Liquidations: They seem to be happening everywhere at the moment, what went wrong? (with examples)
It seems that every day in New Zealand we are seeing a familiar business being placed into liquidation…
What’s going on? And what does it mean when a company is placed into liquidation?
Can I avoid being placed into liquidation?
All valid questions.
To put it simply, a company is placed into liquidation when it can no longer pay its debts.
These are what’s known as insolvent liquidations. In other words, your company is insolvent when it can not repay it’s debts as they fall due.
How does this happen?
Often a company will take on debt in good times to fund an expansion of the business. The company is making good profits and cash flow that are allowing them to service this new lending.
However, when the economy slows, margins are compressed, and customers start to pay a little bit slower….then those debt repayments are not so easy anymore.
Directors will talk to their lenders and see if they can give them some breathing room, but if things have gotten too dire, then the creditors may place the company into liquidation to recover some of their funds...if any.
Creditors will be hoping that by putting the company into liquidation they can salvage some of the remaining value in the company which can then be used to repay what they are owed.
For instance, the company probably still has assets that can be sold. Or, the whole business can be sold; this will usually be the course that provides the most amount of money as a going concern is worth more than a pile of assets.
After the liquidators have paid themselves from the proceeds of any asset recoveries, the creditors will receive the rest.
In insolvent liquidations, its rare that shareholders will receive any of their investment back as the creditors have a ‘higher’ claim. That is, they are the first to be repaid.
I’ve heard the IRD can put your company into liquidation. Is that true?
Absolutely, it happens a lot.
Tax debt can grow rapidly as business is doing well and directors are not putting aside funds to pay these taxes.
If a director is focused on growing the business, or living the high life, then often paying taxes falls to the wayside as a priority.
The funds that should be used to pay tax, are used to pay staff bonuses, buy new company machinery, equipment, or upgrade the office premises.
Essentially what’s happening is the IRD is funding these purchases. And at some point they say enough is enough and apply to the high court to put the company into liquidation.
That’s what happened with the aged care provider Sound Care Group last year. Have a read of the article if you’re interested as it explains some of the reasons why aged care facilities have been running into financial difficulty.
It’s important to realise that the IRD is a preferential creditor in New Zealand, so during a liquidation, their debts will be repaid first.
They are also very serious when it comes to PAYE taxes that are overdue. If a company let’s this get out of hand, the IRD are quick to jump into gear.
The restaurant went down owing nearly $2m to the IRD.
Inland Revenue served the company with a statutory demand for the outstanding taxes and when the company didn’t pay on that demand, they served the company with a liquidation application.
The shareholders then decided to place the company into liquidation, before the court could do so.
I am not privy to the liquidation so I don’t know exactly why the shareholders did this, but I presume it was to avoid having no control during the liquidation process.
If the shareholder appoints the liquidator then of course they will have more transparency and a ‘friendlier’ relationship with the liquidator vs if the court appointed liquidators which the shareholders don’t know.
This leads me to my next point….
As a company Director, you must place the company into liquidation if you believe it is insolvent
In New Zealand we have what’s known as ‘Directors duties.’
These are a set of rules that directors must abide by.
There’s a whole list and you can read more about them in the Companies Act.
If a director is found to have breached these duties, then they can be found personally liable for the companies debts. Which is a very bad thing if your company has gone into liquidation…
If you’re found liable then the liquidator will fight to have you pay the company a sum (all or part) of the company debts to repay the creditors.
This is what happened in the famous Mainzeal case.
Most of the time directors will have director insurance to protect them in these situations, but if not, then they will often be made bankrupt.