“There will be insolvencies. There will be bankruptcies. There will be some businesses that will not recover. That’s the harsh reality of an economic downturn that’s the worst in 100 years,” – Reserve Bank Governor Phillip Lowe on a recent appearance before a parliamentary committee.
What is insolvency?
Legally, what is Insolvency? Insolvency occurs when a business is unable to make payments for its debts and therefore has to default. As a result, the business may be wound up – either on its own decision or through a creditor’s application.
Even though the laws pertaining to insolvency state that a business becomes insolvent upon its failure to pay for the debts, the Courts have, on various occasions, decided that a business may not be insolvent only because it is unable to repay debts.
In short, there may be instances where a business faces shortage of funds. Under such circumstances, the business could be asset rich but cash poor and therefore, because the business has assets in its name, it cannot be declared insolvent.
While insolvency implies the inability to pay debts when due and applies to both individuals and businesses, under Australian Laws, bankruptcy is a legal process initiated only against individuals who fail to pay their debts on time.
Likewise, liquidation is a method to close down a business in a processed way and therefore is not applicable to bankrupt individuals.
Insolvency vs business administration
While both insolvency and business administration can be an overwhelming process for the operators of a business, the business administration process actually aids the business in repaying its debts, avoiding insolvency as far as possible.
Liquidation on the other hand, involves selling all assets to repay the creditors before closing the business.
What are the indicators of insolvency?
Before declaring a business as insolvent, many factors are taken into consideration. These include determining whether or not the business:
- is incurring continuing losses;
- is cash poor;
- has unpaid creditors;
- has defaulted in paying its tax obligations;
- is able to borrow funds; and
- has dishonoured cheques.
When the answer to most of the above questions is YES, the business has a high probability of being declared insolvent.
What happens when a business is declared insolvent?
When a business is found to be insolvent and negotiating with the creditors is impossible, the business will be wound up and closed. This may be done either by Voluntary Administration, Liquidation, or by entering a Deed of Business Arrangement.
Voluntary Administration is when the directors of the insolvent business or its creditors appoint an external administrator to investigate the business’s affairs and help determine whether the business should enter into a deed of business arrangement, go into liquidation or be returned to the directors.
Liquidation is the systematic winding up of a business’s affairs and requires selling the business’s assets and disseminating that income to creditors. Surpluses, if any, are then distributed amongst the shareholders.
A Deed of Business Arrangement is entered between the troubled business and its creditors. The deed outlines how the business’s affairs will be managed and tries to help the business continue while ensuring better returns for the creditors, instead of immediately winding up.
Forced vs Voluntary Liquidation
An insolvent business may be wound up forcibly or voluntarily.
A compulsory (forced) winding-up happens when the liquidation begins with an application to the court. The court then appoints a liquidator and orders the business’s winding up. In compulsory liquidation, once there is an order to wind-up the business, the liquidator requests ASIC to deregister the business.
A voluntary liquidation is initiated by the shareholders of a business. The liquidator thereafter takes control of the entire process in conjunction with the creditors. The liquidator must then submit a report to ASIC and hold a final joint meeting of the creditors and members and detail how the liquidation will proceed and how the business’s assets were realised. ASIC automatically deregisters the business within three months of receiving the notice of the meeting of creditors and members.
How can we help?
The key role of our Insolvency Experts is to gauge the financial position of the business and ensure a smooth insolvency process.
Our main aim is to balance the obligations of the business and the rights of the creditors. Some of our tasks might include:
- Scrutinising the financial statement of the business and understanding its financial position;
- Making arrangements to sell the assets of the liquidating business;
- Handling the settlement process in concurrence with the creditors;
- Evaluating the creditor’s claims and negotiating/agreeing with them on the basis of available funds;
- Overseeing the fund distribution to the creditors while ensuring that the money required to pay for the liquidation has been kept aside;
- Timely lodgement of reports with ASIC for any suspected misconduct by members or former members of businesses;
- Providing remuneration reports to assist the creditors make reasonable remuneration demands; and
- Remaining independent of any references or potential conflicts of interest.
What are the temporary changes to insolvency laws in view of the COVID – 19 pandemic?
As a response to the unprecedented crisis, the Australian Government has announced new laws with a view to safeguard companies from going insolvent as a result of the challenges caused by the pandemic. The new law came into effect on 25 March 2020 and temporarily provides:
- relief for business directors from personal liability for insolvent trading;
- raising the threshold for issuance of statutory demand from $2,000.00 to $20,000.00;
- increasing the time for compliance to the statutory demand from 21 days to 6 months.
Whilst the measures give directors temporary relief from personal liability there is still the requirement to ensure that directors act in good faith to ensure companies are not trading insolvent.
Insolvency or the prospect of insolvency can be extremely stressful for SME owners so it is essential that timely legal advice is obtained to ensure any risks from insolvency is minimised. We can help. It’s what we do.