In order to determine At What Point Should A Company Shut Down? the starting point is to consider whether the company is solvent or insolvent. If a company is solvent the directors have much more flexibility compared to a company that is insolvent.
When a company is solvent for the vast majority of owner-managed businesses when the company’s directors and the shareholders are the same people there is freedom of choice as to the point when it should shut down and be closed. However, when a company is insolvent then the point in time when it should cease trading and shut down depends on whether liquidation is inevitable going forward.
Picking The Point To Shut Down An Insolvent Company
The need for speed is pertinent when picking the point to shut down an insolvent company.
Solvency is a key driving force for directors to consider to prompt them into shutting down a company.
Two key issues that are relevant for shutting down a company are wrongful trading and the creditor duty.
Impact Of Wrongful Trading On Shutting Down A Company
If the business is an insolvent company with debts such that either it is unable to pay the debts when they fall due or it is balance sheet insolvent because its assets are less than its liabilities, then unless there is the prospect of rescuing the company and returning it to solvency it will typically wind up in liquidation at some point. In such circumstances, the directors will need to be mindful of continuing to trade and making the position even worse than if they shut it down. In doing so they place themselves at risk of wrongful trading which runs the risk of personal liability for the director for the increased debts incurred in the period after which they should have ceased trading.
Impact Of The Creditor Duty On Shutting Down A Company
There is an overarching principle that needs to be considered by directors who are trading an insolvent company. This is known as the Creditor Duty. It says that when a company is insolvent or on the verge of insolvency then the interests of creditors will supersede those of the shareholders. The directors have to act in the interests primarily of the creditors. As a result, although the Creditor Duty is a sliding scale duty, in that the more insolvent a company is the less it should be taking into account the shareholders and the more it should consider creditors if a director trades on whilst insolvent they run the risk of causing creditor losses to increase. This needs to be considered, particularly when wrongful trading is a real risk.
As a result, once a director cannot see a way of trading out of the situation and liquidation seems to be inevitable then they should stop trading and shut immediately.
On the other hand, if a company is insolvent but has a profitable core business and steps are taken by the directors to curtail the losses and enable the company to return to profit then there is no need for a company to shut down.
At What Point Should I Shut Down A Solvent Company?
Whilst a solvent company has far greater flexibility in determining when to shut down and indeed if it needs to shut down at all than an insolvent company, nevertheless a director needs to ensure that they act in the best interests of the company, its shareholders and if necessary shut down a company if it does not seem to have a viable future in the longer term.
This will prevent shareholders (as opposed to creditors) from suffering avoidable losses. Of course, the directors and shareholders may be the same people which will enable the directors to collectively have much freedom of choice as to what losses they will stomach.
Plainly it perhaps makes sense for owner-managers who have money tied up in their shares in a business to consider if they could more profitably deploy their capital in another business or investment if they were to shut down.
The point in time when a solvent company should shut down might be affected by taxation considerations. In the case of a Members Voluntary Liquidation, a distribution of capital by a liquidator can be subject to qualification for Business Asset Disposal Relief, enabling a shareholder to pay as little as 10% capital gains tax. The current lifetime limit for this relief is £1,000,000 but there has been frequent speculation about changes being made. An owner-managed director who is getting closer to retirement age may wish to shut down a business sooner rather than later to potentially avoid the possible risk of missing out on this conceivably attractive tax advantage.
