What is Insolvency?
If a business can’t pay its debts on time, it is insolvent.
Continuing to trade while insolvent can lead to the directors of the company being personally liable for its debts.
If you have concerns about your ability to pay your debts, you should seek professional advice as soon as possible. You may be able to place the company in administration or liquidation to avoid personal liability. It is also possible for a creditor to force a company into administration or liquidation. This article will explain the difference between liquidation and voluntary administration and when to choose one over another.
Liquidation is the process of winding-up a company’s affairs so that it can cease trading. This involves selling the company’s assets and distributing any profits amongst creditors and any surplus amongst shareholders.
Liquidation can occur because the company can no longer afford to pay its debts (i.e. the company is insolvent). This type of action will usually be brought by a creditor who has been awarded a judgment against the company and seeks to wind-up the company as part of its recovery action. The creditor will have to show the Court that the company is insolvent or deemed to be insolvent.
Court ordered liquidation can also occur where disputes between shareholders or directors cannot be resolved. This commonly occurs where directors cannot agree on decisions which are material to carrying on the business.
Alternatively, the company can be voluntary liquidated by resolution of the company directors and, if appropriate, the company members at the relevant meeting. The voluntary liquidation can occur by voluntary administration (explained below) or a creditors’ voluntary winding up.
Voluntary liquidation is generally used when a company is insolvent and a Deed of Company Arrangement cannot be entered into.
Once a liquidator is appointed, the liquidator will:
Identify, protect and realise the assets of the company;
- Conduct investigations into the financial affairs of the company;
- Make appropriate recoveries;
- Issue reports to ASIC and creditors;
- Make a distribution to creditors and shareholders (if a surplus exists);
- Apply to ASIC to deregister the company.
The investigations by the liquidator will look into when and why the company became insolvent. As part of the investigations, the liquidator will seek legal advice to determine if there are any potential claims against the directors or transactions that can be “clawed back”, such as unfair preference payments.
Where a company is liquidated, a liquidator will be appointed to control the company. All of the company’s control of assets, running of its business and other financial affairs are transferred to the liquidator. This means the control of the entire company is removed from the directors.
At the end of the liquidation, the company will cease to exist and be removed from the ASIC register.
Voluntary administration is an option chosen by the company directors where they want to continue the business. Once voluntary administration is entered into, an independent person, called the voluntary administrator, will take control of the company and try to work out a way to save the company. Where there is no way to save the company, the administrator will aim to administer the affairs of the company in a way that will maximise return to creditors.
Voluntary administration commences with the appointment of an administrator. Depending on the circumstances of the company’s debts, the administrator may be appointed by the directors, a secured creditor who has a security interest in all or substantially all of the company’s assets or a liquidator.
Within 8 business days of being appointed, the administrator will hold a first meeting of creditors. This is a meeting with the creditors of the company allowing them to vote to replace the administrator and/or create a committee of inspection. From there, the administrator will commence its investigation into the company’s affairs and provide the creditors with a report. The report will have sufficient information regarding the company’s business, assets, property and financial circumstances.
Within 25 business days of being appointed, the administrator must conduct a second meeting of creditors. The second meeting is more significant as the future of the company will be decided. The creditors have the power to return the company to the control of the directors, enter into a Deed of Company Arrangement or put the company into liquidation.
Voluntary administration is a useful tool allowing a company to think about its future without running the risk of insolvent trading. While the company is in voluntary administration:
- Unsecured creditors cannot begin or continue to pursue claims against the company without the consent of the administrator or the Court;
- Owners of unperishable property, including the owner of property leased to the company cannot recover their property;
- An application cannot be brought to place the company into liquidation;
- Where a director previously gave a personal guarantee for a company debt, a creditor cannot take steps to recover the debt under the personal guarantee without the Court’s consent.
While the effects of voluntary administration may sound very useful, the reality is it is difficult for a company to exit voluntary administration and be placed back in the hands of the directors.
Deed of Company Arrangement
As previously mentioned, creditors can elect for the company to enter into a Deed of Company Arrangement (Deed). If the creditors vote for a Deed to be entered into, the company must sign the Deed within 15 business’ days of the creditors’ meeting, unless a longer time is permitted by the Court. If this deadline is not met, the company will automatically enter into liquidation.
The Deed will set out the debts covered by the Deed and the extent to which they will be paid out, the property used to pay the creditors and the order the funds will be paid to the creditors.
Here at Taurus Legal Management we specialise in providing insolvency and re-structuring advice. If you need assistance, please call a member of our team today on (03) 9481 2000.