. Contact me to discuss your options.
A simple liquidation will often be completed within six months. Those involving more complex matters can take a year, or sometimes several years.
The factors that tend to delay completion of a liquidation are long, drawn-out legal matters, or the sale of high value assets.
Some liquidations, if involved in legal processes, can take some years to go through the Court system.
Most companies in New Zealand are small to medium, so the liquidation should be completed with 12 months.
Does your company need to go into liquidation? Contact me to discuss your options.