Liquidation or Administration

Insolvent trading occurs when a director allows a business to incur debts even though they are aware the business is unable to pay them as and when they fall due, rendering the business insolvent. 

It is important to note that the duty to prevent insolvent trading also applies to any person acting in the position of director, even if they are not formally or validly appointed as a director.

The Deed of Company Arrangement process or DOCA as it is often referred to, is a means to salvage and restructure an insolvent or near insolvent company and provide creditors with a better outcome than they would experience if the company was to directly enter liquidation. 

A Deed of Company Arrangement must follow a Voluntary Administration and is proposed by the Directors during the Voluntary Administration period. The Administrator investigates the proposed Deed of Company Arrangement and makes a recommendation about whether company creditors should accept or reject the proposal. As a rule of thumb the Deed of Company Arrangement needs to offer creditors a better outcome than if the company was liquidated.

There are a number of commercial considerations that need to be taken into account when drafting a Deed of Company Arrangement. It is not just a simple case of a company seeking to compromise debts with creditors. Often the company will need to make significant changes to the way it does business if the Deed of Company Arrangement  is to have any chance of succeeding. In addition, the company and its directors will need to have some goodwill left with a majority of its creditors, as it is the creditors that will ultimately decide the company’s future, so acting early is vital.

This type of administration was introduced to encourage directors of insolvent companies to take early action and is a mechanism for companies facing financial distress to obtain a “breathing space”. It also provides directors with protection from personally guaranteed corporate debts during the period of the Voluntary Administration period.

During the Voluntary Administration process, there is a moratorium period of approximately 5 weeks (six weeks at Christmas and Easter) in which creditors, subject to a number of exceptions, are prohibited from taking any action against the company to recover debts, enforce charges or have the company wound up without the consent of the either the Administrator or the Court.

The Administrator will convene two meetings of creditors during the administration:

• The first meeting will be held within 8 business days of the Administrator’s appointment at which creditors may vote to replace the Administrator and/or appoint a Committee of Creditors; and
•  The second meeting of creditors will be held within 25 or 30 business days after the  Administrator’s appointment at which creditors may vote to decide the Company’s future.

The Administrator’s role is to take control of the affairs of the business, investigate the financial affairs of the company, report the findings and recommend to creditors one of the following three courses of action:

1. That the administration cease (and control of the company be returned to the directors);
2. That the company enter into a Deed of Company Arrangement; or
3. That the company be wound up in insolvency.

There are a number of common factors that can indicate that your company is in financial distress. Being unable to pay critical creditors, staff superannuation and the Australian Taxation Office are the most common. Below are some of the signs the Australian Securities and Investments Commission states can indicate your company is undergoing financial difficulty:

• Ongoing losses
• Poor cash flow
• Lack of cash-flow forecasts and other budgets
• Creditors unpaid outside usual terms
• Solicitor's letters, demands, summonses, judgments or warrants issued against your company
• Suppliers placing your company on cash-on-delivery (COD) terms
• Overdraft limit reached or defaults on loan or interest payments, or
• Overdue taxes and superannuation liabilities.

A director may be held personally liable to compensate creditors for the amount of the unpaid debts incurred from the time the business became insolvent to the start of the liquidation. 

In 2015, the Australian Securities and Investments Commission focused on insolvent trading by directors, noting that the following penalties can apply in certain circumstances:

• Civil penalties: these can apply for contravening the insolvent trading provisions of the Corporations Act 2001, which can include pecuniary penalties of up to $200,000
• Criminal charges: if dishonesty is found to be a factor in insolvent trading, a director may also be subject to criminal charges, which can include a fine of up to $220,000 or imprisonment for up to five years, or both.

The Corporations Act 2001 provides some statutory defences for directors, however, directors may find it difficult to rely upon these if they have not taken steps to keep themselves informed about the company's financial position.

Eligible employees are entitled to claim under the Federal Government Scheme known as the Fair Entitlement Guarantee Scheme (FEGS), which provides for various employee entitlements upon the insolvency of a business, however, it should be noted that FEGS does not cover outstanding superannuation.

As a director of a company in liquidation, you no longer have the ability to act on behalf of the company in any capacity, however, you do have the legal obligation to assist the liquidator when requested to do so. Some of the obligations of a director include:

• Providing the company's books and records
• Advising the location of the company's books and records if they are not in their possession
• Advising the Liquidator of the location of the company's assets and assisting with their realisation if requested to do so, and
• Providing the Liquidator with a Report on Company Affairs and Property

Not necessarily. Many company directors fear that if their company goes into liquidation, they will also be made bankrupt. Unless guaranteed, the personal financial affairs of the director are separate from those of their company.