Problems in a business generally arise slowly. Problems can become disasters if not recognised and managed. Directors have some latitude in choosing to trade out of a temporary liquidity problem or to advance an insolvency procedure. Directors must carefully consider the responsibility they have to creditors and their duties under the Companies Act 1993 and if they can turn the business around.
Steps towards Solvency for a Viable Business
Insolvency is the inability to pay debts when they become due. Steps can be taken to avoid insolvency. The following are steps that can be considered for a viable business:
- Start with a review of overheads. When considering cutting expenditure take steps to analyse the costs involved. The restructure and reduction of staffing for example can be expensive.
- Dispose of surplus assets to improve cashflow. Often plant and machinery can be surplus to a company’s requirements.
- Reduce stocks and work in progress in order to improve cashflow. Sell surplus stocks.
- Re examine the company’s purchase order position and tighten overall management control.
- Seek additional sources of new funds, such as an overdraft/loan, injection of capital, increasing the equity base or taking on a new investor. Investors will want to see the company has forecasts to profitability, that the product/service is right for market and that management is capable.
- Good management and financial resources are essential.
- If the company has deteriorated to the point a rescue option is a requirement, advice should be gained to avoid collapse and to ensure a planned process is in place to avoid insolvency.
Director Considerations
In embarking on any of the steps to avoid insolvency, it is important to consider factors that can go against you as director:
- Avoid preferring certain creditors ahead of others. A liquidator can clawback transactions from creditors who have gained a preference from an established date of insolvency (if knowledge is held of the company’s insolvency).
- Any asset sales need to be at market value. A liquidator can challenge transactions at under value or to related parties and transactions for excessive consideration.
- A sale of a going concern can be difficult to advance when losses have been incurred or the trading position has deteriorated. Due diligence by interested parties can take time and creates delay when at a time when a company is running out of cash. Continuing to trade whilst insolvent can lead to director liability
Rescue Plans
The purpose of a rescue operation is to ensure a business becomes profitable. This requires a plan and a somewhat ruthless approach.
An option for a company that is struggling is to offer an informal compromise to creditors seeking 100% support to instalment arrangements and usually some debt relief. This is advanced where the company is viable and has suffered a setback. These arrangements requiring 100% support however are difficult and all parties can become disillusioned and failure can lead to liquidation by application to the High Court by a disgruntled creditor. The informal process if managed well can buy a moratorium if full support is gained.
Companies Facing Financial Distress – formal turnaround options
If the company's position has deteriorated to a point where a rescue option is required, advice should be gained early. Continuing to trade an insolvent company and increasing the exposure to creditors can find a director personally liable.
An option for a company in financial difficulty is to offer a formal company compromise under Part XIV of the Companies Act 1993, where creditors by class vote on a proposal for payment usually over a time period and often agreeing to a lesser amount. The proposal needs to show it will provide a better outcome than an immediate liquidation. The company compromise requires a majority in number and 75% in value of creditors voting by class on the matter to support it. The non-voters and non-supporters can be bound by those voting in favour if the requisite majorities are gained.
A voluntary administration (“VA”) is a more structured form of company compromise with an independent administrator engaged to review, manage and rearrange the business and financial affairs to generate the best outcome for a business owner and for creditors. The administrator's focus is to provide creditors and shareholders with a better financial return than might have been achieved were the company put straight into liquidation.
Business Failure in NZ
If the company has failed and has minimal prospects of recovery then liquidation is advanced. A liquidation can advance voluntarily by 75% in number/value of shareholders appointing a liquidator or by the application of a creditor to the High Court (by way of a winding up proceeding) or less common by the board of directors should the company constitution allow.
A secured creditor also has options where concern arises. They can appoint a Receiver and Manager subject to the terms of their Security documentation. The Receiver can seek to sell the business as a going concern and clear the secured creditor’s debt.
For advice on insolvency options contact our team on 0800 30 30 34. We are here to help.
Related Article:
https://www.mvp.co.nz/articles/business-recovery/creating-a-business-strategy-to-survive-and-thrive