Preserving value through liquidation

“Liquidation” or “winding up” are terms that tend to be associated with some negative connotations in the business lexicon. This is no surprise, given that liquidation is an activity that typically ensues as a result of a declining business.

By definition, liquidation is the process by which a company is brought to an end. When a company undertakes a liquidation exercise, a liquidator is appointed to take control and possession of the company’s assets, wind up its affairs, carry out proof of debt, settle with creditors, and distribute any surplus monies to the shareholders. If the company’s assets are insufficient to cover its liabilities, liquidators will be tasked to dispose of and/or recover any remaining assets, and thereafter use the recoveries to pay its creditors.

With the onset of the global COVID-19 pandemic, it appears that liquidation is likely to become increasingly commonplace in the days ahead. Currently, in the immediate aftermath of the outbreak, we are already witnessing numerous reports of company closures and other accompanying liquidation activities in Malaysia.

But contrary to popular belief, liquidation can in fact help companies to preserve value. In this article, we will bust some of the myths about liquidation, and illustrate four ways in which it can be beneficial for businesses:

1. Liquidation can help businesses to stem losses

Liquidation is often perceived to be an option that a company considers only when it becomes insolvent. But this is not true: there is process, known as “solvent liquidation”, by which a solvent company can be voluntarily wound up, provided that it is able to obtain the majority approval from not less than 75% of its shareholders. This is also commonly referred to as a Members Voluntary Liquidation (MVL), and is a tool that is sometimes used to preserve the value of a solvent company, and protect it from further losses.

In this scenario, the onus is on the company’s directors to act quickly and decisively to initiate the MVL process. Any delays will mean that the loss-making company must continue running operations for longer than is optimal, accumulating more liabilities, and in turn decreasing the company’s value over time. Furthermore, as a company’s value decreases, creditors will begin to gain more influence, and the management may then find it challenging to continue steering the company’s overall direction. In the event of an eventual insolvency, it will also become too late for the company to undertake an MVL; under an insolvent liquidation, all recoveries will be used to pay its creditors.

Take for example, a company in a sunset industry which has been suffering losses, and is at the point of potentially turning insolvent. If it no longer has a viable business, but still has sufficient assets to cover all its liabilities, an MVL could be an option. Although as with all liquidation exercises, termination of employment is inevitable, employees would be in a better position under such a termination exercise where they will be able to receive a reasonable amount of termination benefits – as compared to minimal to no benefits under an insolvent liquidation process. Furthermore, shareholders may also stand to benefit from a return of surplus funds from the liquidator at the end of an MVL process.

2. Liquidation can offer protection against wrongful trading

A solvent liquidation may also offer directors or officers of a company some legal protection against wrongful trading – otherwise also known as insolvent trading – which relates to the act of continuing day-to-day operations when a company is no longer able to pay its debts.

It is an offence for an insolvent company to enter into contracts they do not have the means to fulfil. As stated in Malaysia’s Companies Act 2016, a director or officer of a company who has been convicted of being a party to contracting a debt, and who at the time of contracting the debt had no reasonable or probable ground of expectation that the company is able to pay the debt, shall be liable to imprisonment for a term not exceeding five years or a fine not exceeding RM500,000, or both.

Directors should also note that they may be disqualified by the Court from becoming a director of a company if he or she has been a director of two or more insolvent companies within the last five years, where the company is deemed to have gone into insolvency due to his or her conduct as a director, either wholly or partly.

Arguably, such outcomes are far worse than that of a solvent liquidation. Given the severity of the consequences of wrongful trading, directors and business owners should be made more aware of the need for value preservation.

3. Liquidation can help to prevent the dissipation of assets

Under dire situations, the line separating what is acceptable and what is unacceptable may be blurred, and this could result in the breach of financial duties by company directors or officers. These breaches may include disposal of properties at undervalue, undisclosed related party transactions, undue preference payments, or even an outright dissipation of assets for personal gain – all of which are actions that are not carried out in the best interests of the company.

In these instances, creditors, shareholders (including minority shareholders), and other affected stakeholders will need to step up to play a more proactive role to remedy the situation. One option is to file a court winding up application against the target company so that a liquidator can be appointed to displace the directors. Once the winding up order is issued, the powers of the directors will cease immediately, and the liquidator will assume control of the company. If there is a real danger of asset dissipation, an interim liquidator may be appointed ahead of the winding up order to safeguard the company’s assets.

In general, the powers of a liquidator are quite broad. These include taking possession and control of all assets, investigating the affairs of the company, taking legal action against perpetrators, and clawing back assets which have been illegally taken out from the company. Any litigation work carried out by the liquidator is usually done with the assistance of a lawyer.

The Companies Act 2016 also provides various circumstances under which a company may be wound up by the Court. In these situations, the aggrieved parties will need to collate the relevant supporting evidence, if any, and consider their possible legal options in consultation with a lawyer. The objective here is to act fast before the assets are dissipated through the multiple layers of transactions that are conducted outside the company – or worse, outside the jurisdiction, where the process of recovery becomes even more complicated, costly, and time-consuming.

4. Liquidation can help to rehabilitate abandoned projects

Abandoned projects – mostly commonly witnessed in housing or commercial real estate developments – may arise due to certain issues relating to poor sales and cost overruns. When a project is abandoned, purchasers or unit owners remain obliged to fulfil their loan commitments with their financiers, even if they will now no longer receive the properties that they have purchased.

To rehabilitate an abandoned project, liquidation could be one possible method. In this process, the appointed liquidator will first carry out a feasibility study to ascertain if the project can be rehabilitated. Such endeavours are complex ones, as they involve a wide range of different stakeholders – including but not limited to unit buyers, contractors, and consultants – each with their own set of interests.

To overcome this, the liquidator can undertake a Scheme of Arrangement exercise, as provided in the Companies Act 2016, that essentially aims to strike a compromise or arrangement between the relevant creditors (including secured lenders and purchasers), with the objective of rehabilitating the project in a viable manner.

Here, time is again of the essence. The longer a project has been abandoned, the higher the cost of its rehabilitation due to the deterioration of the structures, vandalism, and other issues. Stakeholders will therefore need to act quickly to seek the necessary legal advice, and leverage the provisions of the Companies Act 2016 to appoint a liquidator to take control and possession of the project site.

When done right, liquidation may not necessarily always signal the demise of a company. In fact, in certain circumstances, liquidation may in fact enable a company to successfully resume regular operations. Under the Companies Act 2016, the Court may make an order to terminate the liquidation and give such directions as it thinks fit for the resumption of the management and control of the company to elect directors of the company to take office, from the liquidator if proof to the satisfaction of the Court that all proceedings in relation to the liquidation of a company ought to be terminated.

Ultimately, however, the caveat is that all stakeholders – and not just company directors – must act swiftly and decisively to preserve the value of a distressed company before it is too late for them to do so.
 

The views and opinions expressed are those of Khoo Siew Kiat, Restructuring Services Leader, Deloitte Malaysia; and Eddie Goh, Director, Restructuring Services, Deloitte Malaysia, and do not necessarily reflect Deloitte’s view.