It’s inevitable that some businesses will fall into insolvency in their lifespan. This means the business is in a position where they are unable to pay their debts. Despites efforts to turn the situation around, most insolvent businesses won’t be able to avoid liquidation. One option in this scenario is to try and sell your business before entering into administration. Selling an insolvent business is a delicate process that can very easily end up as illegal activity, if the wrong steps are taken. Here are some factors to consider when attempting to sell up.
Before you try and sell your insolvent business, it’s important to understand what you will gain from doing so. From a financial perspective, selling can save you the costs associated with entering voluntary administration and/or liquidation. You will also have control over the sale of assets, which can ensure you get the most value as possible. Typically, a sale which occurs prior to administration/liquidation will attract a greater amount.
In terms of non-monetary positives, the sale of your business can help maintain your image. Your business can also continue to trade under new management, which keeps it alive instead of disbanding. This may also provide the opportunity for your employees to stay on.
Selling to a Related Party
When looking to sell your insolvent business, it is acceptable to have a related party purchase it. The idea behind this is that a related party will provide a higher price for the business in comparison to an unknown entity. However, there are a number of legal provisions that must you must satisfy in order to sell to a related party. The following requirements stem from sections within the Corporations Act.
Related Party Definition
- A related party, for the purpose of purchasing an insolvent business, includes:
- The directors of the company
- Director’s spouses
- Relatives of directors and spouses
- An entity controlled by a related party (e.g. any of the parties above)
Arm’s Length Terms
In order to conduct a sale with a related party, the transaction must include arm’s length terms. Arm’s length refers to a transaction were neither party bears a special duty or obligation. They should act under no influence and for their own interests. In order to determine whether a related party transaction is at arm’s length, the following factors will be considered:
- Are the terms similar to an unrelated party transaction with comparable circumstances
- Is there another legitimate alternative available instead of a related transaction
- Nature of the negotiations
- Implications of this transaction both now and long term
In addition, all related party transactions should be for fair value and in the best interests of the business. Staying within range of market price and having the process independently reviewed is also recommended.
With so many rules and regulations surrounding the sale of a business, it can be very easy to fall foul of the law. Illegal phoenix activity is a common offence amongst those selling insolvent businesses. This is when a new company is created in order to continue the business of an insolvent company. The insolvent company is then intentionally folded to avoid paying outstanding debts.
If you engage in illegal phoenix activity as a director, you will be in breach of your company duties. The duties require you to act in good faith and make proper use of your position. Punishment can range from fines to imprisonment.
There can be a number of benefits to selling off your insolvent business. However, it is important to be aware of the complex legal web which guides the process. The advice of a company lawyer will be helpful in breaking down these legal factors and verifying your sale.
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