What Happens If A Company Cannot Pay Its Debts?

What Happens If A Company Cannot Pay Its Debts? Sometimes it becomes difficult for companies to pay their debts due to financial distress. Such a situation occurred in 2020 due to the outbreak of Covid-19 when companies all over the world were struggling to pay off company debts but failed.

In this situation, it is crucial to know the options your company can avail of when your company can be insolvent.

When a company becomes insolvent?

When a company fails to pay its debts on the due date then it can become insolvent. In such a situation, the director of the company is responsible to inform the stakeholders of the company about the company’s financial status and take necessary action.

It can be termed as the breach of the duties of the director if a company continues its business even if it has been declared insolvent. The director can be liable for fines and/or imprisonment for such acts.

How to wind up an insolvent company?

When a company fails to satisfy the statutory demand of its creditors or payback its debts on the due date then it becomes an insolvent company. When an insolvent company is winded up then it is known as liquidation of the company. The liquidation of a company can happen by:

• The order of the court: To wind up a company, an application can be submitted by the creditors to the court and prove the insolvency of the company so that a liquidator is appointed by the court.

• The creditors: If after becoming insolvent a liquidator is appointed by the directors of the company. To wind up the company, its creditors can meet within 18 days of declaring insolvency and change the liquidator if necessary.

• Voluntary administration: If the creditors, during voluntary administration, decide to liquidate the company then to sell the assets of the company its administrator is appointed as the liquidator.

The company cannot continue its operations during liquidation and to satisfy the creditors of the company the assets of the company will be sold by the liquidator to pay company debts. The funds remaining after satisfying the creditors will be dispersed among the shareholders.

Then the liquidator will apply for deregistration of the company to ensure its non-existence.

When a company should go under Voluntary Administration

When the directors of a company fail to refinance or restructure company debts then a liquidator or voluntary administrator can be appointed by the directors.

This administrator can help the financially distressed company by planning to restructure debts with the creditors or selling an asset of the company. The creditors cannot claim their money during this period until the court permits them.

Process for appointing a voluntary administrator

• The directors of a company call a board meeting or pass a resolution in writing to appoint an administrator.
  
• The company functions under voluntary administration after this resolution is passed by the board.
  
• Within 18 days of the appointment of the administrator, the creditors must meet, if time is not extended by the court, to create a committee of creditors or replace the administrator.
  
• The affairs of the company are investigated by the administrator and a report is sent to the creditors.
  
• After 25 to 30 days of the appointment of the administrator, the creditors must meet to decide to accept a DOCA, return the company to its directors or liquidate the company.
  
• The company will start working under the administration of a deed signed within 15 working days of the acceptance of DOCA by the creditors. In the case of liquidating the company, the administrator is appointed as the liquidator of the company.

Prohibited illegal activities

When a business that fails to pay company debts, transfers its assets intentionally to a new business to avoid paying the dues to the employees, tax, or creditors then such activities are known as re-birthing or phoenix activities.

In this situation, when there is no asset to pay creditors, the old company is normally put for liquidation or into administration. However, the directors of the old company can continue their business by creating a new company.

Such activities are illegal and the directors and secretaries of the old company have to face criminal consequences including financial penalties and/or imprisonment.

What Happens If A Company Cannot Pay Its Debts? – Conclusion

Thus, when a business fails to pay company debts then it can become insolvent and may have to wind up its operations and sell its assets to satisfy its creditors as well as shareholders.