Michael Reid: Liquidation - sometimes it’s the only practical option
Michael Reid, managing partner, Meston Reid & Co, offers advice for individuals looking to liquidate their company.
One reads plenty media comment about an increase in both corporate and personal financial failure due to various factors and certainly, although there is some government assistance for energy costs, many of the temporary law changes and financial support structures that we saw in recent years have now been removed.
Government changes/pronouncements, coupled with a rise in both inflation and interest rates seem to have created an increased element of uncertainty. There is no doubt that the Meston Reid & Co insolvency team have fielded far more questions about the impact of insolvency. Here we will consider whether liquidation may be the answer when corporate financial problems rear their head.
The principal definition of insolvency is being unable to meet debts as they fall due in the ordinary course of business (section 123 of the Insolvency Act 1986 “the Act”) and this probably applies to many companies at the moment as they seek to defer settling creditors for as long as possible because they are struggling to collect the book debts and manage the cash flow generally.
It is important to have a financial plan that shows how the company can recover from a temporarily insolvent position. Rather than based upon hope, such a plan should be both realistic and achievable because, if not, the level of liabilities may increase further, leading to the problem of a director being asked to contribute personally to an insolvent position as a result of the wrongful trading provisions contained in the Act.
A key reason why directors operate through a limited liability company is to contain personal financial exposure and clearly anything that risks that veil of protection needs to be considered very carefully.
When looking at a company’s balance sheet, accounting convention reflects assets at their book value, but most businessmen understand that in the event of a distressed sale, plant and equipment, vehicles, IT equipment etc tend to realise far less than the carrying value in the accounts.
Accordingly, when looking at the balance sheet, a director may well think that there is a comfortable asset base, but what happens if the older book debts are not collectible or some of the newer/larger ones are not recovered because the customer collapses into insolvency?
Further, what is the market value of second-hand desks/chairs and IT equipment? It might be argued that a formal liquidation process merely reduces the value of assets to the disadvantage of creditors, and experience suggests that even when directors think there is plenty of cash to go round, the sad truth is that only a small dividend (if any at all) is available once market forces dictate how much assets are really worth.
That is not a reason to avoid liquidation and an orderly realisation process, because the position might worsen to the detriment of all concerned, particularly directors if wrongful trading applies.
For many directors, it has been a struggle to keep a company afloat in recent years.
There are increasing creditor demands to settle some old liabilities, and being unable to pass price increases to customers erodes the margin that generates cash.
Also, higher interest rates simply mean more money paid to the bank on a monthly basis rather than being available as working capital. Directors are under pressure to start repaying a bounce-back loan and many comment that they have tried everything to save the business.
Trying everything might include refinancing vehicles, entering a factoring agreement for book debts, trying to refinance buildings, or seeking additional investment, but there comes a time when all avenues have been explored and there is simply not enough cash flowing through the business, resulting in difficulties in paying creditors and worse, meeting the weekly/monthly payroll burden.
In such cases it is tempting to liquidate the company because, for example, there may be insufficient resources to make longstanding employees redundant because of the cost of paying notice pay and redundancy, meaning that liquidation is the only way of ensuring that employees receive their statutory entitlement.
It is not unreasonable for a director to take the view that “enough is enough” and seek to liquidate the company. It removes the stress that has been causing sleepless nights and does not signify personal failure because there are many perfectly valid reasons why the financial plan makes it clear that corporate survival is simply not possible.
There are plenty of ways in which to view a company’s financial condition and the common ground means applying experience, practical knowledge and realism. Although a difficult decision to take, sometimes ceasing to trade and appointing a liquidator is the only sensible way forward. Of course, if liquidation incepts, certainty descends upon the situation and the Act determines how assets are dealt with and creditors paid.
That said, deciding to liquidate is a serious matter and advice should always be sought but there are many cases where liquidation is the answer.
Michael Reid is managing partner at Meston Reid & Co.