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    The dangers of the "just place it into liquidation" mentality

    Dec 21, 2020 2:42:51 PM

    We recently had clients seek advice from us to resolve a situation they found themselves in, where they had been told by a key advisor to “just place the company into liquidation”.

    This article seeks to inform you of why the “just place the company into liquidation” idea is not as simple and straight forward as it sounds.

    We look at 5 key dangers that need to be considered when placing a company into liquidation. They are:

    1. Claims by the Liquidator;
    2. Breaches of the Corporations Act 2001 (Cth);
    3. Division 7A loan issues;
    4. Personal Guarantees; and
    5. ASIC implications, including reputational damage and/or insurance issues.

    Danger One - Claims by the Liquidator

    Once a company is placed into liquidation, the appointed liquidator has a duty to seek if there are any possible claims to be brought on behalf of the company against the director(s) personally.

    We currently have a matter where we have been engaged by the liquidator to advise them of the possible claims, they can seek to bring against the director to recovery funds due to the company. Based upon our initial advice there are various options available to recover funds due to the company.

    If you place a company into liquidation prematurely without considering the possibility of any personal claims, you may inadvertently place yourself into a situation where you expose yourself to personal liability.

    Danger Two - Breaches of the Corporations Act 2001 (Cth)

    A liquidator must investigate if there has been any breach of the Act by the director. This may include discharging their director’s duties to ensure that adequate books and records have been kept or they have not acted dishonestly or in bad faith to gain a personal advantage from the company.

    We had a matter recently where the company was placed into liquidation and the director was sued personally for a breach of directors’ duties which resulted in the necessity to consider personal bankruptcy. The director could not afford to pay the personal claim made against them. Not only have they lost their business, but they have also had to go into bankruptcy.

    Danger Three - Division 7A loan issues

    Directors and shareholders of companies may loan funds from the company to fund purchases such as a motor vehicle or real estate. These must be recorded in the ledger and repaid as required. It is not ‘free money’ as appears to be a common misconception. There is strict compliance under division 7A of the Income Tax Assessment Act 1936 to be followed and may be deemed dividends. Company loans may be treated as an asset to the company.

    For example, we had a matter recently where a director had amassed a division 7A shareholders loan of $500,000 and the company was going into liquidation. The liquidator treated the loan as a recoverable asset and commenced proceedings against the director personally for $500,000. This resulted in the director going into bankruptcy.

    Danger Four - Personal Guarantees

    It is not uncommon for a director of a company to provide a personal guarantee for a line of credit to seek services or supplies on behalf of the company.

    We recently acted in a matter where the company was looking to be placed into liquidation as they have been significantly impacted by COVID-19. The director had given a personal guarantee for supplies. Although the company was deemed insolvent, the director had to pay out that personal guarantee. Failing to do so would result in them being personally sued for the guarantee amount owed. Personal guarantees go beyond the liquidation of a company and continue as a personal debt.

    In the event the director was unable to pay, they may need to consider bankruptcy as a real possibility.

    Danger Five - ASIC implications, including reputational damage and/or insurance issues

    The implications by ASIC being the three-strike rule. If a director has been involved in three liquidations that have not been a member’s voluntary liquidation, then the authorities will be watching closely. There may be concerns about the legitimacy of the business moving forward.

    This consequently may affect relationships and applications for services, supplies and lines of credit.

    We recently had a matter where the director had been involved in a creditors voluntary liquidation where they had received negligent advice and transferred assets for under market consideration. The directors were pursued by the liquidator and had to pay out around $100,000 in claims.

    Summary

    Liquidation is sometimes a necessary step.

    Acts of insolvency make people nervous and so the reputational damage or concerns that it raises is a serious consideration. Therefore, the intended and unintended consequences of liquidation must be considered. They need to be handled appropriately and with due care and with a communicative strategy in place.

    We recommend that both the company and directors get legal advice to ensure all parties are informed as to the possible impacts of a liquidation.

    Conclusion

    In some circumstances, the liquidation is inevitable, but it is imperative you receive the right advice from the correct advisor. Insolvency is a legal issue and requires lawyers who specialise in this area to advise you with all the options and the best strategy for your situation. It is simply not good enough to say you relied upon the professional advice of a key advisor and deal with the consequences later. This will not absolve you of the personal liability attached with breaches of the Act.

    In summary, if you have concerns about your business and its solvency then contact us to book a FREE FIRST CONFERNCE with our Insolvency Team. Our Chief Executive Partner James Frank is an ARITA accredited expert who can advise you and provide a strategy forward.

    If you have further questions, please contact us at frank@franklaw.com.au. 

    This is not legal advice. 

    Katherine McCarthy

    Written by Katherine McCarthy