Somebody asked me this question the other day and it appears to be a common sentiment. With so much doom and gloom in the press about companies failing and the general fallout that occurs around large receiverships (Mainzeal being a good example), the big question has to be “When should the directors recommend liquidation?”
The problem is that most companies in NZ are owner managed i.e. small to medium sized entities that are short on capital from the start and being financed primarily by trade credit (backed by personal guarantees) and a loan (or two) against the shareholders personal homes. So, when their company fails the fallout can be horrendous.
The employees lose their jobs, the suppliers lose their customer and everybody (banks, IRD, finance companies, employees & creditors) lose money. Then, to top it all, the owner/manager loses his house and can be bankrupted.
In short, nobody wins and the effects are normally widespread.
What should a director do if his/her company is feeling the pinch? The simple answer is talk to their advisors. The company accountant is undoubtedly the best placed to advise a company and its directors on their options. Ultimately, directors and shareholders shouldn’t be afraid of pulling the plug on a failing business. It’s undoubtedly better to stop trading early on when there is clearly no other option rather than struggle on until somebody else makes the decision for you. I’ve heard a phrase a few times and it is quite appropriate; Love your company but don’t fall in love with it.
Liquidation brings finality. It seeks to realise all assets, pay as many creditors as possible and then strike the company from the register. If a company is losing money and there is no clear restructuring option available, it should be liquidated and the directors and shareholders should move on with their lives. Hopefully still in possession of their house!
Directors need to be aware of the Solvency Test in the Companies Act which is quite clear. Once directors are aware that the company is insolvent they must consider the creditors and not just the shareholders. Trading while insolvent opens directors up to potential actions by creditors who have lost money as a result of their actions.