Will eliminating the entity open a 'Pandora's box' of new claims?
21 November 2016
Are you concerned that liquidating an entity pre or post acquisition will increase the number of claims being made against it? Or do you have an insolvent entity that you want to get rid of?
Are these reasons part of what’s stopping you from decluttering your group? It may not be as bad as you think! Below, we demystify some more myths which we commonly encounter.
Some groups are concerned that putting the company into members’ voluntary (solvent) liquidation (‘MVL’) will increase the level of claims received, add workload and costs. This is particularly the case where there is a history of claims against an entity (e.g. employee/warranty).
On many occasions, they leave the entity alone, hoping nothing further will come to light (i.e. opening ‘Pandora’s box’), during which they incur the ongoing costs of maintaining the company as well as wasting management time. As a result they increase the risk of losing corporate knowledge as time goes by and miss the opportunity to de-risk the group. In our experience, an increase in claims is not the case.
Liquidation is a statutory process which requires a liquidator to give notice to any known creditors, contingent or otherwise, of his or her appointment. This is to ensure that all potential creditors are made aware of the process and are given an opportunity to lodge their claim within a defined period. It does not add to the liabilities of the company as the liability is already there, what it does is to speed up the process of seeking out and dealing with such liabilities. The company is not therefore in a worse position by taking action. In fact the opposite can be the case if claims are not made in the relevant period.
For example we had a client who ‘re-used’ a dormant entity which they had not eliminated and had historically been involved in heavy manufacturing, as an investment vehicle. When it was time to wind up the company and return the funds to the investors, they were concerned that it might give rise to potential personal injury claims from former employees as the company had, over the years, received claims for industrial deafness. As part of the liquidation process we gave notice to c.5,000 former employees to seek out whether there were any further claims. The result, not one claim was received.
Obviously every case is different, but it goes to prove that what you think might happen, doesn’t always. Leaving an entity, because you think additional claims might arise, is not good governance and the claims won’t just go away.
The company is insolvent so I can’t eliminate it via a MVL, right?
The short answer is yes but there are ways in which you can restore a company to solvency so that you can. But I know you are thinking - why would I want to do it?
There are two principal reasons: firstly it enables you to remove entities which have historically acted as ‘dividend blockers’, e.g. where there are insufficient distributable reserves to allow dividends to be paid up to the group. Secondly, it avoids the negative connotations associated with an insolvent liquidation.
Common ways an insolvent entity can be eliminated is through debt waivers, (these should be released by way of formal deed and it is essential that the nature of the debt is understood to make sure the credit arising would not be taxable) or issuing share capital. In addition you could consider debt for equity swaps or obtaining consideration for group relief of losses. In every case, advice from a tax specialist will be required to ensure that it does not trigger a tax liability somewhere within the group. However, with the proper tax planning, in our experience it rarely happens.
We recently had a US client with a wholly owned subsidiary in the UK who wanted to eliminate, but the accounts showed that the UK entity was insolvent due to inter-company liabilities. By seeking tax advice both here and in the US, we were able to find a solution which allowed for a deduction in the counterparty’s US tax computation. This would otherwise not have been available if a different way of restoring the company to solvency (e.g. recapitalisation) had been taken.
What if I don’t want to restore it to solvency, what can I do then?
The alternative, if you don’t want to restore the company to solvency, is to eliminate it by way of a creditors’ voluntary liquidation (i.e. an insolvent liquidation). This is generally more costly than an MVL, has more potential consequences for the directors i.e. statutory returns on the Director’s conduct have to be filed with the Government, and usually takes longer to conclude.
For more information, please get in touch using the details below, or read our previous article here: ‘Decluttering your business; what stops you and should it?’. What issues are you facing when looking to eliminate legal entities? Leave a comment below to discuss further.