Having outstanding debts as a company can feel like a death sentence. Being unable to repay those creditors means more than just a financial obligation. If things progress to a certain point, those creditors may be able to take control of the company to resolve those debts.
There are generally a few options that can be taken. There is, of course, the option to repay the outstanding debt. This is the easiest resolution but oftentimes is simply not possible for companies that are in financial trouble.
There is also the opportunity to bring in a voluntary administrator to assess the financial condition of the company. The administrator will also assess what the best course of action is for the creditors, bringing about a resolution that works best for the creditors.
Unfortunately, there is also the chance that the company could be liquidated. When it is determined that the company cannot pay back their outstanding debts, either parts or the entirety of the company are sold to offer restitution on the debts owed to the creditor.
Liquidation is never an ideal scenario, but there is a lot more to know about the subject than that. Let’s take a closer look at liquidation – what it means and why a company may find it as the best available option.
What Is Liquidation?
The simplest explanation is that it is the end of life for a company. Company liquidation is typically the absolutely last solution because there are simply no other options left for the survival of the company. Even voluntary administrators will work to find a resolution that not only pays the creditors back but keeps the business alive.
Under the umbrella of a company, directors and shareholders’ activities can greatly impact the future, both immediate and long-term, of the company. Sometimes, those activities result in debts that simply cannot be repaid.
When it is determined that those debts cannot be paid, the process of liquidation is meant to bring all of those activities to a decisive close.
Appointing a Liquidator
Should the decision be made to liquidate the company – either internally or through a voluntary administration – a liquidator is then appointed. The liquidator works to help unravel the many interests of the company, making sense of what may be liquid (sellable) and what won’t be.
All parties involved with the company – directors, shareholders, and the creditors themselves – feel the effect thanks to the immediacy of liquidation. It is important to note that liquidating a company does not always result in the best course of action for a creditor.
More often than not, companies that are liquidated don’t come close to being able to repay their debt to creditors. The liquidation process is simply so creditors can collect something even if it is not close to the entirety of the debt.
The liquidator has the toughest task of all. They must find a way through all of the competing interests in the company. Their task is to finalise all of the affairs of the company so that it can possibly end its life with all outstanding issues taken care of. Should liquidation of the company not resolve all outstanding debts, then there is generally a priority created depending on a few criteria.
During the liquidation process, the liquidator works to try to ensure that everyone is getting as they should and that no company gets something that they are not due. When all assets have been distributed or liquidated, the company ceases to be.
Risk Management Is a Crucial Factor
There are more than a few reasons why a company may ultimately decide that liquidation is the best potential path. Even if a company has successfully managed to sell off its investments, there is always the possibility that potentially unforeseen liabilities could appear somewhere down the road.
Perhaps there is a situation where an accountant facilitated the sale of a company to a different client only to find out that there was a claim connected to the original client that has materialised many years after the fact.
Or perhaps a husband who conducted an enterprise through the business itself ends the business and hands control of the company to his wife. The wife then starts a completely different business, which could present risk factors going forward.
The process of liquidation is meant to avoid that risk exposure further down the line. By liquidating the company, those risk management factors become a non-issue.
Avoid Breaching Director Duties
There are some directors and leaders who simply walk away when a company is in financial difficulty and do nothing. But that is a major potential risk. There is the chance that creditors will eventually find the director looking for payment. There is also the risk of having to deal with angry and potentially unpaid employees. Oh, and there is the breach of Director’s Duties to consider as well.
There are a number of duties that a director is required to uphold, which means exercising powers and duties using diligence and care. That means being properly informed of the company’s financial position and ensuring that it does not partake in trading activity if the company is insolvent.
Director’s duties are also meant to be exercised with the best interests of the company at heart. If it is clear that this was not the case, a director would be in breach of their duties.
Finally, there is the possibility of using the position of director to gain an improper advantage for either yourself or someone else as well as to cause detriment within the company. Walking away can run the risk of facing penalties from the securities commission.
Avoiding Director Penalty Notice (DPN)
While there is a perception that directors of failing companies get away free and clear, that is definitely not the truth. Directors have certain expected responsibilities to uphold to their company at all times. If they are in violation, they could be found in breach of their duties.
Breaching those duties could mean getting a director penalty notice (DPN), which can make a director personally liable for things such as unpaid superannuation to the ATO or the company’s PAYGW obligations. Not to mention that the ATO can make a director personally liable if they try to abandon the company with the sole purpose of avoiding notice.
Companies that are put into liquidation within 21 days of receiving a DPN can potentially avoid that personal liability.
Keep Creditors From Hounding
Anyone who has ever had a creditor knows that they are persistent to say the least. When you owe someone money, it is a good bet that they will try to communicate the outstanding issue as much as humanly possible.
It can be infinitely stressful to deal with. Calls, letters, and other forms of communication can feel like they will never end. It is enough to take the already stressful situation of a company struggling and amplify it.
Without a liquidator, there is a chance that the creditors will begin their own independent legal action. Liquidation is meant to prevent legal action from taking place. It can also stop a potential writ from being executed by law enforcement. Most importantly, it stops debt collectors from hounding those in charge of the company.
Avoiding Trading While Insolvent
Being insolvent as a company means that the company cannot pay back its financial obligations. But being insolvent also carries with it a few more consequences that may not exactly jump to the attention of the shareholders.
Directors of companies that are insolvent have an obligation to prevent the company from doing any trading while insolvent. Should a company be insolvent, there are certain restrictions that must be adhered to, including trading.
For all involved in a liquidating company, there is no easy part about this process. But some companies have been in serious, scary debt to creditors. The process of liquidation is meant to get directors and other relevant members away from that spectre hanging over their heads.
It is never an ideal situation to liquidate a company. The directors have a certain vision for the future of the company and closing its doors is not something that they are actively thinking of or hoping for. But sometimes it is simply the best way to go about things.
The one silver lining about the liquidation process is that it offers a solution. Instead of having creditors hounding the company, all of that stops and the director, owners, and so on can begin the process of moving forward with their lives.
At the end of the day, there are other methods that can be implemented to find solutions between debtors and creditors. Unfortunately, not all of those solutions end up being good ones. When liquidation is the only recourse, it can feel like the end of the world.
In reality, liquidation is a necessary step. Companies that owe outstanding debts typically only end up adding to that debt, getting further into the hole. But liquidation can solve all that and provide the next step forward.
Founder Dinis Guarda
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