Insolvency Does Not Always Mean Liquidation

The terms insolvency and liquidation are often used interchangeably, but they mean different things.

Insolvency is a financial position. Liquidation is a formal process.

A company is insolvent when it cannot pay its debts as and when they become due and payable. This is primarily a cash-flow test. A company may have valuable assets but still be insolvent if those assets cannot be converted into cash in time to meet its debts.

Common warning signs include:

• ongoing cash-flow shortages;

• overdue ATO, superannuation or supplier debts;

• defaulted payment arrangements;

• suppliers withdrawing credit;

• increasing reliance on short-term funding; and

• statutory demands or other recovery action.

Liquidation, by comparison, is the formal process of winding up a company. A liquidator takes control of the company, realises its assets, investigates its affairs, assesses creditor claims and distributes any available funds. The company will ordinarily be deregistered when the process is complete.

Insolvency does not automatically require liquidation

Just because a company is insolvent does not necessarily mean it should immediately enter liquidation.

Depending on the circumstances, other options may include:

• Small business restructuring, allowing an eligible company to propose a restructuring plan while its directors remain in control.

• Voluntary administration, allowing an administrator to assess whether the business or company can be restructured through a deed of company arrangement.

• An informal workout, involving negotiations with the ATO, financiers, landlords or other key creditors.

• Safe harbour, where directors develop and pursue a course of action reasonably likely to lead to a better outcome than an immediate administration or liquidation.

• Further funding or refinancing from existing stakeholders, financiers or new investors.

• A business sale or operational turnaround, including cost reductions, asset sales or recapitalisation.

These options will not be suitable for every company. Their viability depends on the underlying business, the causes of its financial difficulties, available funding, creditor support and the ability to implement a realistic turnaround plan.

When we speak with directors

We regularly speak with directors of companies that are insolvent or experiencing financial distress, but that does not mean they are in liquidation.

For example, directors may approach us after the company defaults on an ATO payment arrangement, falls behind with suppliers, and becomes unable to meet its current obligations. At that stage, no liquidator has been appointed, and the directors remain in control.

At Worrells, we work through the available options with the directors and their existing accountants and legal advisers. This may include examining:

• the company’s current and projected cash flow;

• whether the underlying business remains viable;

• the availability of further funding;

• possible negotiations with creditors;

• formal restructuring options;

• safe harbour considerations; and

• the likely outcome of liquidation if a restructuring is not achievable.

Speaking with an insolvency practitioner does not commit the company to liquidation. It allows directors to understand the company’s position, compare the available pathways and make an informed decision.

The key takeaway

Insolvency describes the company’s financial condition.

Liquidation is one formal process that may follow.

Liquidation may be appropriate where the business is no longer viable, or another solution cannot realistically be implemented. However, early advice may give directors an opportunity to explore restructuring, refinancing or another turnaround strategy before their options become more limited. For more information, contact your local Worrells Principal.