Insolvency Options
It has been four years since the financial crisis hit us but some businesses are still affected by it and struggling. Others have gone into receivership or liquidation. This article attempts to identify the different options available to a company before it is closed down.
When a company runs into financial difficulty, the owners can engage an insolvency expert who can assist with negotiating new terms with its bankers, creditors, or customers. Often, the directors/shareholders sink more funds into a business with the hope of saving it and just as often they incur greater losses because it is too late by then.
If they seek help early they may have a choice of options rather than have unpleasant outcomes forced upon them. These options are summarised below.
Creditors’ Compromise
This is an agreement between the company and the various classes of creditors. Creditors typically comprise the lenders of money, trade creditors for purchases, Inland Revenue for unpaid PAYE and GST, hire purchase creditors, landlords, etc.
The purpose of a compromise is to allow the company to survive by avoiding liquidation and trading out of its financial difficulty. Usually, the directors decide to allow the company to enter into a compromise with its creditors. On the other hand, the creditors will agree to a compromise only if they believe that they will get more money by not placing the company into liquidation. To reach a compromise, a majority number representing 75 percent in value of each class of creditors voting in favor of such a resolution is required.
Once an agreement is reached, all debts are frozen and no creditor can take action against the company during the term of the compromise. The outcome could be that the creditors are repaid either in full or in part. Where they are repaid in part, the balance of the remaining debt is written off by the creditors. Creditors’ compromise is probably a good option where the business is fundamentally solid but is in financial difficulty.
Voluntary Administration
Voluntary administration is a rescue mechanism that can be initiated by the directors of a company in distress or a creditor with a charge over the whole or substantially all of the company’s property.
This is done by appointing an independent and suitably qualified person (an administrator) to take full control of the company and its business to provide a better return to creditors than they would if placed straight into liquidation.
Voluntary administration is intended to be a relatively short-term measure that freezes the company’s financial position while the administrator and the creditors determine the company’s future. Often, it results in liquidation.
It is not a favored option because the administration process is very expensive, Inland Revenue has a preferential creditor status (see schedule 7 of Companies Act 1993) and lastly, the company directors are not held personally responsible for tax liabilities of the company.
Receivership
A secured creditor, such as a bank, financial institution, or a private lender, usually puts a company into receivership by appointing a receiver to recover the funds lent by it.
A secured creditor is a General Security Agreement (GSA) holder who would have been allowed to register a security interest over the company’s assets on the Personal Property Securities Register (PPSR) at the time of lending funds to secure its debt.
The receiver acts for and reports to the secured creditor only and it effectively has control over those of the company’s assets that are subject to the security.
Receiverships are governed by the Receiverships Act 1993, so although the receiver’s primary duty is to recover the secured debt; it must protect the rights of other creditors. Once the secured creditor is repaid from realized assets, the receiver ceases to act after notifying the Companies Office. If there are unsecured creditors who are still owed money or further assets to be realized, then the company can be put into liquidation.
Liquidation
A company can be put into liquidation by its directors, shareholders, or creditors with the main purpose of realizing the company’s assets to pay its creditors.
Once a liquidator is appointed, liquidation commences immediately. The procedure for liquidations is set out in the Companies Act 1993. A liquidator’s powers are wider than a receiver’s in that a liquidator can carry out investigations into why the company failed, take possession of the company’s records to assess its assets, and set aside insolvent transactions and other actions.
The directors have to support and co-operate with the liquidator including providing information when requested as their powers are limited throughout the liquidation process.
Sometimes, a company is placed into liquidation by court order, usually when the directors/shareholders do not take any action when the company is already insolvent. In such situations, the court appoints a liquidator (maybe a private or the court’s Official Assignee).
Once liquidation is complete, the company is struck off the Companies Register.
A company does not have to be placed into receivership first before it can be placed into liquidation. Likewise, a receiver can be appointed before or after a liquidator has been appointed.
Important: This is not advice. Clients should not act solely based on the material contained in the Client Newsletter. Items herein are general comments only and do not constitute or convey advice per se. Changes in legislation may occur quickly. We, therefore, recommend that our formal advice be sought before acting in any of the areas.
