Things can turn around quickly in business, and it’s important to have a contingency plan for when prospects are looking worse. Whether it’s a pandemic, a change in consumer preferences or a failed investment, any number of things can lead to company insolvency, which is why business owners should be prepared for any eventuality.
That’s where receiverships come in. In simple terms, a receivership is a court-appointed tool that is used to protect companies from insolvency and to ensure that lenders recover funds that are owed to them. The ultimate goal of a receivership is to return a company to profitability and to avoid the process of bankruptcy. Keep reading to find out the receivership definition and how it works.
Many companies that run into financial trouble ask themselves: “what is receivership?”. Well, a receivership is a process that is invoked during court proceedings and that aims to avoid business bankruptcy. You can think of it as a kind of shield for a troubled company.
A company in receivership will assign a ‘receiver’ or a trustee who steps in to take control of the entire company, its assets, as well as any financial and operating decisions.
The decision of who to appoint as a receiver is generally agreed by the secured creditor under an agreement or by the Court on behalf of said creditor. This secured creditor is traditionally a creditor who has loaned money to the company and aims to collect these payments through the receivership process. If the receiver is appointed privately then they will act only on behalf of the secured creditor, whereas those appointed by the court must act on behalf of all creditors involved.
In their role, the receiver must attempt to protect the company in receivership by taking over all asset and management decisions, all while ensuring that all operations comply with government standards and regulations. The goal is to avoid bankruptcy and liquidation of all assets, although some assets may need to be sold in order to pay creditors.
What’s the difference between receivership and bankruptcy?
There are some important differences between bankruptcy and receivership, meaning that it’s essential to understand both fully. In fact, the two processes are not mutually exclusive, and receivership and bankruptcy can both occur at the same time.
Bankruptcy is a legal action that places the needs of the borrower first and protects them over the lender. When a company files for bankruptcy, they are attempting to protect themselves from the collection actions of creditors. Some bankruptcy applications may aim to continue business operations and solve financial issues, whereas others aim for total liquidation of the company and termination of operations.
On the other hand, a receivership is not actually a legal action, and the main aim is to protect the lender’s assets. This generally occurs over an interim period, and the receiver is essentially protecting the lender’s assets to ensure that they can collect their debts.
Why would a company go into receivership?
Now that you’re aware of the receivership definition, you might be wondering why a company would choose this option. There are various factors that may lead a company to choose to go into receivership, but a typical case is explained below.
Often, a business requires finance for its operations and wants to borrow from the bank to cover these. In exchange for the loan, the bank requires a level of security over the assets that they are providing to the company, and will therefore ask the company to enter an agreement with specific terms. If the company violates these terms, the bank may appoint a receiver that is charged with managing the company and recovering the money owed to the bank.
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