Employees get a preference in a liquidation. It’s a well known and publicised fact. Schedule seven of the Companies Act 1993 stipulates, quite clearly, that employees get paid first … most of the time. There are a few exceptions to the rule which we discussed in our previous article on the matter “So you think employees get a preference do you?”.
There are, however, other exceptions to these rules that are often overlooked by business owners.
Cash is King
Cashflow is always vital in any business and can, in many circumstances, be the one thing that either saves a business or destroys it.
Part two of the solvency test (section 4 of the Companies Act) states that a company remains solvent if it can pay its debts as they fall due. When companies struggle with a lack of cash, they fail this part of the test and must be deemed to be insolvent.
That places the directors of the business in a tricky situation. They must, at that point, be mindful of the creditor position and not just the position of the shareholders. No director wants to be accused of trading recklessly. They must therefore seek alternative forms of funding or identify and implement ways to improve cash flow so as to be able to pay the company’s debts.
There are a variety of ways to improve cash flow such as cost cutting, increasing margin or convincing customers to pay a little earlier. If those type of improvements aren’t possible then alternative funding must be sought, the most common being a shareholder loan or capital injection.
A bank loan or overdraft may be feasible if there are sufficient assets to provide security, if not, what do you do? Many companies turn to debt factoring or trade finance options. Trade finance is, essentially, a loan to buy stock while debt factoring is an advance provided over a company’s accounts receivable.
There are a variety of finance providers offering these services, some more reputable than others. Many of the banks offer these services and it can have a very positive impact of a business, providing them with early cash flow to meet their obligations.
What’s the catch?
What many fail to realise is that both debt factoring agreements and trade finance agreements are usually provided with security over the stock and/or debtors. In a typical liquidation scenario, the physical assets of the business are secured but the accounts receivable and stock sales are used to pay the preferential creditors first i.e. the employees.
Where security has been provided over those assets, quite often, employees can be left unpaid.
Do you have a client who needs advice on a struggling business? Contact Simon at sdalton@gerryrea.co.nz for a free consultation.