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What are the Consequences of Liquidation?

If a company cannot repay its debts, it is insolvent. An insolvent company may go into liquidation. There are two types of insolvent liquidation in New Zealand: Voluntary liquidation, initiated by company shareholders, and liquidation by creditor, initiated by external parties.

When a company goes into liquidation, a professional liquidator is appointed by the shareholders or by Court order. This liquidator takes control and responsibility for the company’s financial affairs, selling the company’s unsecured assets to repay debts and distribute funds before the business is dissolved.

Both forms of liquidation can have massive consequences on your company. In this article, learn what happens in the full liquidation process, how it can impact the people involved, and the alternatives to liquidation in New Zealand.

Legal Framework for Liquidation in New Zealand

The legislation for liquidation is covered by Part 16 of the Companies Act 1993.

A liquidator cannot have any personal connection with the company and must work in the best interests of the creditors. The Act grants them a wide berth of statutory powers, allowing them to obtain documents and information about the company being liquidated from creditors. 

As per the Insolvency Practitioners Regulation Act 2019, liquidators must be licensed insolvency practitioners registered with the New Zealand Companies Office.

Voluntary Liquidation

Voluntary liquidation is when the company’s shareholders willingly decide to place the company in liquidation. At least 75% of the eligible shareholders must agree with this decision in a special resolution. Voluntary liquidation gives the shareholders greater control in the liquidation process, including the ability to appoint a liquidator upfront. 

Liquidation by Creditor

Liquidation by creditor is also known as court-appointed liquidation or compulsory liquidation. In this situation, a creditor requests the High Court to order the company be put into liquidation. The creditor must prove that the company is insolvent before a Court order can be made and a liquidator is appointed by the Court. 

Immediate effects on business operations

When a company goes into liquidation, the liquidator takes control of the company’s assets and financial affairs. The liquidator’s responsibilities are to:

  • Investigate the company’s financial affairs and directors’ actions
  • Identify what caused the company to fail
  • Take possession of the company’s unsecured assets
  • Sell assets to recover funds
  • Pay back debts to secured and preferential creditors
  • Distribute the remaining funds to other creditors
 
The length of the liquidation process depends on the size of the company and the circumstances that led to liquidation. It can take as little as 6 months but may go on for 1-2 years for larger businesses.
 
During this period, the company usually ceases trading and staff go through employment termination. Employees can file a claim in the liquidation if they are owed any salary, wages, holiday pay, or redundancy pay. Other creditors, such as suppliers and bank lenders, can also file a claim.
 
The liquidator can hold a creditors meeting to help them investigate the company’s business affairs. The first meeting must be called within 30 days of their appointment for Court-appointed liquidation or within 10 days for other liquidations. During the initial creditors meeting, the creditors can vote to replace the liquidator if they believe the appointment is unsuitable.
 
Once the company’s assets have been sold, the liquidator starts distributing funds to the creditors. The liquidator will notify the New Zealand Companies Office, which then removes the business from the Companies Office Register.
 
Sometimes, a company can continue trading to be sold as a going concern if the liquidator decides that it can still be salvaged.

Financial implications for shareholders and directors

While shareholders can vote to initiate liquidation, they cannot influence the process outside of initially appointing the liquidator. Shareholders may be paid out with the distributed funds; however, they take a backseat to creditors and may not receive any dividends if there is not enough money recovered.
 
The company is a separate legal entity to its shareholders and directors. However, many business loans require a personal guarantee or an agreement that a guarantor will repay a debt if the company defaults. Usually, this guarantor is the director of the company. Thus, if the company goes into liquidation, creditors may pursue personal guarantees, requiring the director to repay debts personally. If a director cannot repay a personal guarantee, they may have to declare bankruptcy.
 
If a director cannot fulfil their obligations, their personal creditworthiness may be affected. Lenders may see them as financially risky, causing them to face more challenges when applying for personal loans or mortgages.
 
If a liquidator finds that a director has committed misconduct (such as fraud or trading while insolvent), they may apply for an order to disqualify the director from being involved in the management of another company for some time. Directors who have consistently been involved with failing companies may also be barred from acting as directors in the future.

Asset distribution and creditor claims

If the liquidator recovers money, the payments will generally be distributed in this priority as per Schedule 7 of the Companies Act 1993:
 
  1. Fees and expenses of the liquidator
  2. Petitioning creditor
  3. Secured creditors
  4. Preferential creditors (employees and Inland Revenue)
  5. Unsecured creditors
 
Secured creditors are creditors who have loaned money to the company with assets as a security, such as the company’s building mortgage or property. If the company fails to repay its debts, the assets can be repossessed by the secured creditor. Secured creditors can include a bank or suppliers. In the case of a liquidation by a creditor, the petitioning creditor is the secured creditor who requested the liquidation to begin with.
 
Preferential creditors have priority for payments among creditors. These can include employees, who are owed up to four months of wages and holiday pay up to a certain point. Inland Revenue can be another preferential creditor if the company owes GST or PAYE tax.
 
Unsecured creditors are others who are owed money, goods, or services but do not have company assets as security. An unsecured creditor could be a consumer who paid for a product but did not receive it.
 
Creditors who are owed money from the company in liquidation cannot directly chase its owners for debt repayment with legal action. They can only recover money owed if they file a claim with the liquidator. The liquidator will pay out their debts should enough money be recovered in the liquidation process. They will also send ongoing liquidation reports to the creditors.
 

Tax consequences of liquidation

Businesses that consistently fail to pay taxes can be subject to Inland Revenue requesting a Liquidation by Creditor. To prevent this, all taxes must be paid on time. If a business struggles with tax debt, working with an expert to negotiate a settlement with the IRD is helpful. Inland Revenue is often willing to write off tax penalties and even interest and core tax.
 
While the business is winding up, it is still important to follow all tax regulations. A business in liquidation must file PAYE income tax returns and GST up until it stops trading. Once closed, it must notify Inland Revenue and deregister.
 

Long-term impacts on business reputation

Company liquidation goes beyond legal issues. It affects the brand’s perception among consumers, as well as the reputation of the company directors.

A director who was in management of a liquidated company could face challenges for future business ventures. Customers may be more sceptical about buying goods and services from their new company, mainly if the business provides an ongoing service or does not provide products upfront. Potential business partners may also be less willing to work with the director of a company that has been liquidated in insolvency.

Furthermore, liquidation can make taking out a large personal or business loan more difficult. The director will likely need to rebuild credit ratings by showing regular repayments on smaller loans. Transparent communication with creditors is essential, as lying on a loan application can result in rejection, blacklisting from the lender, or even being charged with fraud.

Alternatives to liquidation in New Zealand

There are a few alternatives to liquidation for companies in New Zealand. However, these must be enacted well before the company enters insolvency.

One option is voluntary administration. In this legal process, the board will appoint a third-party administrator, who must be a licenced New Zealand insolvency practitioner. Once the appointed administrator takes control of the company, they will investigate the business’s financial affairs, report their findings to creditors, and recommend steps for the company to take in the future. Creditors will then vote on what to do at a watershed meeting.

Another alternative is to compromise with creditors. In this instance, the company will negotiate with creditors to give them more than they would have if the company were to be liquidated.

Before entering voluntary administration or compromising with creditors, business owners should discuss their options with an experienced insolvency lawyer. By doing so, they can determine the best choice for their company’s financial position and prevent liquidation in the future.

Next Steps

If you find your business struggling financially, getting professional advice is essential. Hiring an experienced New Zealand insolvency lawyer is well worth it to mitigate the cost, legal issues, and reputational damage of liquidation.
 
At Norling Law, our insolvency lawyers offer a FREE 30-minute Legal Consultation where we discuss your business’s issues and what we can do to help. After the discussion, we can decide whether we can assist you and at what cost. Visit our office on the North Shore in Auckland, or talk to us by phone. Book a consultation with us today.
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