Photo courtesy of Thomas Angermann
Give your client another option to consider
We bet you’re wondering: “Why would a company choose to undergo a solvent liquidation? How would a company even find itself in this position?”
Essentially, a solvent liquidation is a liquidation where the directors declare their organisation will be able to pay all of its debts. Liquidators are appointed in the usual way, by shareholder resolution. Liquidators have the same powers and obligations and creditors must also make a claim in the usual way.
The point of difference: directors declare the company to be solvent and sign a certificate of solvency.
What’s the catch?
A director who signs a certificate of solvency is providing a personal guarantee that the company will be able to pay its debts. If, in fact, the company cannot pay it debts, the director becomes personally liable to pay.
Why would a director choose personal liability?
So, why would any director choose to sign such a document? What are the advantages?
1) The biggest advantage is time.
Usually, in a liquidation, creditors receive approximately one month to make a claim in the liquidation. Before making any distributions to creditors or shareholders, the liquidator must wait, even if the company appears to be solvent and a distribution to shareholders is likely.
Let’s assume you, or your client, are the director and sole shareholder of a company and that you have just sold the business assets in an effort to cash up. For arguments sake, let’s also assume the assets included a commercial property which sold with a large capital gain — and there are no known creditors. If you declare the company solvent, a liquidator would be more willing to make an immediate capital distribution to shareholders rather than wait for creditors to make a claim.
2) The other key advantage:
If a liquidator makes a distribution of capital during the course of a liquidation, it will not incur income tax. Whereas, a distribution declared prior to liquidation could be deemed as taxable income by the IRD.
When would it be a bad idea for a director to take on personal liability?
Simply put: the director is not sure the company is solvent. Perhaps, there is a contingent liability they are not certain about; or perhaps, the shareholders are simply not in a hurry to get paid.
If in doubt, a director should not sign a declaration of solvency.
If your client is facing financial trouble, or looking for the best short- or long-term exit solutions, then difficult decisions lay ahead.
Gerry Rea Partners is always here to help you provide the right guidance. If you have a client with unusual circumstances that require further consideration, please contact us and we will discuss the next steps.
If you have further questions about solvent liquidations, please contact Simon Dalton at firstname.lastname@example.org.