What does insolvency mean?
Insolvency refers to a company or individual who is unable to pay its debts when they fall due for payment.
What is the difference between bankruptcy, liquidation and voluntary administration?
Bankruptcy occurs where you, upon a voluntary application by a debtor or the filing of a creditor’s petition, a court declares a person a bankrupt.
Voluntary administration is where the directors of a company in financial difficulty or a secured creditor with a charge over most of the company’s assets appoint an external administrator called a ‘voluntary administrator’.
The role of the voluntary administrator is to investigate the company’s affairs. They are to report to creditors and to recommend to creditors whether the company should enter into a deed of company arrangement, go into liquidation or be returned to the directors. A voluntary administrator is usually appointed by a company’s directors. This occurs after they decide that the company is insolvent or likely to become insolvent.
Liquidation is the winding up of a company. It usually includes selling the company’s assets and distributing the proceeds among creditors and distributing any surplus to shareholders. A company can be wound up by a court upon the application of a creditors or by the company voluntarily.
Process involved with winding up a company
If you are a creditor seeking to wind up a company, we have outlined the brief process below.
If you are concerned that a company you are dealing with may be insolvent or is likely to become insolvent in the near future, we recommend writing to them asking whether the company remains solvent. We have included a template letter with this package.
If a debtor owes you money, in the first instance you should send them a letter of demand outlining the amount owing, when the debt became due and how the amount can be paid. We have set out in this package a template letter for you.
You may wish to negotiate the debt with the other party. In some cases, and it really depends upon the circumstances, it is beneficial to accept a reduced amount of the total debt owed. Otherwise you may spend significant funds obtaining the entirety of the debt.
Any agreement reached between the parties should be captured in a deed of settlement. Our office is able to draft this for you to ensure you rights and obligations are captured.
If the company appears to be solvent or has produced evidence that they are solvent, you may wish to institute proceedings in the relevant state court.
To ensure your best chance of success in obtaining a judgment debt, you should seek the assistance of a lawyer in the drafting of your claim and statement of claim.
If the company is insolvent, you can proceed straight to issuing a statutory demand. You will need to comply with the relevant legislative requirements to ensure the statutory demand is executed validly and served correctly.
If the statutory demand is not complied with, the creditor is able to apply to the court for a winding up order. If a winding up order is made by the court, a liquidator will be appointed to wind up the company and deal with any remaining assets and debts of the company.
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Understanding claw back provisions during liquidation
If a liquidator is appointed to wind up a company, the liquidator can in certain circumstances claw back payments already made by the company to third parties in order to repay the debts of the company.
These are referred to under the Act as unfair preferences.
To establish that a creditor has received an unfair preference, the liquidator appointed to the company must show:
- A transaction was entered into between the company and one of its creditors
- The transaction resulted in the creditor receiving more from the company than it would have received if it proved for the debt in the liquidation
- The company was insolvent at the time of the or as a result of the transaction
- The transaction was entered into during the period of six months ending on the relation-back day (date creditor’s application filed in court). Please note that, where the recipient of the funds is related to the company though, this period is extended to four years.
Importantly, the creditor has to be an unsecured creditor. An unfair preference cannot be given to a secured creditor in circumstances where the value of the security held is greater than the amount of the debt.
How does a person become a bankrupt?
Bankruptcy can come about in two ways, voluntarily or a creditor lodging a creditor’s petition.
You can enter into voluntary bankruptcy. To do this you need to complete and submit a Bankruptcy Form.
Alternatively, if a creditor (someone you owe money to) files a creditor’s petition, you will also become a bankrupt.
Process of lodging a creditor’s petition
If you owe a creditor $5,000 or more, they are able to apply to the court to have you declared bankrupt. The creditor is required to lodge a creditor’s petition.
For the creditor’s petition to be successful, the debtor will need to have committed an “act of bankruptcy” as defined by section 40 of the Bankruptcy Act 1966.
The most common act of bankruptcy is the failure to comply with a bankruptcy notice.
Most creditor’s will make an application to the relevant state court (the appropriate court changes depending on the quantum owed). This occurs after usual debt recovery efforts such as letters of demand are unsuccessful at recouping the debt. Once a judgement is received for the amount of the debt, the creditor would usually seek enforcement of the debt.
Where the debt remains unpaid, the creditor should then issue a bankruptcy notice to the debtor for the amount of the judgement debt plus interest.
If the bankruptcy notice is not complied with, an act of bankruptcy is said to have occurred. The creditor will be able to apply for the debtor to be declared a bankrupt by way of creditor’s petition.
If a person owes an amount of over $5,000 and has not responded to a letter of demand for the sum, the creditor should issue the debtor with a bankruptcy notice. Our bankruptcy package includes a copy of the relevant form and a checklist for correct completion of the form.
If the Federal Circuit Court is satisfied that the relevant requirements have been complied with, the court may issue a sequestration order which makes the person bankrupt.
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Process of voluntarily applying for bankruptcy
To voluntarily apply to become a bankrupt, you will need to complete a bankruptcy form. This form is often referred to as a Debtor’s Petition. It can be completed online on the Australian Financial Security Authority website.
Prior to deciding whether voluntary bankruptcy is the right decision for you, you should speak with a financial planner and lawyer to determine whether that decision is within your best interests.
Once you become a bankrupt you will be provided with a reference number which you can provide to creditors. Creditors should then liaise with your bankruptcy trustee to recoup any funds owing to them.
What are the consequences of bankruptcy?
Bankruptcy normally lasts for 3 years and 1 day.
The following may apply to you, depending on your individual circumstances, during that time:
- You may be required to make compulsory payments from your income
- There may be restrictions placed on the type of employment you can hold and you may not be able to run a business
- Your overseas travel will be restricted
- A trustee will be appointed to manage your bankrupt estate and the debts of your estate
- Your name will be listed on the National Personal Insolvency Index, which is a searchable register
- You may have difficulties obtaining credit in the future
- The trustee has the ability to sell your assets
Insolvency lawyers and insolvency advice
If you are facing insolvency and need advice, we are here to help. Please contact us today and our experienced insolvency team will assit you to get the best outcome for your situation.