Generally, insolvent companies are liquidated involuntarily by an order of the court of law. An official liquidator is appointed to take over the affairs of the company. In the process of liquidation, the first preference is given to the concerns of the creditors. Therefore, it is implied that the liquidator’s main duty is to liquidate the assets of the company to clear off liabilities.
Before answering whether or not a company can trade in its liquidation phase, there are a couple of differences that should be considered.
Insolvency v/s Liquidation
Insolvency is a situation wherein the company is unable to pay off its debts. A number of solutions exist to overcome insolvency. However, if none of those solutions are feasible, the company heads toward liquidation.
Liquidation, on the other hand, refers to the winding up of a company’s businesses and a complete shutdown.
Can a company trade during insolvency or liquidation?
This is a question a lot of people have and the answer is ‘no’. Insolvent companies or those undergoing liquidation should not undertake trading activities. Especially in a case of liquidation, a company should ideally cease its trading operations as the directors no longer have control over its affairs.
During the process of liquidation, the liquidator takes over the affairs of the company. As stated previously, the liquidator gives primary preference to the creditors. Therefore, his/her main focus is on the sale of assets to pare liabilities.
Moreover, trading during insolvency and liquidation phase is illegal in a lot of countries. If detected, the liquidator can form a basis to prosecute the directors. However, there are a couple of major exceptions to this trading rule.
Exceptions to trading in the liquidation phase
There exist a couple of exceptions through which a company can continue trading during insolvency or liquidation. They are:
- The liquidator will allow trading if it will help repay creditors. One must remember that the primary duty of the liquidator is towards the creditors. Hence, a liquidator can allow trading activities if it helps discharge liabilities.
- Trade will be allowed if it helps collect accrued debts of the business. The amount so collected will be used for repayment of creditors, if required.
If the liquidator authorizes the trading operations, there are a couple of more things to keep in mind. The company cannot receive new credit in the form of loans or otherwise. Similarly, the company cannot accrue fresh debt while engaging in the trades. This makes sense, given that the company is already trying to pay off previous debts.
The Bottom Line
To summarize, companies should not trade during insolvency or liquidation phase. The directors are no longer in control of the business as the affairs are taken over by the liquidator.
The liquidator may allow trading activities to resume if such activities help repay creditors. Even if trading operations are authorized, a company in its liquidation phase cannot collect additional liabilities and accrue new debts.