Regardless of the state of the economy, companies go into liquidation. There is always a mixture of shareholder and creditor appointments.
The liquidation process is relevant to anyone who has an interest in a company or trades with a company. If a company fails, the ripples can go far and wide. In that situation, knowledge is power!
Liquidations can sometimes be a long process with many moving parts. It is useful to consider some of the larger aspects of a liquidation.
I make some introductory comments in regard to various aspects of the liquidation process with a view to delve into more detail over the coming months.
Appointment of liquidator by shareholders
Shareholders may appoint a liquidator of a company. However, they must follow a certain process to ensure that the appointment is valid. The process is not complex but it is important that it is followed precisely.
In this situation creditors are often left with the impression that the liquidator works for the shareholder and that there must be a relationship between the shareholder and liquidator. If this belief is held, they may seek to remove that liquidator from office.
While it is possible for creditors to remove the liquidator, there is a process that must be followed and action must be taken promptly. In particular, creditors must call a creditors meeting for the purpose of replacement within 10 working days of the liquidator giving notice that they don’t intend to hold a meeting (they usually don’t intend to hold a meeting).
Accordingly, decisive action is required to replace a liquidator at this stage. There are many common pitfalls that creditors fall into. The pitfalls may be form or substance related.
In any case, to be successful in the replacement, creditors representing the majority in number and value must support the resolution to replace.
Appointment of liquidator by creditors
Most commonly, creditors appoint a liquidator by utilising the statutory demand process and then on to filing a liquidation application at the High Court.
The timeframes in both processes are tight and strict. They must be adhered in order to avoid onerous consequences.
Some also (perhaps unintentionally) abuse the process by the strategy employed, while others hold traditional beliefs about actions that they believe to be an abuse of process. Debt collection being one. Yes, it is permissible to use the statutory demand process as a debt collection tool. Cash is king!
Often the ability to appoint an interim liquidator is overlooked. It shouldn’t be. Parliament has given us a useful tool to protect the position if:
- the company’s assets are in jeopardy;
- the status quo should be maintained; and
- the interests of creditors require a safeguard.
Interim liquidators will be given very similar powers to ‘actual’ liquidators. For example, they will be able to take possession of and protect assets, take possession of books and records and documents of the company, examine under oath those with knowledge of the company’s affairs.
Failure to appoint an interim liquidator can sometimes result in a pyrrhic victory for the creditors.
There is a process to be followed should one seek such an appointment and one needs to move the Court promptly to avoid losing the opportunity that an interim liquidator provides.
Liquidation of corporate trustees
It is well reported that New Zealanders are keen establishers of trusts. It has also become popular to appoint companies as trustees of these trusts.
This poses significant issues if the corporate trustee incurs debt and does not pay. In particular, when the company goes into liquidation, the Companies Act 1993 will apply to the failed company.
Any assets of the ‘trust’ are not assets of the company that are available to pay company creditors. Rather, those assets can only be used to pay ‘trust’ creditors. There are many issues that are not straightforward on the liquidation of a corporate trustee. Examples include: how assets are to be distributed, out of what assets the liquidators can pay their fees, duties of the director of the corporate trustee, and a potential conflict between the duty to act in the interest of beneficiaries and the duty to act in the best interests of the company.
Remuneration of company directors
Directors are entitled to receive money from their company pursuant to certain legal obligations, like dividends, salary or wages and reimbursement of expenses paid by or on behalf of the company.
However, if the correct procedure is not followed to authorise the remuneration, the default position will be that the directors have received the funds as a loan and must repay the company. There is no quantum meruit defence either.
Liquidators are adept at collecting these debts. If such a claim is made, it can be devastating to a director who may not have anticipated such a claim being made, having incorrectly believed that the funds were payment of a salary.
Breaches of director duties
Directors owe duties to their company. Additionally, in some circumstances they owe duties directly to creditors of the company.
Breaches can include ongoing actions like reckless trading or can be discrete actions like the sale of an asset to a relative at undervalue. Such a sale is not in the best interests of the company and as such the director may be personally liable to compensate the company for its losses. Breaches may also be in the form of failing to ensure that proper accounting records are kept. If established, directors may be held personally liable for all the debts of the company, without exception.
Liability may not be limited in the event of a breach.
There has been a considerable shift in the way in which voidable transactions are approached by the insolvency industry. This shift is as a result of recent decisions of the Supreme Court and the Court of Appeal.
Voidable transactions are not gone but are more difficult for a liquidator to pursue. This has resulted in far more certainty for suppliers.
Liquidators will now be altering their investigative strategy to account for the changes, the suppliers’ knowledge of insolvency being crucial.
Transactions at undervalue
Transactions at undervalue are fairly common in New Zealand. Often, when directors see the writing on the wall they dispose of company assets to related parties, themselves or their “newco”. Often this is for insufficient value.
In these circumstances the liquidators can claim the difference between what the assets were sold for and what the assets are worth. Liquidators often pursue these claims and there are very few defences to such a claim.
Before assets of significant value are transferred it is extremely valuable to obtain a reliable valuation. If the costs of a valuation can’t be justified by the value of the asset, consider informal options documenting the details of the asset and comparing this to what similar assets are selling for on the open market, like Trade Me. Take copies of those similar asset sales and put those on file.
This option may not be completely watertight but it is much better than doing nothing to assess (and prove) the value at that time. Remember, this transaction may not be looked at by a liquidator for another two years. By that stage it will be even more difficult to determine value at a historical time.
Obligations to assist liquidator
When a company is placed into liquidation, the liquidator has the power to require a wide class of persons (essentially anyone with knowledge of the company) to provide copies of documentation or attend an interview. This is a useful power of a liquidator to reconstruct the knowledge of the company and to assess potential claims.
Liquidators often utilise this power.
Additionally, directors have an obligation to promptly advise the liquidator of the location of all company assets.
Often people fail to assist the liquidator when they are required to do so. There can be serious consequences that may result. These may include payment of court costs, fines or imprisonment.
Litigation funding is increasing in New Zealand although it is not widely utilised. This is starting to become more popular among insolvency practitioners. This is because they are often appointed to a company with potential claims but no funds to pursue.
There are boundaries to funding arrangements. Liquidators must still remain in control of the litigation. There are consequences on creditors, shareholders and those being sued if litigation funding is obtained.
Duties of a liquidator and what can be done if a liquidator breaches a duty
Liquidators have duties. The principal duty is to take possession of, protect, realise, and distribute the assets, or the proceeds of the realisation of the assets, of the company to its creditors in accordance with the Companies Act 1993.
The High Court has a supervisory role over liquidators. The High Court may review actions, omissions or decisions of a liquidator. If a liquidator breaches their duties, the affected party may follow the prescribed process to require the liquidator to remedy the breach or ask the High Court to take certain action.
If creditors want to receive any distribution from the failed company, they must complete a proof of debt form and submit it to the liquidator. This must be submitted before the distribution occurs. Once received, the liquidator must make a decision as to whether to accept or reject the claim. That decision will be final unless appealed to the High Court.
Once assets of the company are gathered and proceeds are held, the liquidator must distribute them to the creditors accepted.
The liquidator must distribute the assets in a certain order of priority. It is possible for creditors to leapfrog above other creditors to obtain priority. However, action is needed to successfully achieve this. In particular, a creditor who protects, preserves the value of, or recovers assets of the company for the benefit of the company’s creditors is entitled to receive, in advance of many other creditors, the costs incurred as a result of the action and the value of their debt in the liquidation.
Liquidators can be held personally liable to account to affected creditors if they distribute funds incorrectly.
Over the coming publications I will address various aspects of the liquidation process detailed above in greater detail. Generally, I will address the mandatory processes and common mistakes and consequences for such mistakes.
Brent Norling is the director of Norling Law Limited, an incorporated law firm established in 2015. Norling Law Limited specialises in restructuring and insolvency, debt collection and security enforcement, and civil litigation. Enquires to firstname.lastname@example.org.