If you’re a director of a company, it is important to understand what insolvency is, the effects of insolvency, and your obligations when your company is insolvent. Otherwise, you and your company may face some severe consequences.
When is a company considered insolvent?
Determining when a company is insolvent is very important as insolvency can and does have serious consequences for the directors under the law of insolvency. Though, it can be difficult to determine whether a company insolvent as there are a variety of different tests to determine insolvency within a legal context.
While insolvency is not defined under legislation, the term solvent is defined. By inference to the definition of solvent, we can determine what insolvency is. Legislation defines solvent as a person who is able to pay all their debts when they become due and payable. A person who cannot do this is, in turn, insolvent. Case law has established that a factual assessment of the circumstances of a company will determine when debts become due and payable.
Indications that your company may be insolvent
There are a few recognised indicators of insolvency that we have observed in case law. These include, but are not limited to:
- Consistent losses
- Incomplete or missing financial records
- No or lack of cash flow and budgets
- Increasing debts with creditors
- Company receiving letters of demands, warrants, summons etc.
- Company is unable to obtain finance
- Company is unable to raise funds from shareholders
- Disputes between directors, the board, management staff
- Complaints from suppliers regarding non-payment
If any of these indicators resonates with your business, we urge you to contact our office immediately so we can assist you in assessing your situation.
What happens when your company is found to be insolvent?
When a company is found to be insolvent, generally one an external administrator will be appointed to the company. This may be a receiver, a liquidator, or a voluntary administrator. When this happens, the company’s directors will have additional duties imposed upon them. Such duties include the duty to consider the interests of creditors of the company and the duty to prevent the company from insolvent trading.
Understanding and being aware of these duties are extremely important for directors. It is strongly advised to seek legal advice if you are a director of a company that is insolvent or nearing insolvent.
What is liquidation?
Liquidation refers to the process in which a specialist accountant (i.e., the liquidator) is appointed to a company to wind up the company’s affairs, realise the company’s assets, distribute the proceeds to the creditors in accordance to the statutory provisions, and de-register the company.
How does a company go into liquidation?
A company may appoint a liquidator itself voluntarily by a members’ voluntary winding up while solvent. If a company is insolvent, a liquidator will be appointed by a creditors’ voluntary winding up.
Liquidators can also be appointed by court order on the application of a creditor after noncompliance of a compulsory winding up order (i.e., a statutory demand).
If a company is nearing the end of voluntary administration and the continuation of the company is not financially feasible, creditors can resolve to have the company wound up by appointing a liquidator.
What does the liquidator do?
The liquidator has many responsibilities during liquidation to ensure that the objectives of liquidation are achieved. Such responsibilities include:
- Gathering and realising the company’s assets
- Reverse all, if any, unfair transactions of the company prior to liquidation and recover the funds of such transactions
- Ensure that the distribution of the sale proceeds and any recoveries to creditors are in proportion to their debts
- Investigate the circumstances that led to the liquidation
- De-register or wind down the company
Consequences of liquidation
The appointment of a liquidator has the following immediate consequences for the company:
- The company will have to cease carrying on business
- Directors and officers will have their powers suspended during the liquidation
- Shareholders may be liable to pay any amounts unpaid on their shares
- Employees may be terminated or continued for a short period until the company has wound up
It is vital to understand and be aware of the signs that indicate insolvency and the consequences insolvency may cause to you and your company. If you believe that your company may be insolvent or is heading towards insolvency, we urge you to contact one of our experienced lawyers today who will be able to assist and guide you through the process of insolvency and liquidation and your obligations during this time.