The Australian Insolvency Regime

The insolvency regime for corporations is governed in Australia by the Corporations Act. There are a number of elements to the regime that you should be aware of. If used correctly, and with the right protection, the insolvency regime can be used by businesses to allow them to restructure their debt and continue.

1. Insolvency vs bankruptcy

In Australia “insolvency” usually refers to companies, whilst “bankruptcy” applies to individuals, including sole traders operating a business. Click this link to read more about the benefits of businesses incorporating as a company as opposed to operating as a sole trader. This article relates to corporate insolvency.

2. Cash-flow test

In Australia, a company will be insolvent if it does not have money readily available to pay its debts when they are due and payable. This means that whilst a company may have assets on its balance sheet and may have done a significant amount of work for which they are yet to be paid, if they do not have the cash to pay a debt they are technically insolvent. Directors should pay close attention to this, as businesses can unexpectedly go “bad” if for any reason cashflow is very suddenly reduced.

3. Insolvent trading

One of the duties of a director of a company is not to trade while the company is insolvent. If the company is insolvent at a time when a new debt is incurred, the directors of the company may be personally liable for that debt. The directors will be spared personal liability for insolvent trading if they put the company into “voluntary administration” (see below) as an action for insolvent trading is only available to a liquidator.

The operation of the liability for insolvent trading was temporarily amended during the Covid-19 period. Since March of 2020, directors have been protected from liability for insolvent trading if they incurred debts in the usual course of their business. This protection is set to end on 31 December 2020.

4. Forms of external administration for insolvent companies

There are three main forms of external administration for insolvent companies:

· Liquidation

· Voluntary administration

· Receivership

Receivership can take place at the same time as either liquidation or voluntary administration.

It is important to know the differences in these regimes, as these terms are often used interchangeably and incorrectly by the press. Each of the regimes operates uniquely and there can be very different outcomes for small businesses and their owners.

4. Liquidation

This form of external administration either takes place as a result of a company not responding to a statutory demand or because the directors recognise that the company cannot pay its debts when they are due and payable and it is unlikely that the company can be rehabilitated under a deed of company arrangement (see below). It is considered to be a terminal form of external administration. I will post an article about statutory demands in the coming weeks.

In liquidation, a Liquidator takes control of the company and their job is to realise all of the assets of the company. This includes selling the hard assets, selling the business (if it can be sold) and collecting outstanding payments due to the company and then distributing the proceeds to the creditors in the order set by the Corporations Act.

The order in which stakeholders are paid what they are owed from the realisation of the assets of the company are as follows: secured creditors, priority creditors (employees and insolvency practitioner), unsecured or trade creditor and shareholders. It is extremely unlikely that shareholders will get any return from the assets of the company.

There is virtually no chance that a company that goes into liquidation will ever come out and it will ultimately be deregistered.

5. Voluntary administration

The voluntary administration regime was introduced in the last few decades to provide a mechanism that allows companies to restructure their debt and to continue to trade, through a deed of company arrangement (DoCA). It is considered to be a rehabilitative form of administration, in that its aim is to keep the company alive and trading.

During the administration process, an external administrator is appointed (usually) by the directors of the company. The administrator will stay in control of the company, and is personally liable for trading debts, until the administration has ended.

A DoCA is a proposal that is put to those entities owed money by the company for them to agree to be paid a lesser amount than they are owed and allows the company to continue trading. In order to successfully propose a DoCA, the proposal must deliver a better outcome to creditors than they would receive under liquidation. If this is the case, the administrator will recommend that the creditors will accept the proposal and the creditors will then vote as to whether to accept it. I will post an article about DoCAs in the coming weeks as to what they are, how they can be used and what outcomes can be achieved.

There is a new form of restructuring regime for small business that is similar to the voluntary administration, which has just been announced by the Federal Government. I will post an article about streamlined restructuring process (known as the “Small Business Restructuring Plan”) in the coming weeks.

6. Receivership

Receivership in its most common form occurs as a result of an appointment by a creditor that has security over “all or substantially all of” the assets of the company. In most cases, this will be the bank. A receiver can be appointed at the same time as either a liquidator or a voluntary administrator has been appointed to the company. The owner of a small business could also be a secured creditor, if they have the protection referred to below, in which case they would also have the power to appoint a receiver.

The job of the receiver is to collect and sell all of the assets of the company to satisfy the debt owed to the secured creditor and to give any amount remaining to the company, or to the liquidator or the voluntary administrator. Until the secured creditor has been paid what it is owed, the receivers are in control of the company as opposed to the directors or the external administrator (either the liquidator or the voluntary administrator).

7. Protection

Small businesses and their owners have a far better chance to survive the insolvency regime, regardless of the type of appointment, if the owners protect the personal investment that they have made in the company as a secured loan, registered on the PPSR. Go to www.krodok.com.au to learn more.

8. Get early advice

It cannot be stressed enough how important it is that you seek advice from an insolvency specialist if you receive a statutory demand or you think that your business may be facing financial difficulty, or a sudden reduction in cashflow. The earlier that businesses seek advice, the greater the chance that they can survive and thrive again.