Insolvency Issues

Liquidations are no alien. It can happen to any organization regardless of status, longevity and industry. However many, especially the general public, are not aware of all the facts there is to it which is why we tapped the experts of AABRS to help us lay down the lies versus the truths about liquidations.

LIE: All liquidations are brought upon by creditors and are therefore forced.

TRUTH: There are actually two types to this proceed: voluntary and forced. With that said, a company has the option to take on the procedure out of its own free will without requiring any action from creditors or any other third party.

LIE: Only the financially troubled liquidates.

TRUTH: This is by far the biggest lie that people tend to believe. As a matter of fact, a solvent, viable and profitable company may choose to liquidate for reasons that include reinvestment, retirement, risk aversion and purpose exhaustion among others. In short, even a good standing entity like Apple and Google can liquidate. That is, if they want to.

LIE: They leave nothing to owners and shareholders.

TRUTH: Not exactly. If the proceeds of the liquidation cover the entirety of the liabilities thus paying off all creditors in full, whatever remains shall be distributed in proportion to each owner and/or shareholder’s share of the business.

LIE: Creditors are paid in full from the proceeds.

TRUTH: Not all the time. Voluntary liquidations carried out by solvent entities always end up paying off all creditors in full simply because it has the resources to do so. In the case of insolvent businesses, there are two scenarios. Either the creditors are paid in full or they are paid pro rata. This means that the proceeds shall be divided among all creditors by virtue of percentage.

LIE: A liquidated company can no longer do business.

TRUTH: Technically, this is true but it does not go to show that the owners cannot put up a new business anymore. Should owners have the will and the resources to go on a different or similar entrepreneurial venture, they can do so. The previous company’s creditors cannot run after this new entity so there’s no need to be worried about that. The relationship and responsibility has been severed after the liquidation process.

A Creditors Voluntary Liquidation or a CVL for short is one of two types of processes initiated by a company’s board of directors themselves as a result of the entity’s financial distress and inability to fulfill its maturing obligations.

The CVL is one taken after careful examination of the company’s affairs and careful deliberation among interested parties has been called for. It is one where evidence of insolvency is at hand and all other business recovery options are deemed futile and more damaging. Moreover, companies take on a Creditors Voluntary Liquidation to avoid having it forcefully wound up by court as a result of a petition handed by a corporate creditor or a group thereof after having exhausted all viable means to collect.

When going down the CVL route or at least planning too, below is a list of things that the company and its directors must not do. These mistakes can be very detrimental if not full on fatal. It is best to act fast but at the same time such must be done cautiously, wisely and correctly.

1.    Dodging Creditor Claims

The number one mistake that a company makes is by continuously dodging creditor claims, not taking on calls and avoiding them altogether. Such gesture can only provoke and lead them to make a winding up petition at court which will be very disadvantageous on your part. Open communication between both parties is necessary.

2.    Continuing to Trade

When insolvency has been proven, the company must cease operations and stop trading as doing so can be seen as a fraudulent act against creditors and customers. Any operations allowed are only those necessary and related to the liquidation process and nothing else.

3.    Not Examining Finances Well

Be sure to examine your company well. You must have full evidence of insolvency as you cannot take a CVL otherwise. No company is legally allowed to opt for a CVL when solvent as that will enable them to rescind part of its liabilities.

4.    Proceeding With No Direction

The company must come up with a detailed plan to ensure that everything goes well every step of the way. This shall also avoid any hiccups and hang-ups to prevent any more losses tot eh company and its creditors.

5.    Failure to Appoint a Quality Professional

A creditors’ voluntary liquidation is an insolvency procedure taken by entities who after thorough examination and assessment has concluded that the company is already insolvent and can therefore not be able to fulfill all of its maturing obligations in full.

There are two tests to determine if a company is possibly insolvent. The first is called the balance sheet test where it seeks to determine the ratio or proportion of assets versus liabilities. A healthy entity is bound to have more assets than liabilities. The second is called the cash flow test where the flow of money is examined. A solvent company is bound to have more cash inflows than outflows. Being debt heavy or having more expenses that income does not automatically translate to being insolvent as a lot of other factors will still have to be thrown in but it could mean trouble.

After all measures and assessments have been exhausted and the company is proven to be unable to meet its liabilities the owners and directors should already consider their options. One of those choices would have to be the creditors’ voluntary liquidation or the CVL. It is a formal cessation of the business and as its name suggests, a voluntary winding up of one’s affairs.

Part of the procedures to be taken would be the filing of an insolvency status which has to be proven beyond reasonable doubt. A CVL should not be a means for entities to run away from their creditors. During the course of a CVL, a liquidator or insolvency practitioner will also be appointed to manage the entire process. All the assets will be sold and its proceeds shall be used to pay out the creditors in full and if not, in proportion to their interests.

What is insolvency? How does it happen? What effects does it bring its befallen? These questions will be answered as you read on through this cheat sheet to corporate insolvency from AABRS..

Simply defined, insolvency is a state where an entity cannot anymore fulfil its dues as they mature. Simply put, it cannot anymore pay its debts. It should not be in any way confused with bankruptcy which is more of the legal act or proceeding brought about by the former. All bankrupt companies are technically insolvent and it cannot anymore be reversed or reformed. On the other hand, being insolvent does not necessarily mean that an entity is considered bankrupt. It can still find ways to recover or at least minimize its losses through the various business recovery options available today.

There are two simple ways or tests that determine whether your business could be suffering this unfortunate fate. They are the cash flow and balance sheet tests. The former seeks to take a look at the cash flows of the entity. If its inflows are lower than the outflows or if it is significantly low that it hinders payment of obligations then you could be in bad shape. The latter sees the balance sheet and sees the asset to liability ratio. A higher amount of liability is considered an omen.

The reason for a company going insolvent is brought about by many factors. One major explanation would have to be on credit mismanagement. Others would include inability to go with the times, high competition, poor economy, inflation of raw materials and the list goes on.

The effects that it brings are quite numerous, listed are a few:

It tarnishes corporate brand and image. Suppliers, business partners, clients and customers can withdraw their support with the company. No one wants to do business with an entity that does not pay its dues.

Management and directors can be held accountable up to their personal properties if they fail to meet and prioritize creditor needs. This could happen should they choose to go on with trade to the point that liquidation becomes inevitable.

It can ultimately lead to a winding up court procedure. Should the company not act quickly, creditors may appeal to court and force the business to liquidate. Such would be a lethal blow and there would be no more turning back at this point. Any sale of assets will be considered void and bank accounts will be immediately frozen.\

Contrary to popular belief, businesses may in themselves choose and wish to wind up their operations and cease trading. This is what is pertained by voluntary liquidations. There are actually two kinds to it: the MVL (Members’ Voluntary Liquidation) and the CVL (Creditors’ Voluntary Liquidation). But what sets the difference between these two? What keeps them similar and different at the same time? Which is which? Let’s find out the answers to these questions as we read on further below.

A Creditors’ Voluntary Liquidation is initiated by an insolvent company. That means that its liabilities have outgrown its assets and/or its cash outflows overweigh the inflows. To put it simply, the company is at a loss and it cannot anymore fulfil its obligations as they come due. Under this process, all corporate assets are to be sold with its proceeds distributed to stakeholders in favour of creditors.

It is illegal under the law to continue trading under the guise of insolvency. A CVL is one of the business recovery options taken in order to avoid and minimize further consequences and losses that can be brought about should creditors file a Winding Up Petition at court. That will then call for a forced liquidation bringing with it a more serious and unwanted slew of consequences.

A Members’ Voluntary Liquidation on the other hand is initiated by a solvent company. This means that assets are still above liabilities and cash inflows are greater than outflows. Simply put, the business is still full operational and can still fulfil its duties and obligations as they become due. So why wind up then?

There are cases when directors and owners will choose to cease operations even when the business is still in good standing. This brings them to come to terms with an MVL which also seeks to sell all corporate assets and use its proceeds to pay off creditors and then redistribute the rest to the shareholders and owners. Reasons as to this procedure include but are not limited to retirement of owners and directors, loss of a vital member to the organization, lack of successor, cessation of corporate purpose and total fulfilment of objectives.

AABRS Effects and Consequences of Bankruptcy

When a company is deemed bankrupt, it often entails that the entity is already unable to repay its outstanding debts and liabilities. Oftentimes this is brought about by a petition filed by the corporate creditors while in some cases it is brought about by the voluntary action by the entity itself. In such a case, the company has to repay its outstanding liabilities by selling off its assets. This of course is done after the company has been rightfully evaluated and proven to be validly bankrupt. This is done because bankruptcy relieves the debtor of its obligations that have been made prior to the filing. Apart from those already stated above, there are other consequences or effects brought about by bankruptcy. Here is a list by the professionals at AABRS.com.

EFFECT # 1: RELATED BUSINESSES CAN ALSO GET A HARD BLOW – Related business both company owned ones or even those that it deals or transacts with will be affected. Let’s take a grocery chain company for example. If they go bankrupt and close down then there is a tendency that several of its branches will be affected too not just one. Plus, the vendors or suppliers that it deals with shall lose a big client and suffer a drop in their sales.

EFFECT # 2: ECONOMIC AND SOCIAL SETBACKS CAN OCCUR – Because a bankrupt company closes down and ceases to exist so will its employees and its economic impact. Many people will lose their jobs thereby flooding the unemployment market even more which gives a bad toll on the economy in general.

EFFECT # 3: CREDIT RATING CAN GO BAD – Since the company was unable to pay off its debts and were only to do so partially or wholly by selling tis assets then this will ripple to a bad credit rating. This affects the owners of the business as this will show in their credit rating and history. Plus, if they choose to open up a new business in the near future, bad credit history and rating can hunt them.

EFFECT # 4: ASSETS AND BANK ACCOUNTS ARE FROZEN – Since the company is already in a state of financial distress, he bankruptcy process forces a freeze on its fixed assets and bank accounts. This means that the entity is no longer allowed to disburse or sell off any of its properties. This is to ensure protection of the corporate creditors.

Let’s say that you are a director in a corporation, a sole proprietor or even a partnership and you have agreed to close down due to certain reasons and even if the business is still considered solvent. What can you do? According to AABRS experts, a good option to consider is the MVL which stands for members’ voluntary liquidation. But what is it? How does it work? Will it be beneficial to you as owners, the business stakeholders and creditors?

An MVL is adopted by a solvent company who voluntarily and willingly winds up their operations. A liquidator is appointed to handle the sale of assets and the distribution of its proceeds to the appropriate parties: creditors, employees, shareholders, owners, and etcetera.

It is important to take note that such process is only to be done by a solvent company. This means that the entity is able to meet both its present and future obligations as they mature, cash inflows are strong and consistent and the value of all its assets exceed all of its liabilities, current or noncurrent.

Another thing to remember is that before you get to wind up your affairs and liquidate, the shareholders must first draft a sworn declaration of solvency which states that the business has thoroughly conducted an examination of its financial statements and that they have concluded the organization’s ability to repay any existing debts.

Additionally the company should not be facing any problems nor is there any ongoing action filed against it by one or more of its creditors. In the event that the business is found insolvent then other options should be looked into such as a pre-pack administration or creditors’ voluntary liquidation to name a few.

Now here are two common instances when an MVL is used:

It can happen in a family run business wherein the parents may have wished to retire and the children do not want to run the business or chose other fields to concentrate on.

A death, resignation or retirement of a core member of the organization has led the officers to agree that the company is best closed down due to the loss of a significant member whose skills and expertise are necessary and important for the organization to run. This is common in many technology related industries.