Australia: An Introduction To Insolvency Law - Part One

Last Updated: 18 May 2009

1. Introduction

'Insolvency' is defined as the absence of solvency. Solvency, in turn, is defined as the ability of an entity to pay all of its debts as and when they fall due.1

In Australia, laws relating to insolvency are governed by the Corporations Act 2001 (Cth) (Corporations Act).

The overarching aim of insolvency law is to balance the interests of debtors, creditors and the general community when matters of insolvency arise. In particular, the insolvency regime seeks to provide:

  • an equal, fair and orderly procedure by which to handle the affairs of insolvent companies (insolvents), ensuring an equal and equitable distribution of the assets amongst creditors;
  • procedures to ensure debts are satisfied with as little delay and expense as possible;
  • mechanisms allowing for treatment of the affairs of insolvents before their position becomes unsalvageable;
  • to provide procedures which enable both debtors and creditors to be involved in the resolution of the insolvency problem; and
  • mechanisms which allow for the examination of insolvents, their directors, officers and associates, for the purpose of investigating the affairs of the company and even for ascertaining the reasons for insolvency.2

Where a company is insolvent:

  1. if it is thought that the company may be salvageable with a prospect of surviving its financial difficulties, the company may enter into a non-liquidation arrangement; or alternatively
  2. it may be liquidated in circumstances where it has no realistic prospect of reviving its financial prospects.

This paper seeks to briefly explore each of these options in turn.

2. Voluntary Administration and Deeds of Company Arrangement

These forms of administration are considered when the debtor company is insolvent or likely to become insolvent. Unlike receivership, which is usually initiated by a secured creditor, these two forms of administration are typically initiated by the company itself.

Voluntary Administrations and Deeds of Company Arrangement (DOCA) are dealt with under Part 5.3A of the Corporations Act. The purpose is to provide for the business, property and affairs of an insolvent company to be administered in a way that:

a) maximises the chances of the company, or as much as possible of its business, continuing in existence; or

b) if it is not possible for the company or business to continue in existence, results in a better return for the company's creditors and members than would result from an immediate winding up of the company.

1.2 Voluntary Administration

(a) Introduction

Voluntary administration commences at the point in time when an Administrator is appointed under section 437A of the Act and usually terminates on the execution by the company of a DOCA or a resolution by the creditors that the company should be wound up.

An Administrator may be appointed by:

  • the company (s 436A);
  • a Liquidator or provisional Liquidator (s 436B); or
  • a chargee of the whole, or substantially the whole, of the company's property where the company is not already being wound up (s 436C).

The company comes under the authority of an Administrator immediately upon his or her appointment. Upon appointment, the Administrator is obliged to lodge a notice of appointment with ASIC in order to provide notification that the company is under external administration. The Administrator must also publish a notice of appointment in a newspaper. Once an Administrator is appointed, the company name must be followed by the descriptor "(Administrator Appointed)".

The optimistic outcome of the voluntary administration process is the execution of a DOCA. If the DOCA is executed it will lead to another administration, governed by the terms of the DOCA. Although both administrations are dealt with under Part 5.3A, the two are actually separate administrations.

(b) The Administrator

An Administrator must be a registered Liquidator who gives consent in writing to accept the appointment. There are several factors which disqualify a person from acting as an Administrator and these are set out in s 448C(1). Disqualified persons include creditors with an interest in the company over $5000, a director, secretary or employee of the company, a director, secretary or employee of a company that is a mortgagee to the company's property, or an auditor of the company. While a person is not necessarily precluded from acting as an Administrator just because they have had prior contact with the company, substantial involvement with the company will disqualify a person as it will effect their ability to act impartially and fairly during the process.3

The essential role of the Administrator is set out in s 437A of the Act. That section states:

(1) While a company is under administration, the Administrator:

(a) has control of the company's business, property and affairs; and

(b) may carry on that business and manage that property and those affairs; and

(c) may terminate or dispose of all or part of that business, and may dispose of any of that property; and

(d) may perform any function, and exercise any powers, that the company or any of its officers could perform or exercise if the company were not under administration.

The Administrator is also required to investigate the affairs of the company and consider any possible causes of action and report to creditors. This power is set out in s 438A which states:

As soon as practicable after the administration of a company begins, the Administrator must:

(a) investigate the company's business, property, affairs and financial circumstances; and

(b) form an opinion about each of the following matters:

(i) whether it would be in the interests of the company's creditors for the company to execute a deedof company arrangement;

(ii) whether it would be in the creditors' interests for the administration to end;

(iii) whether it would be in the creditors' interests for the company to be wound up.

In carrying out these tasks the Administrator acts as agent of the company (s 437B). As such, the Administrator has broad powers to deal with the company's property and carry on the company's business. The Administrator is permitted to exercise the powers given to officers of the company. The Administrator is also entitled to the company's books and the officers of the company have an obligation to hand over any books in their possession. The directors are also required to provide the Administrator with a statement about the company's business, property, affairs and financial circumstances within a week of the Administrator being appointed, and must assist the Administrator whenever reasonably required.

(a) Effect of voluntary administration

The effects of voluntary administration are wide ranging and include the following changes:

  • the company's business, property and affairs come under the control of the Administrator: s437A;
  • the company's officers lose the right to use their authority and can only exercise that authority with the written approval of the Administrator;
  • the appointment of an Administrator leads to a statutory moratorium meaning that legal proceedings, wind up proceedings and execution against company property cannot be commenced or continued by creditors without written consent of the Administrator or leave of the Court;
  • the retention of the company's employees is ultimately within the Administrator's discretion, and the Administrator may terminate employees without incurring any personal liability;
  • contracts with a company under administration are not automatically terminated - the appointment of an Administrator does not reflect an intention on the part of the company to repudiate contracts already entered into, nor does it necessarily constitute a breach or repudiation of a continuing contract. This will however, depend upon the terms of the particular contract. Unlike a Liquidator, an Administrator does not have any statutory right to disclaim contracts. If an Administrator chooses to repudiate a contract, the other party will, as is usually the case under a receivership, be left with a claim which is an unsecured claim against the company for damages;
  • while the company is in administration, the owner or lessor of property that is used or occupied by, or is in the possession of, the company cannot take possession of that property or otherwise recover it - except where a supplier of perishable property is entitled to recover those goods under s441G or where the owner/lessor can obtain the Administrator's written consent or the leave of the Court under s 440C(a) or (b);
  • creditors who have supplied goods to a company pursuant to a contract which includes a retention of title clause, and the company then goes into administration, are often unable to recover the goods because of the restriction of s 440C provided the company is using the goods;
  • where property is being used or occupied by the company in administration, but belongs to someone else, the Administrator is only able to dispose of it in the ordinary course of business with the consent of the owner or with leave of the Court: s442C;
  • creditors are required to obtain leave of the Court to enforce guarantees against directors, their spouses, de facto spouses or their relatives: s 440J;
  • during the period of administration, the Administrator controls all financial and other dealings of the company. If the Administrator, in good faith, makes a payment or enters into a transaction, s 451C states that act is valid and effectual for the purposes of the Corporations Act and cannot be set aside in a subsequent winding up of the company.

(b) The creditors meetings

Two creditors' meeting are to be held under Part 5.3A of the Corporations Act.

The first creditors meeting is required to be held within 8 business days of the commencement of the administration (pursuant to s436E of the Corporations Act). The purpose of this meeting is:

  • to determine whether to appoint a committee of creditors: s 436E(10). The purpose of the committee is to consult with the Administrator about matters relating to the administration and to receive and consider reports prepared by the Administrator;
  • to allow the creditors to remove and replace the Administrator if they decide to do so. This generally occurs where the Administrator is regarded by creditors as being too sympathetic to the existing management of the company.

The second meeting of creditors is held at the end of the administration to determine which of three available routes the creditors want the company to take. The Administrator will convene the meeting and is to provide a report regarding the company's financial position and a statement indicating the Administrator's opinion with reasons as to whether it is in the creditors' interests to choose any of the three options set out in section 439C of the Act.

At a meeting convened under s 439A, the creditors may resolve:

  • that the company execute a DOCA specified in the resolution even if it differs from any previously proposed deed (if any) details of which accompanied the notice of meeting (note - the material details of the proposed deed are required to be included); or
  • that the administration should end; or
  • that the company should be wound up.

The second option will see the company return to the management of the directors and will result in an end to the moratorium. The third option will mean that the company will begin to be liquidated and the Administrator automatically becomes the Liquidator of the company.

The first of the options under s 439C may see the company executing a DOCA, which are considered in more detail in the following section.

3. Deeds of Company Arrangement

3.1 Introduction

Although a form of administration, a DOCA does not stand alone like a Scheme of Arrangement (which is addressed in greater detail later within this paper). A DOCA is essentially an agreement between the company and its creditors that follows from a Voluntary Administration.

If a DOCA is accepted by creditors, it may be that the DOCA will result in a successful reconstruction of the company. Alternatively, the DOCA may act simply as a means to maximise the benefits of the creditors of the company over the short term.

During the operation of the DOCA, the company generally continues to trade, however any debts incurred after the execution of the DOCA are not covered.

An Administrator of the DOCA must be appointed. This will usually be the former Administrator, as this person will have a greater understanding of the company's affairs.

There are few restrictions on the types of DOCA that can be executed. The legislation permits flexibility so that the contents of the DOCA can meet the requirements of the company and its creditors. For example, the DOCA may involve a simple moratorium for a set period, a composition of creditors' claims whereby creditors agree to accept less than what is owed, or a plan to pay creditors in instalments, or a mixture of these things.

3.2 Advantages of a DOCA

As the aim of the DOCA is to produce a better outcome for all parties, as expected, there are advantages to a DOCA for creditors, directors and the company as a whole.

(a) Advantages for the Company and its Directors

A distinct advantage for the company is that it can continue to trade during the DOCA period and may be able to survive its financial difficulties. The company will be required to operate under the terms of the DOCA.

Some of the advantages of a DOCA to the company and its directors are:

  • the officers will not be seen as officers of a company that is in liquidation;
  • creditors of the company will no longer place pressure for payment on the company;
  • because the company is not in liquidation, insolvent trading claims against the directors cannot be commenced;
  • the company may be able to carry forward tax benefits as deductions against any future earnings; and
  • the company may redevelop its business during the DOCA period.

(b) Advantages for the Company's Creditors

The obvious primary benefit for the company's creditors is that there is a potential for a better dividend than what the creditors would receive if the company were to be wound up by a Liquidator.

Other advantages of a DOCA for the company's creditors are:

  • a dividend under a DOCA may be received quicker than if the company was being wound up; and
  • third parties may be willing to contribute funds to the company which would not otherwise be available if the company was in liquidation;
  • the directors, related companies and some creditors may be willing to defer or waive their claims under a DOCA which will increase the funds available to the DOCA creditors;
  • the creditors of a company may elect to retain the company as a customer;
  • DOCA Administrators can be selected based on their experience in a particular industry in which the company trades; and
  • the Administrator of a DOCA will not have the power to recover from creditors voidable transactions such as preference payments.

3.3 The DOCA

(a) Form of the DOCA

It is the obligation of an Administrator of a proposed DOCA to have a form of DOCA prepared which sets out the terms of the deed agreement. Under Section 444A(4) of the Corporations Act, those matters that must be included in the DOCA are:

  • who the Administrator of the DOCA will be;
  • the date on which claims against the company must have arisen;
  • the property of the company that is available to pay creditor's claims;
  • the nature and duration of the moratorium period;
  • the extent to which the company is to be released from its debts;
  • the circumstances under which the DOCA will terminate and the day on or before which claims must arise to be admissible under a DOCA;
  • the order in which the proceeds of the company's property are to be distributed amongst the DOCA creditors; and
  • Regulation 5.3A.06 of the Corporations Regulations 2001 (Regulations) provides that Schedule 8A of the Regulations be included in a DOCA unless they are specifically excluded and replaced with other terms.

3.4 Execution of a DOCA

If the creditors of a company resolve that a DOCA be executed the DOCA must be executed by the company within 21 days after the Section 439A (second creditors) meeting or any such further time as allowed by the Court. The Administrator is also required to execute the DOCA as soon as practicable after the company has executed the DOCA.

When the DOCA is executed by both the company and the Administrator of the DOCA, the instrument becomes effective. Although the document is called a deed, it is not a deed at law and the requirements for the execution of a deed are not applicable.4 The DOCA does not require a company seal to be valid when executed.

3.5 Effects of a DOCA

Once a DOCA is executed, the administration of the company ends and the moratorium restrictions that apply to creditors come to an end and are replaced by the DOCA's moratorium provisions.

The DOCA binds the deed Administrator, the company and its officers and the members of the company and releases the company from its debts to the extent provided by the DOCA. If a creditor fails to lodge a proof of debt in the administration of a DOCA, that creditor may be prevented from participating in any distribution of the fund created by the DOCA.

(a) Effects of the DOCA on the Company

The company is bound by the terms of the DOCA throughout the term of its operation. The company will also be required to change all public documents by inserting the words (Subject To A Deed Of Company Arrangement) after its name. In exceptional circumstances the Court may order under Section 447A of the Act that this requirement may be dispensed with.5

(b) Effects of the DOCA on the Directors of the Company

When the voluntary administration of the company ends and the DOCA comes into operation, the powers of the directors are resurrected. However, the DOCA binds the directors of the company.

(c) Effects of the DOCA on the Company's creditors

The DOCA binds all creditors in so far as they possess any claims arising before the date referred to in the DOCA. Creditor's claims are therefore generally compromised under the terms of a DOCA. As a consequence, a creditor who is bound by a DOCA will be unable to apply for a winding up order against the company in respect of a debt that arose prior to the date mentioned in the DOCA for claims.

(e) Effects of the DOCA on Secured Creditors

Secured creditors can continue to deal with their own security and are generally not bound by the terms of a DOCA. This is subject to whether they participated in and voted in favour of a DOCA or if they are otherwise prevented pursuant to a Court order from dealing with their property.

In circumstances where a secured creditor has the capacity to interfere with a DOCA, the Court can order that a dissenting secured creditor be prevented from threatening the viability of the DOCA and order that that creditor not realise or deal with its security for a set period of time. A party applying for such an order under Section 444F(2) of the Act has the onus of establishing that a secured creditor's interest will be adequately protected if an order is made prohibiting the creditor from dealing with its security.6

(f) Effects on Owners and Lessors

Owners and lessors of property are able to deal with their property and are not bound by the DOCA unless they voted in favour of a DOCA or if they are otherwise prevented by Court order.

3.6 The Administration of a DOCA

A DOCA will be governed by its terms. Generally, Schedule 8A of the Regulations will govern the terms of a DOCA unless the Schedule is excluded and replaced with alternate terms.

(a) Recovery of Funds

Once the DOCA is in force, the Administrators of a DOCA will call in the funds payable under the DOCA. The source may be from the sale of assets, realisation of debtors, collection of funds to be injected by the directors or a third party or a contribution to be made by the company from its profits.

(b) Proofs of Debt

Once the Administrator of a DOCA has collected the funds the subject of the DOCA, he or she will call for proofs of debt from the creditors who are entitled to prove under the DOCA.

The Court has typically taken a broad interpretation of the word "creditor" and has in the past included claims by creditors who hold contingent, future or unascertained damages claims.

(c) Priority Creditors

Subject to any variation set out in the DOCA, generally the priority of payments to creditors under a DOCA is governed under Section 556 of the Act.

(d) Payment of dividends

After assessing the proofs of debt of creditors and after receiving all funds due under the DOCA, the Administrator of a DOCA is required to pay a return to creditors. If creditors receive their dividends under a DOCA they are accepting those dividends as full and final satisfaction of all claims against the company as at the date of the administration. Their claims against the company are thereafter extinguished.

3.7 Termination of a DOCA

Under Section 445C of the Act, a DOCA will terminate when:

(a) The Court orders under Section 445D of the Act that a Deed by terminated;

(b) the company's creditors resolve at a meeting of creditors that the DOCA be terminated; and

(c) the Deed specifies circumstances under which the Deed will terminate and those circumstances have occurred. For example, when the Administrator has paid all entitlements to creditors under the DOCA.

4. Liquidation

4.1 Introduction

Liquidation is a process whereby the assets of a company are collected and realised, and the resulting proceeds are applied in discharging all relevant debts and liabilities. The balance which remains after paying the costs and expenses of winding up is distributed among the members according to their rights and interest, or otherwise dealt with as the constitution of the company directs.7

A company may be liquidated on either a voluntary basis or on a compulsory basis.

4.2 Voluntary Liquidation

(a) Members Voluntary

A members' voluntary wind up is only available if the company is solvent.

In this form of wind up of the company's affairs, the process is initiated by a special resolution of the company pursuant to s491 of the Corporations Act, and the creditors have no involvement as they will be repaid in full. A special resolution requires the support of 75% of the members who attend and vote at a meeting that is duly called after 21 days written notice is given. The directors (by a majority) are required to give a declaration as to the solvency of the company and must file this declaration with ASIC.

If at the meeting of members, the members of the company vote in favour of the voluntary wind up of the company by an ordinary vote, a Liquidator will be appointed to the company. Should the Liquidator subsequently determine that the company is in his or her opinion insolvent, contrary to the directors solvency declaration, then the Liquidator must either apply to the Court for the company to be wound up in insolvency, appoint an Administrator to the company or convene a meeting of creditors. If a meeting of the creditors is convened, from the time of the meeting the wind up will be classified as a creditors' voluntary winding up.

(b) Creditors' Voluntary

Notwithstanding the title, a creditors' voluntary winding up is not initiated by creditors. It is rather, initiated by members who have resolved, by special resolution, that the company is insolvent and generally occurs as a result of directors determining that the company is insolvent and recommending that it be wound up. Alternatively, it may also be initiated by a Liquidator appointed pursuant to members voluntary wind up where the Liquidator forms the opinion, contrary to the directors solvency declaration, that the company is insolvent.

In the case of a creditors' voluntary winding up, there may not be a need for the Court to become involved in the liquidation at any stage with the company ultimately being deregistered with ASIC by the Liquidator.

4.3 Compulsory Liquidation

A compulsory liquidation is typically the result of an action taken by a creditor of an insolvent company. Compulsory liquidation is a statute-defined procedure which enables a person to apply to the Court for an order that the affairs of a company be wound up.

It is important to note that section 462(2) of the Corporations Act (the Act) actually allows a broad range of persons to initiate compulsory liquidation proceedings. For example, the company, the creditors, the members, the Liquidator, ASIC and, in respect of a general insurance company registered under the Insurance Act 1973 (Cth), APRA, may all apply to the Court for a company to be wound up. However, in most cases, compulsory liquidation will be commenced by creditors.

A company can be compulsorily wound up on account of insolvency on 5 broad grounds:

  1. where the company is proved to be insolvent after an application is made to the Court by a creditor under s459P (s459A);
  2. where an application is made to the Court pursuant to ss 232, 462 or 464 and the Court determines that the company is insolvent (s459B);
  3. where the creditors of a company subject to voluntary administration resolve that it be wound up (ss 446A(1)(a) , 446A(6));
  4. where a company fails to execute the instrument providing for a deed of company arrangement within 21 days of the meeting of creditors in circumstances where the creditors resolved to accept the deed (ss 446A(1)(b), S444b (2)(a), 446A(6)); or
  5. where the creditors of the company resolve that a deed of company arrangement be terminated (ss 446A(1)(c), 445E, 446A(6)).8

The most frequent situation in which a company is wound up is the first of the options above9 - where the company is proven to be insolvent after an application is made to the Court by a creditor under s459P. This section deals with circumstances where a creditor has made an application to the Court for a winding up order. To be a qualified applicant for such an order, a creditor must be owed a valid, legally enforceable debt. Both secured and unsecured creditors are entitled to apply for a winding up, however, the debt must be current - a prospective or future creditor cannot apply, except with leave of the Court.

4.4 Presumptions of Insolvency

There are presumptions of insolvency that can be relied upon by creditors so as to avoid the need to provide actual proof that the debtor company is insolvent. This is helpful as in most cases, proving insolvency to an evidentiary degree would be an impossibly difficult task for a creditor.

Section 459C of the Act provides that a company will be presumed to be insolvent if, during or after the three months preceding the day on which an application was made for the winding up of the company, any one of the following six situations occurs;

  1. the company failed to comply with a section 459E statutory demand;
  2. execution process issued on a judgment in favour of a creditor was returned wholly or partly unsatisfied;
  3. a Receiver was appointed in respect of property of the company pursuant to a floating charge;
  4. an order was made for the appointment of a Receiver for the purpose of enforcing a floating charge;
  5. a person entered into possession or assumed control of property to enforce a floating charge; or
  6. a person was appointed to enter into possession or assume control of property of a company under a floating charge.

4.5 Statutory Demands

The most common way to prove insolvency is non-compliance with a statutory demand issued pursuant to section 459E of the Corporations Act. This is due to the fact that preparing a statutory demand is a relatively simple, uninvolved and inexpensive process. Nevertheless, the case law authorities are littered with examples of many failed statutory demands and extreme caution should be undertaken in their preparation and service.10

Part 5.4 Divisions 2 and 3 of the Corporations Act set out a regime for dealing with statutory demands which must be strictly adhered to. The statutory demand sets in motion wind up proceedings which can have serious consequences for the debtor company. Due to the fact that creditors gain the benefit of presumed insolvency where a statutory demand is not complied with, the Court requires creditors to ensure that demands are expressed in clear, correct and unambiguous terms. Any error, however slight, has the prospect of resulting in the statutory demand being set aside by the Court.

There are a number of important issues to note about the preparation of statutory demands. Although the points below do not set out a comprehensive guide as to all the requirements of statutory demand, the following points can provide some assistance:

  • section 459E(2) of the Act deals with the form of the demand. It requires that the demand must:
    • specify the debt claimed, or if the demand relates to two or more debts it must specify the total amount of the debts;
    • require the debtor company to pay the debt within 21 days;
    • must be in writing in the prescribed form (form 509H); and
    • must be signed by or on behalf of the creditor.
  • with respect to the debt to which the demand relates:
    • the debt must be due and payable - it cannot be contingent, prospective or unliquidated;
    • a creditor is not entitled to serve a demand at the same time as taking proceedings against the debtors company's directors in relation to the same alleged debt - this is considered to be an abuse of process;
  • the demand need not be based on a judgment debt;
  • the demand must be served on the company by leaving it at it's registered office, sending it by post to that office, or delivering a copy of the demand personally to the director of the company.

On being served with a valid demand, the debtor may:

  • pay the debt; or
  • secure or compound the debt to the creditor's reasonable satisfaction.

Failure to do so within 21 days (unless an extension is granted) will mean that insolvency is presumed and the creditor may use that presumption in order to make a winding up application to the Court pursuant to section 459Q of the Corporations Act.

A debtor company can also apply to challenge a demand on the following grounds:

  • where there is a genuine dispute about the existence of the debt (s 459H(1)(a));
  • where the company has an offsetting claim (s 459H(1)(b));
  • where there is a defect in the demand and substantial injustice will be caused if the demand was not set aside (s 459J(1)(a)); and/or
  • where there is some other reason why the demand should be set aside (s 459J(1)(b)) (this section enables the Court to take into account matters such as improper or invalid service, or mistakes or misstatements in the statutory demand, among other things).

4.6 Commencement of Winding Up Proceedings

In a compulsory winding up, the day on which the relevant Court order is made will constitute the date of the commencement of the winding up (note: this is only the case where an order is made in circumstances where there is no prior insolvency administration). The date on which the application to wind up the company was filed is called the relation-back day.

Whether the liquidation process is initiated by an order of the Court or through a creditors' voluntary winding up, a Liquidator will be appointed to administer the winding up of the affairs of the company.

4.7 The Liquidator

(a) Appointment

In a compulsory winding up the Court will appoint a Liquidator to the company, generally upon the nomination of the applying party. In a voluntary winding up, the Liquidator will be appointed by the members or creditors of a company after consenting to so act.

Liquidators are practising accountants and are generally required to be members of the Institute of Chartered Accountants of Australia and/or CPA Australia. Importantly, they must be an independent person and be seen to be independent.

(b) Role of the Liquidator

The role of the Liquidator has been described as a hybrid role with elements of fiduciary trustee, agent, officer of the corporation and in some instances officer of the Court: Sydloq Pty Ltd v TG Kotselas Pty Ltd (1996) 14 ACLC 846.

The Liquidator owes fiduciary duties to the company, its creditors and members. The Liquidator is required to act honestly, fairly and impartially at all times, and must avoid any conflicts of interest.

The Liquidator is required to exercise his or her powers and discharge his or her duties with the degree of care and diligence that a reasonable person would exercise if they were a director or officer of a corporation if the corporation's circumstances and occupied the office held by, and had the same responsibilities within the corporation as, the director or officer.

Upon the appointment of a Liquidator, the powers of all directors are suspended and the company itself will cease to carry on business except to the extent that the Liquidator believes it will assist the beneficial disposal of the business. The Liquidator will take over operation of the company and can deal with the property of the company.

The functions of the Liquidator are:

  • to wind up the affairs of the company;
  • to ascertain and recover the property of the company;
  • to distribute the company's assets equitably among its creditors; and
  • to examine the circumstances which precipitated the liquidation and which may reveal improper dispositions of property and criminal offences.11

(a) Duties of the Liquidator

Specific duties of the Liquidator include:

  • to ascertain and take possession of the assets of the company. The Liquidator is empowered to take into custody all property which the company is or appears to be entitled to. The Liquidator may need to initiate litigation in order to obtain such property, including litigation in respect of any transactions which appear to constitute unfair preferences. Issues to note regarding this point as set out as follows:
    • the Liquidator is entitled to all the assets belonging to the company at the commencement of the winding up. Any property disposed of after this point is void unless validated by the Court;
    • generally, property held on trust by the company for another party is not the property of the company;
    • the Liquidator is not entitled to goods in the company's possession that are subject to valid retention of title clause and have not been paid for. These goods must be returned to the owners;
    • aside from current assets. the Liquidator can also recover property or money from other persons, and avoid certain obligations. This point will be dealt with more extensively in the paragraphs below;
  • to preserve the assets of the company by taking an inventory, insuring the assets, investing funds wisely and defending any claims initiated against the company to recover assets or claim for damages;
  • a duty to realise the value of the assets for the benefit of the company;
  • a duty to report and investigate on the affairs of the company, including settling a list of contributories and ascertaining the liabilities of the company;
  • administrative duties which require certain documents to be lodged with governmental bodies, and the keeping of accurate accounts and records of all matters relating to the liquidation.

(b) Supervision of the Liquidator

Given the wide powers granted to liquidators, there is a need to supervise their activities to ensure that the powers are exercised fairly. The conduct of liquidators is supervised by both ASIC and the Court. Section 536 of the Act grants these parties the power to inquire into the Liquidator's conduct if it appears he or she may not have performed duties correctly, or where a complaint is made regarding their conduct. In addition, under s 1321, a person aggrieved of any act, omission or decision of a Liquidator may apply to the Court to challenge the decision. If it is shown that some misconduct has occurred, or a conflict of interest has arisen, the Court has power to remove a Liquidator.

4.8 The Avoidance Regime - Part 5.7B Div 2 of the Act

The Liquidator of a company may in some cases seek to claw back the benefit of transactions which the company undertook prior to the commencement of the winding up.12 These are generally referred to as "voidable transactions". The aim of the division is to protect "the interests of unsecured creditors which might otherwise be prejudiced by a company disposing of assets or incurring liabilities or entering into unrealistic loans shortly before winding up".

(a) Voidable Transactions

Section 588FE of the Corporations Act provides for 3 classes of voidable transactions:

  • Insolvent Transactions which meet additional criteria and which occur within certain time periods (ss 588FE(2) to (5)) - such as unfair preferences and uncommercial transactions);
  • Unfair Loans (s 588FE(6));
  • Unreasonable Director-Related Transactions (s 588FDA).

These will be dealt with in turn.

(i) Insolvent transactions

Insolvent transactions are transactions entered into by a company whilst insolvent, or transactions entered into by the company the result of which caused the company to become insolvent.

An insolvent transaction may be voidable when one of the following conditions apply:

  • It was entered into during the 6 month period immediately before the relation back day or during the period between the relation back day and the winding up;
  • it was an uncommercial transaction entered into during 2 years prior to relation back day;
  • it was a related entity transaction during the 4 year period prior to the relation back day;
  • it involved a situation where the company was a party to an unfair preference or uncommercial transaction in order to defeat, delay or interfere with the rights of any or all of its creditors and the transaction was entered into during the ten years immediately prior to the relation back day.

There are 2 categories of insolvent transactions: unfair preferences (s 588FA) and uncommercial transactions (s 588FB).

Unfair Preferences

A transaction is an unfair preference if the company and the creditor are parties to the transaction and the transaction results in the creditor receiving from the company, in relation to an unsecured debt owed to the creditor, a greater amount than it would have received in relation to the debt in a winding up of the company.13

The Liquidator will be required to prove the various elements in order to retrieve the monies paid out by the company. These include that:

  • there was a transaction between the company and a creditor;
  • the transaction was an insolvent transaction (that is the company was insolvent at the time of the transaction or the transaction caused the company to become insolvent);
  • the transaction occurred within six months of the relation back date or within four years of the relation back date if the transaction is with a related entity; and
  • the creditor received more than it would have in a winding up of the company.

If a transaction is held to constitute an unfair preference, the recipient will be required to repay the benefit received from the Company to the Liquidator for general distribution to all creditors.

Uncommercial Transactions

An uncommercial transaction is an insolvent transaction (that is the company was insolvent at the time of the transaction or the transaction caused the company to become insolvent) that a reasonable person in the place of the company would not have entered into, taking into account:

  • the relevant benefits and the detriments to the company; and
  • the respective benefits to the other parties involved and any other relevant matter.

Notably, and unlike an unfair preference, it is not necessary for the Liquidator to demonstrate that the transaction was between the company and a creditor. The transaction can be between the company and any party.

An uncommercial transaction can be voided if it was entered into during the 2 years prior to the relation-back day, or 4 years prior to the relation-back day if a related entity is a party to the transaction.

Fraudulent Transactions

Where it is not possible to categorise transactions as unfair preferences or uncommercial transactions, they may still be voidable even if entered into outside of the time periods usually applied to such transactions. This will be the case where transactions were entered into by the company for the purpose of defeating, delaying or interfering with the rights of creditors during the 10 years prior to the relation back day.14

(ii) Unfair Loans

A Liquidator may seek to avoid an unfair loan pursuant to s 588FD of the Corporations Act where the loan or loans were subject to interest or charges that are extortionate. In determining whether a loan is unfair, the Court will look at such things as the risk assumed by the company in lending, the value of any security in respect of the loan and the term of the loan. The unfair loan provisions do not require that the transaction be an insolvent transaction.

(iii) Unreasonable Director-Related Transactions

The intent of this provision is to permit liquidators to reclaim unreasonable payments made by companies to directors prior to liquidation, for example, by way of an excessive bonus. This provision extends to payments made to "close associates" of any director, conveyances, transfers, other dispositions of property, the issue of securities, and the incurring of an obligation to enter into these obligations.

A transaction will be deemed an unreasonable director-related transaction if a reasonable person in the company's circumstances would not have entered into the transaction.

(a) Defences

Several defences are available to parties seeking to resist a claim from a Liquidator in relation to voidable transactions. The Court is prevented from making an order against a party where it would materially prejudice a right or interest of persons who can bring themselves within the protective provision.

Where the person defending the Liquidator's claim was not a party to the voidable transaction, they must prove that they did not receive a benefit as a result of the transaction, or if a benefit was received, that it was received in good faith and at the time there was no reasonable grounds for suspecting company insolvent - this is an objective test.

If the person defending the Liquidator's claim is a party they must prove;

  • that they became a party to the transaction in good faith;
  • that at the time they became a party to the transaction, they had no reasonable grounds for suspecting that the company was insolvent at that time or would become insolvent;
  • that a reasonable person in the recipient's circumstances would have had no such grounds for so suspecting; and
  • that valuable consideration was provided or that they changed their position in reliance on the transaction.

4.9 Criminal offences and Civil Actions against Company Directors

As part of the investigation process into the affairs of the company, the Liquidator is required to investigate the company's officers to determine whether such persons may be liable for certain activities which occurred during the life of the company. In some cases this can provide an avenue of financial recovery for the Liquidator.

Liquidators will look into the affairs of the company to determine whether company officers have complied with their common law duties of good faith (to act honestly in the best interests of the company, to exercise powers for a proper purpose and to act with an unfettered discretion), duties of care and skill, and statutory duties under the Act.

If a Liquidator finds that a director has breached their duties to the company they may be able to proceed against them to recover damages for the company.

(a) Common law duties and recovery

The breach of common law directors duties may enable a Liquidator to recover property from a director or may give the Liquidator a right to an account of profits. For example, where a director removes or misuses company property, this would be a breach of their duty of good faith and may render the transaction voidable. In such circumstances the Liquidator may attempt to recover the property from the director who is deemed to hold it on constructive trust for the company. A director who breaches the duty to use reasonable care and diligence will also be liable for damages if the company suffered loss as a result of the breach.

(b) Civil penalties

A person who contravenes duties under ss 180-183 of the Act may also be subject to a civil penalty order of up to $200,000 on the application of ASIC. In addition the director may be ordered to pay compensation to the company if the Court is satisfied that the corporation has suffered loss as a result of the director's breach.

(c) Criminal liability

Officers who breach ss 180-183 of the Act may also be criminally liable if:

  • there is recklessness or intentional dishonesty and powers are not exercised in good faith in the best interests of the company;
  • there is, in the use of directors' position, an element of dishonesty and either intention or recklessness in obtaining a gain or causing the company a detriment; or
  • directors use the information that they receive dishonestly with either the intention of gaining an advantage or causing the company to suffer a detriment, or acting recklessly as to whether they might gain an advantage or cause the company a detriment.

(d) Insolvent trading

Section 588G states that directors will contravene the section if all the following criteria apply:

  • they are directors when the company incurs a debt;
  • the company was insolvent at the time when the debt was incurred or became insolvent as a result of the incurring of the debt;
  • there were reasonable grounds for suspecting that the company was insolvent or would become insolvent as a result of the debt being incurred; and
  • a reasonable person in a like position in a company in the company's circumstances would be aware of the company's insolvency.

If a director is found to be in breach of this provision, they may be subject to a civil penalty application by ASIC. ASIC may also seek compensation orders on behalf of the creditors.

Directors may also be subject to criminal prosecution where, in addition to the requirements for civil breach that they be directors at the time when the debt was incurred and that the company was insolvent, the directors:

  • suspected at the time when the company incurred the debt that the company was insolvent or would become insolvent as a result of incurring that debt or other debts; and
  • their failure to prevent the company incurring the debt was dishonest.

4.10 Termination of the Winding Up

A winding up may be terminated in two circumstances:

  1. where the Court orders the termination because, for example, a solvent company was allowed to go into liquidation through the inadvertence of the directors; or
  2. through the finalisation of the winding up process and the deregistration of the company.

The latter circumstance is by far the most common.15

Swaab was recently named a 2009 Winner in the ALB Employer of Choice awards, and was winner 'Best Law Firm in Australia (Revenue < $20m)' and 'Attribute Award for Exceptional Service (Australia Wide)' in the 2008 BRW- Client Choice Awards.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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This article is part of a series: Click An Introduction To Insolvency Law - Part Two for the next article.
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