Author
Mitch BallChief of Insolvency Operations & ASIC Registered Liquidator
(02) 9220 7117
Ongoing losses, increasing debt, trouble obtaining finance, and overdue taxes are all signs that a company may be at risk of insolvency. Legally, Directors are required to prevent insolvent trading but many of the signs are overlooked until it is too late. Debt reaches an insurmountable level, and the company is forced into liquidation. As a Director, it is essential to understand the fundamentals of insolvency along with your rights and responsibilities.
This guide provides detailed information on the fundamentals of insolvency and the liquidation process.
Receivership, Administration, and Liquidation
To completely understand company liquidation, it is necessary to know the difference between receivership, administration, and liquidation.
Receivership is where a receiver is appointed by a secured creditor, most often a bank, to sell the charged assets and repay what is owed. Most notably, it does not necessarily mean that the company will wind up.
This is also the case with administration which involves providing an administrator with the time required to accurately determine the financial position of a company, and the most suitable course of action to be taken.
Liquidation differs from receivership and administration as it means the end of the road for a company. When a company enters liquidation, any assets are sold off and the proceeds distributed with accordance to legal requirements.
The following parties get paid first during company liquidation:
- The cost of liquidation must be covered
- Secured creditors
- Priority unsecured creditors such as employees
- Unsecured creditors
The company stops trading and ultimately ceases to exist.
Why do companies go into voluntary liquidation?
Creditors’ Voluntary Liquidation (CVL) is the most common type of liquidation. This is where the shareholders of a company that is trading insolvent, or facing insolvency, commence a voluntary liquidation. This might be the best option for an insolvent company for numerous reasons including:
- Size: For smaller companies, the administration process may not be economically viable.
- Finance: Inability to pay outstanding is the most obvious reason why companies become insolvent. Insufficient funds to pay the ATO and other creditors leaves companies with no other choice but to liquidate.
- Lack of assets: No assets or a lack of valuable assets to sell off and pay creditors could prevent a company from continuing trading.
- Trading at a loss: Trading insolvent is illegal. An inability to recover from previous losses or trading at a loss could result in the decision to begin the process of a CVL.
Contrary to the thoughts of many, liquidation is not limited to companies that are under financial distress and cannot repay their debts. Many companies go into what is called Members’ Voluntary Liquidation (MVL). This is where a solvent company elects to shut down its operations. This can happen for one of many reasons including:
- Viability: Although solvent, the Directors of a company may have determined that it has limited prospects for growth. Consequently, they may elect to liquidate and distribute any remaining assets.
- Lifestyle/Retirement: This is often the case for family run companies where there is an absence of a party to succeed one that is transitioning to retirement or relocation overseas. If a sale cannot be achieved, the Director(s) may choose to voluntarily liquidate.
- Restructuring: A common process for large corporate entities, restructuring may involve closing several subsidiaries that it may own. In such an event, a members’ voluntary liquidation is often the most suitable option.
- Sale or Transfer: It is not uncommon for the acquisition of a company to occur for the purpose of its assets only. Like above, the assets would be transferred and the company that was purchased placed into liquidation.
Are Directors personally liable for company debts?
One of the main fears that Directors have during the liquidation process is personal liability. Directors are only personally liable in special circumstances which include:
- Secured Loans: In the event where your personal assets have been used as security, they could be used to pay off any outstanding company debts.
- Guarantees: If you have signed any personal guarantees or Director guarantees for the purposes of getting a lease or obtaining supplies, you will be personally liable for such debt.
- Trading Insolvent: This is often overlooked and Directors must not forget that insolvent trading is illegal. Moreover, a Director may be held personally liable for any debts incurred if it is determined that they continued trading while clearly insolvent.
- Tax Implications: A Director should always be aware of their position with the ATO. This includes any unpaid PAYG/super contributions Director Penalty Notices that have not been addressed.
What happens to Directors of liquidated company?
Liquidation can be a difficult process for the parties involved and that includes Directors. The burden of blame is often placed on them for any business failures, and like employees, they are generally left unemployed.
Nevertheless, it is important to remember that a company is a separate legal entity to its Directors. Provided that you are not personally liable for any of the reasons listed above, there will be limited ramifications, if any at all.
- Credit Rating: A personal bankruptcy can severely impact your credit rating, but this is not the case with directorship. For Directors of a liquidated company, it will depend on the circumstances. There will be zero impact on the credit rating for Directors of a company that entered a members’ voluntary liquidation.
- Future Directorship: In normal circumstances, there is nothing to stop you from being the Director of another company. This does, however, change if you have been the Director of several companies that have liquidated, or have previously failed to carry out your Director duties.
This further emphasises the importance of being aware of your Directors’ duties, and any avenues such as the safe harbour provisions that can protect Directors from being held personally liable for insolvent trading.
Can Directors put a company into liquidation?
Directors can certainly put a company into liquidation, and in many circumstances, it is their duty to do so. One of the major Directors’ duties is to prevent insolvent trading. If a Director has identified the presence of indicators of insolvency, they must act accordingly. This may include exploring options such as voluntary administration, and potential liquidation. The consequences of failing to do so may result in civil penalties, compensation proceedings, and criminal charges.
As noted above, liquidation is not limited to companies who are experiencing financial distress. Directors of solvent companies may also place them into liquidation. This is known as a members’ voluntary liquidation. During the process, company assets are sold and distributed with all creditors paid prior to the company being wound up. There are a handful of basic steps when voluntarily winding up a solvent company. They are:
- Directors must make a declaration of solvency and lodge it with ASIC
- Company members must pass a special resolution with at least 75% of the members agreeing on the course of action
- Notice to wind up the company must be published on the Published Notices Website
- A liquidator is appointed and begins process
- Liquidator finishes winding up company and lodges final documentation to ASIC
- Company is deregistered 3 months after the necessary forms have been submitted.
Mackay Goodwin are insolvency specialists who offer a range of liquidation services. Our team of experts can help assess your financial situation and specify the most suitable course of action. Contact Us today for a free consultation.
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