| an introduction | guiding you through |

CorporateInsolvency

Avior Consulting is a boutique financial advisory firm helping companies achieve their financial goals in difficult circumstances.

Our services include restructuring and insolvency, and corporate turnaround.

This book is written for directors and the accountants, lawyers and other trusted advisors offering guidance. It explains in plain English:

• the types of solutions available when a company is in financial distress;

• how a director may protect himself whilst pursuing a restructuring plan;

• the types of formal insolvency regimes that may arise for a company;

• the ways a director may be personally exposed whilst her company is in difficulty; and

• common types of recovery actions a liquidator can take.

If your business or your client’s business has financial problems, take action and contact us. Get clarity and move forward.

PURPOSE OF THIS BOOK

It can be a very stressful time if your (or your client’s) business is experiencing financial difficulty. Aggressive creditors, operational issues, worried employees – together they make it hard for you to rise up and see over top of the daily fires demanding attention. And whilst you’re working to right the ship, it takes on more water. We get it.

The most important thing you can do during this time is to find a way to move forward, whatever form “moving forward” takes. As part of that process you should seek professional advice that gives you clarity on the business’ position and an understanding of the options available. Avior Consulting provides that kind of input – confidentially and without cost. It is possible that the business can be saved if you act quickly.

Acting quickly is also wise in terms of protecting your personal assets. The time frame when a company is having trouble paying its debts (and possibly approaching insolvency) is an important one and may be scrutinized in the future when major stakeholders assess the directors’ actions.

RESTRUCTURING AND INSOLVENCY

If restructuring becomes the best option, Avior Consulting has substantial experience helping directors navigate this process. Our managing director is a registered liquidator and a restructuring specialist who has assisted many companies to restructure their balance sheets and operations. This insolvency experience is balanced with broad commercial acumen and financial modeling expertise to enable us to successfully restructure companies in a wide variety of situations. We have excellent relationships with all of the major Australian banks which increases the potential for a successful restructuring outcome.

Our experience in conducting formal insolvency appointments is deep and broad. Whether it’s a Voluntary Administration to facilitate a restructure of the business or winding up the business’ operations through a Liquidation, our strong technical expertise and commercial experience mean that these appointments will be conducted efficiently with due consideration for all stakeholders.

Avior makes full use of technological tools in relation to managing books and records, disseminating reports and using financial data generally. Work delays are minimised through our ability to work remotely. This, combined with our commitment to be on the ground where needed, means that we can properly manage an appointment regardless of its location.

CORPORATE TURNAROUND We are experts at turning around the performance of businesses that are in difficulty.

When a business is in any form of difficulty, the level of distraction rises significantly and the ability of key management to focus on the business’ underlying performance is reduced. Senior management’s activity shifts to resolving the dozens of crises arising each day as business performance continues to slide.

Our scientific approach to helping management refocus includes:

1. Understanding immediate cash flow needs and stabilising critical balance sheet weaknesses;

2. Addressing any major stakeholder concerns including banks, suppliers, customers, shareholders and staff;

3. Implementing a meaningful reporting system to monitor progress;

4. Reviewing costs for sustainable savings that are

achievable both immediately or over a period of time;

5. Helping management design a plan for driving revenue growth;

6. Creating a culture of execution in the business to drive the turnaround plan;

7. Working with management to repair any balance sheet issues including debt restructuring.

We have strong relationships with all major Australian banks and knowledge of their requirements when considering whether to support a turnaround strategy.

No matter how desperate the situation appears, we can design plans to rescue the business and turn its performance around.

DisclaimersThe enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty expressed or implied is given in respect of the information provided and accordingly no responsibility is taken by Avior Consulting Pty Ltd or any member of the firm for any loss resulting from any error or omission contained within this booklet. Users should seek their own legal advice.

safe harbour 1

common types of external administration 11 Voluntary Administration 14Creditors Voluntary Liquidation 23Members Voluntary Liquidation 32Court appointed liquidation 36Receivership 37 Summary Comparison 42 liquidator recoveries 45 Insolvent trading claims against directors 46Voidable transactions 50Unfair preferences 51 Unreasonable director related transactions 56

director personal exposure 59Director liabilities for company debts 60Director penalty notice (DPN) 62

phoenix activity 67

contents

Safe Harbour

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Introduced in 2017, safe harbour is a way for directors to protect themselves from a possible future insolvent trading lawsuit whilst they design and implement a turnaround strategy.

The regime aims to provide company directors with an opportunity to seek proper advice to develop and implement an action plan to achieve a better outcome for the company and its stakeholders compared to simply closing the doors and appointing an administrator or liquidator.

Safe harbour provides a defence for company directors against an insolvent trading action by a liquidator, for the period of time when the business first enters safe harbour until the earlier of a) the entity being placed into external administration, b) the turnaround plan no longer being viable or c) the turnaround plan is no longer needed (described further below at ‘How long does safe harbour last’).

The benefit of safe harbour is that directors can remain in control of the company and take proactive steps to restructure the business in a way that is likely to deliver a better outcome than immediately appointing an administrator or liquidator, without focusing on their personal liability for debts incurred while the restructure takes place.

However, safe harbour is not necessarily available to all companies and its directors. A range of criteria must be met to take advantage of the safe harbour regime’s protection. Once in place, strict rules must be followed to maintain that protection, as described in this guide at ‘Entering safe harbour’ and ‘Staying in safe harbour’.

WHAT IS SAFE HARBOUR?

The safe harbour regime provides protection to directors from a potential insolvent trading claim, brought later by a liquidator, while undertaking a company restructure outside a formal insolvency process.

The safe harbour laws aim to:

• promote early recognition of the threat of potential insolvency;

• reduce the risk of companies not meeting their obligations as they start to experience financial hardship; and

• ensure that during any course of restructure attempts employee entitlements are paid and taxation reporting obligations are met.

WHAT IS INSOLVENT TRADING? Insolvent trading occurs when directors allow their company to incur debts whilst the company is objectively insolvent – that is, the company is unable pay its debts as and when they fall due. In Australia, this is against the law.

A liquidator can claim, as compensation against a director personally, the total unpaid debts incurred from the time the company became insolvent to the start of the company’s liquidation.

If it is proven that the director acted recklessly or dishonestly when the insolvent trading occurred, criminal charges may be brought with the result being a fine and/or prison.

WHY WOULD YOU USE SAFE HARBOUR?

The safe harbour regime provides protection to directors from a potential insolvent trading claim, brought later by a liquidator, while undertaking a company restructure outside a formal insolvency process.

The safe harbour laws aim to:

• promote early recognition of the threat of potential insolvency;

• reduce the risk of companies not meeting their obligations as they start to experience financial hardship; and

• ensure that during any course of restructure attempts employee entitlements are paid and taxation reporting obligations are met.

WHAT IS INSOLVENT TRADING? Insolvent trading occurs when directors allow their company to incur debts whilst the company is objectively insolvent – that is, the company is unable pay its debts as and when they fall due. In Australia, this is against the law.

A liquidator can claim, as compensation against a director personally, the total unpaid debts incurred from the time the company became insolvent to the start of the company’s liquidation.

If it is proven that the director acted recklessly or dishonestly when the insolvent trading occurred, criminal charges may be brought with the result being a fine and/or prison.

WHY WOULD YOU USE SAFE HARBOUR?

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HOW TO ACCESS SAFE HARBOUR

In order to enter safe harbour, the directors suspecting that their company may be or may become insolvent must develop a plan of action that is reasonably likely to lead to a better outcome than an immediate appointment of an administrator or liquidator, and start following that plan.

ENTERING SAFE HARBOUR

Section 588GA of the Act states that in order to implement safe harbour protection against insolvent trading claim, director(s) need to develop and take one or more courses of action that will lead to a better outcome for the company, compared to appointing an external administrator.

To determine what would be a better outcome the director(s) should:

• inform themselves properly of the company’s financial position;

• ensure the company is keeping appropriate financial records (consistent with size and nature of company); and

• obtain advice from an ‘Appropriately Qualified Entity’ who has been given sufficient information to give that advice.

The above list is not exhaustive and each company’s circumstances should be taken into account. WHO IS AN ‘APPROPRIATE QUALIFIED ENTITY’? Appropriately qualified means “fit for purpose” and does not only relate to the advisor’s qualifications. In choosing an advisor, directors will be expected to have considered issues such as:

• the company’s nature, size, complexity, and financial position;

• the advisor’s independence, professional qualifications, and reputation; and

• the advisor’s professional experience.

For example, a small business with a simple structure may need only to seek the advice of a qualified insolvency accountant, lawyer, or other technical advisor with insolvency experience or exposure to insolvency. On the other hand, a larger or more complex business, e.g. a civil construction business or business with multiple locations, may require the advice of a qualified insolvency or turnaround practitioner and / or a specialist lawyer.

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If the plan is unsuccessful and the company goes into voluntary administration or liquidation, directors will be expected to prove sufficient evidence was given to the appropriately qualified advisor they appointed.

Directors should be wary of advisors who suggest actions that could be illegal. An obvious indicator is advice recommending the transfer of business’ assets to another person or company for a price that is below market value. That advice encourages what is called ‘phoenixing’ and phoenixing activity is against the law. Following that advice may compromise your safe harbour protection and expose you to prosecution for phoenixing. STAYING IN SAFE HARBOUR

During the period of safe harbour directors must meet the following obligations:

• pay all employee entitlements on time (including superannuation); and

• lodge all required returns with the ATO on time.

Safe harbour is unavailable when substantial compliance with the above two points has not occurred.

Safe harbour protects directors from being sued by a liquidator for insolvent trading. That is all.

Directors must still comply with their director duties and all other legal obligations. Importantly, if directors do not comply with certain legal obligations, then safe harbour will be determined as if it never existed. When the turnaround is complete, directors are expected to be vigilant for circumstances that may require the company to reenter safe harbour.

HOW LONG DOES SAFE HARBOUR LAST? Safe harbour commences when directors, after first suspecting that the company may become insolvent, start developing one or more courses of action, and one of those courses of action is reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator.

Safe harbour ceases to apply when:

• directors do not take the course of action by the end of a reasonable period;

• directors stop taking the course of action;

• the course of action ceases to lead to a better outcome for the company;

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• a liquidator or administrator is appointed to the company; or

• the company’s turnaround is successful and safe harbour is no longer required.

Importantly, safe harbour is considered to have never existed if any of the following occurs:

• the directors fail to deliver the books and records to an administrator or liquidator; or

• the directors conceal books and records from an administrator or liquidator; or

• the directors fail to provide information to an administrator or liquidator in relation to the company in the prescribed form as required under the Act; or

• the company fails to remunerate employees as required during the safe harbour period, including full payment of superannuation; or

• returns to the Australian Taxation Office are lodged late during the safe harbour period.

CONFIDENTIALITY OF SAFE HARBOUR?

Safe harbour can be undertaken confidentially. There is no registry or database for safe harbour plans to be recorded or searched,

nor are there any declaration requirements. Only those the directors trust with this information will know.

WHAT DEBTS DOES SAFE HARBOUR PROTECT? Safe harbour protects directors from company debts incurred directly or indirectly in relation to developing and implementing the restructure plan. This includes trade debts incurred in the normal course of business. WHAT DEBTS DOESN’T SAFE HARBOUR PROTECT? Safe harbour protection does not apply to all debts.

The debts need to be incurred “directly or indirectly in connection with” developing and taking the course of action. This will include debts incurred in the ordinary course of business, however, if there is a new debt that is not in the ordinary course, and inconsistent with the course of action, that debt may not be covered by safe harbour. For example: the company incurs a debt for a director’s or related party’s personal expense.

Safe harbour also does not protect directors from actions brought for any other breach of the law, including a breach of their director’s duties.

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CAN I COME OUT OF SAFE HARBOUR?

Yes. The intent is that the entity succeeds with the turnaround plan, is out of financial difficulty and no longer needs to be in safe harbour.

To come out of safe harbour, ideally the turnaround plan must be actionable and measurable by setting dates for certain actions to be implemented or achieved by. The plan’s terms should outline a review date that allows for the strategy to reformulate or amend, or to conclude that the company’s solvency is no longer an issue.

To assist with documenting this process, regular meetings should be held and minutes recorded to reflect the action plan’s progress against its goals. Regular progress reports and updated financial forecasts should also be documented. If appropriate, key stakeholders such as company’s financiers should be kept up to date on progress.

The formal definition of insolvency is being unable to pay debts as and when they become due and payable. The presumption is that the company is solvent when safe harbour ends. That being said, an assessment should be made regularly to confirm the company is solvent and viable in the long-term. We also recommend continued monitoring

of the changes implemented, and imbedding the improved strategies into the ongoing management of the company.

WHAT HAPPENS IF IT DOESN’T WORK?

Failure of the plan does not mean the directors lose the protection they had during the safe harbour period. Also, the plan does not have to be certain to succeed. The test is that it is ‘reasonably likely’.

If the test is met then qualifying debts incurred during the safe harbour period are immune from an insolvent trading claim. As soon as it’s apparent that the plan will not succeed, or the plan no longer provides a better outcome than a formal insolvency appointment, directors should consider voluntary administration or liquidation immediately to limit their exposure to insolvent trading.

If a formal insolvency appointment is necessary, directors must comply with certain obligations including completing a statutory report and providing company books and records to the administrator or liquidator to continue relying on safe harbour protection.

Any information or documents not provided to the administrator or liquidator cannot be used later to prove safe harbour protection.

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FACTS ABOUT ABC PTY LTD (ABC):

• Secured creditor, a Bank, wishes to end its relationship with ABC.

• ABC has insufficient funds to repay the Bank and will need to seek alternative finance.

• ABC is also suffering pressure from other creditors for payment and has fallen behind in meeting other liabilities.

ABC is keen to look at refinancing options with another financial institution to pay out the Bank and provide a needed cash flow injection.

Before the directors embark on this journey, they are concerned that ABC is currently insolvent and they could become personally liable for debts they incur should their refinancing efforts fail.

The directors consider safe harbour to be a tool they can use to informally restructure their business, through a refinance, whilst providing the directors with a defence against insolvent trading should their refinancing plan fail to succeed. The directors could utilise safe harbour by formalising ABC’s plan which details:

• current issues.

• amount of funding they require from refinancing.

• options for refinancing including mortgage brokers to be approached.

• time frame of milestones to achieve.

• strategies on professional assistance required to assist during this refinance period.

CASE STUDY

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• seeking professional advice to ensure their plan results in a better return for creditors in comparison to external administration.

• regular reviews of the plan to ensure it is still viable, milestones are still being met and adjustments can be made.

• ongoing professional advice should any adjustments to the plan be needed and to ensure the plan is still achievable.

A registered liquidator reviewed ABC’s plan and determined that their plan was likely to produce a better result to creditors in comparison to external administration. It follows that ABC were in safe harbour whilst executing their plan.

Unfortunately, ABC were unable to procure refinancing due to the large ATO and superannuation debts.1 As a result, the shareholders, who were also the directors, resolved to place ABC into liquidation.

During the safe harbour period, ABC incurred $120,000 in debt that it was subsequently unable to pay. The directors have a defence against an insolvent trading claim,

brought by the liquidator, for the $120,000 portion of the claim as those debts were incurred at a time when ABC was in safe harbour.

1 Financial institutions generally shy away from providing finance when part, or all, of the funds are to pay statutory debts.

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Common types of externaladministration

Voluntary Administration 14

Creditors Voluntary Liquidation 23

Members Voluntary Liquidation 32

Court Appointed Liquidation 36

Receivership 37

Summary Comparison 42

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There are two types of external administration that can be implemented directly by director(s) or shareholder(s): Voluntary Administration or Liquidation. VOLUNTARY ADMINISTRATION OR LIQUIDATION?

When a company is insolvent, directors weigh up the different pathways of voluntary administration and liquidation.

Sometimes the decision is purely based on how a liquidator or voluntary administrator is appointed:

• a voluntary administrator is appointed by either the director(s), the secured creditor (on a finance agreement default), or by a liquidator; and

• a liquidator is appointed by the members (or shareholders).

Voluntary Administration

Voluntary administration may be appropriate if there is interest in:

• salvaging the company’s business (wholly or partially), although this can also be achieved within a liquidation;

• retaining the support of a secured creditor who may seek to appoint a receiver should the company be placed straight into liquidation;

• dealing with a winding up proceeding that is already on foot. A liquidator cannot be appointed when a winding up application has been made;

• retaining the company at the end of the process i.e. for tax losses; and or

COMMON TYPES OF EXTERNAL ADMINISTRATION

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• specifically, the Directors and/or members do not want to pursue a liquidation.

If one, or all, of the above criteria are met, then a further external administration process called Deed of Company Arrangement (DOCA) may be warranted. A DOCA is a formal restructure process, injection of capital or alternative way of dealing with the company’s assets that provides creditors with a return that is higher than the return expected from liquidation. If no DOCA is proposed or viable, then liquidation may be the best path for the company. DOCA’s are explained in the Voluntary Administration section of this guide.

Voluntary administration may also be the best course of action if it is not possible to obtain sufficient shareholder support to place the company in liquidation. However, as voluntary administration has higher reporting requirements, the process is more costly compared to liquidation.

At the end of a voluntary administration and DOCA process, the company’s balance sheet is ‘clean’ - i.e. it has no debts. Liquidation

Liquidation is the process of winding up a company’s financial affairs by getting in and realising its assets, conducting appropriate

investigations and enabling a fair distribution of the company’s assets to its creditors.

The company is deregistered from ASIC’s register and dissolved at the end of a liquidation process. It is important to note:

• ASIC holds the right to ban an individual from holding a director position for a period up to 5 years if he was a director of 2 or more entities placed into liquidation. The ‘strike’ or recording the liquidation on the director’s record does not happen if the entity is placed into voluntary administration and a DOCA is completed.

Whilst ASIC holds this right, it is important to understand that banning is not automatic. Usually ASIC undertakes a review process and requests input from the liquidator as to her opinion on the appropriateness of a director ban.

• liquidation is the only way to fully wind up the affairs of a company and end the existence of the company (deregistration from ASIC’s register).

• there are certain actions against a director that are only available to a liquidator - i.e. insolvent trading claims against a director and unfair preference claims against creditors.

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WHAT IS VOLUNTARY ADMINISTRATION? The voluntary administration process is designed to maximise the chances of a company or its business continuing to exist. It helps insolvent companies deal with their debts, by ensuring that they either:

1. come to a formal arrangement with their creditors through a DOCA; or

2. be placed into liquidation, quickly and inexpensively.

HOW IS A VOLUNTARY ADMINISTRATOR APPOINTED?

A voluntary administrator can be appointed in three ways:

• the directors of a company resolve by simple majority that the company is, or is about to become, insolvent;

• a liquidator determines that a proposed DOCA will provide a better return to creditors than the continued liquidation; or

• a secured creditor after the terms of their finance agreement have been breached.

DOES THE COMPANY HAVE TO BE PROVEN TO BE INSOLVENT?

No, directors can appoint a voluntary administrator if they believe the company is insolvent snow or is likely to be insolvent in the future - i.e. there is an approaching debt and the company does not have enough resources to service that debt.

WHAT DOES THE ADMINISTRATOR DO?

The administrator assumes control of a company’s business, property and financial affairs.

VOLUNTARY ADMINISTRATION

The administrator assumes sole responsibility to perform all functions and exercise any and all director powers that could be exercised if the company was not under dministration, including continuing to trade or dispose of all or any part of a business or property.

The directors and other officers lose all powers to act on behalf of the company unless expressly allowed by the administrator.

WHAT HAPPENS IN VOLUNTARY ADMINISTRATION?

The voluntary administrator will:

• take control of the company’s assets;

• investigate the company’s affairs;

• report any offences to ASIC;

• provide limited assistance to interested parties to formulate a DOCA proposal;

• review liquidation recoveries such as insolvent trading claims or preference claims to compare the financial recovery of these actions, and subsequent distribution to creditors, against any DOCA proposal;

• report to creditors on the

course of action that offers the best outcome for creditors; and

• call the required meetings of creditors to decide the future of the company.

It is common for the administrator to trade on the company especially if a sale of business is contemplated. The merit of doing so is assessed at the time of the appointment and is considered carefully as debts incurred by the company during the voluntary administration become personal debts of the administrator if the company is unable to pay them.

The administrator meets with the company’s creditors on at least two occasions:

1. The first meeting is held within 8 business days of the appointment. At this meeting creditors can resolve to replace the administrator and form a creditors’ committee of inspection to assist the administrator in the voluntary administration process; and

2. The second meeting is usually held 25 business days after the appointment. At the second meeting, creditors will choose the option they believe will best serve their interests. The available options are:

a. accept a proposal for a DOCA (if one is proposed);

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b. end the voluntary administration and pass control of the company back to the directors; or

c. liquidate the company.

WHAT IS A DEED OF COMPANY ARRANGEMENT?

A Deed of Company Arrangement (DOCA) is an external administration process that follows voluntary administration. A DOCA can involve a restructure proposal to keep the business going, an injection of funds to be paid to creditors, a combination of the two, or any other proposal to creditors. The key is that it offers creditors a better return than what they could expect if the company was placed in liquidation.

Accepting a DOCA proposal is one of the options that creditors can choose in relation to the company’s future at the second creditors meeting. If the DOCA is chosen that means that the company does not go into liquidation at that time. This means that recovery actions available to a liquidator, such as insolvent trading and voidable transactions (unfair preferences and uncommercial transactions), are not pursued.

A DOCA can be proposed by the directors or a third party. The voluntary administrator can provide general guidance with the

DOCA’s terms, but she cannot advise on it. For that reason, it’s not unusual for the DOCA proposer (called ‘proponent’) to engage his own advisor. Avior frequently takes on this role.

HOW COMPLETE MUST A DRAFT DOCA BE?

A draft DOCA is usually submitted to the administrator in a summary format. Terms of the DOCA, its objectives, method of implementation, and the effect on creditors are described in the report to creditors circulated by the administrator before the 2nd creditors meeting.

Creditors can propose changes to the DOCA proposal at the 2nd creditors meeting. Where creditors vote in favour of such changes, those amendments must be incorporated into the DOCA. However, any such changes may make the DOCA unfeasible and it may not be able to be executed.

WHAT HAPPENS IF CREDITORS VOTE FOR A DOCA?

If creditors vote in favour of the DOCA, the proposal is converted to a legal agreement that must be signed within 15 business days after the 2nd creditors meeting. If that does not happen the company is placed automatically in liquidation.

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If the DOCA is accepted, the voluntary administrator’s role changes to ‘deed administrator’ and he is responsible for administering the terms of the DOCA and paying the planned distribution(s) to creditors.

Certain rules must be followed in the DOCA agreement. For example, it cannot change the ranking of employee entitlement claims as compared to liquidation.

WHEN DOES A DOCA END?

A DOCA ends when its terms have been carried out and the planned distributions to creditors have occurred. At that time the liabilities that existed on the company’s balance sheet when the voluntary administration began are wiped clean and no claims relating to the period before the voluntary administration date can be brought in the future.

A DOCA can also terminate if key parts of the agreement are not complied with. In that case, the deed administrator must inform creditors of the breach. He may also convene a creditors meeting in order to place the company in liquidation.

DOCA COMPARED TO SAFE HARBOUR

Both approaches are ways of designing and implementing a restructure proposal. The

key difference is that a DOCA is a ‘public’ restructuring tool. Documents with the company’s name must include the words ‘(Subject to Deed of Company Arrangement)’. Also, a search of the company on ASIC’s databases will indicate that the company is subject to external administration. A further key difference is that the company is controlled by the deed administrator during the DOCA period.

Safe harbour, on the other hand, can be a confidential process. There is not legal requirement to inform outside parties of the restructure plan. directors also maintain control.

SECURED CREDITORSDURING VOLUNTARYADMINISTRATION Secured creditors (typically banks) have 13 business days from the appointment date to enforce their security - i.e. appoint a receiver, or receiver and manager to take control of the company’s assets that comprise the security. If they do not do so within that time, their powers are effectively frozen for the duration of the voluntary administration period.

This decision period gives the secured creditor time to decide whether to enforce their security, and the administrator some certainty regarding their powers during the administration.

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UNSECURED CREDITORS DURING VOLUNTARY ADMINISTRATION A freeze or moratorium is imposed on unsecured creditor actions meaning they cannot enforce their claims or apply to wind up the company. A provisional liquidator cannot be appointed to a company without the leave of the court, and all proceedings or enforcement actions against a company’s property are placed on hold.

WHAT HAPPENS TO EXISTING WINDING UP PROCEEDINGS?

The administrator is required to notify the Court and the petitioning creditor of the appointment to ensure the proceedings are halted during the voluntary administration process. The Court still holds the power to appoint a liquidator, however, in practice the Court usually allows the voluntary administration process to continue.

The administrator notifies the Court on the proposals being bought to creditors for the future of the company, whether that be a DOCA, liquidation, or return of the company to director(s). WHAT HAPPENS TO GOODS CAPTURED UNDER THE PERSONAL PROPERTY SECURITIES ACT 2009? The laws governing voluntary administration are designed to

preserve the company to maximize the chances of the business being saved. In general terms this means that creditors cannot ‘reach in’ and interfere with the company’s assets and activities. In particular, the Act prevents:

• an owner of property used by the company from recovering the property;

• a lessor (e.g. landlord) from charging distress rent, taking back possession, or otherwise recovering the property; and

• a secured party with physical possession of security from selling the property or otherwise enforcing the security interest.

The voluntary administrator may still sell or dispose of assets that are subject to a security interest:

• with the consent of the secured party;

• with the consent of the Court; or

• in the ordinary course of business.

Any disposal made by the voluntary administrator requires the net sale proceeds from the secured property to be distributed to those holding relevant security interests.

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VOLUNTARY ADMINISTRATION’S EFFECT ON LANDLORDS A landlord is bound by the same moratorium applying to all creditors, providing the landlord did not commence enforcement proceedings prior to the appointment.

The Act permits the administrator to occupy the company’s leased premises for up to seven calendar days without paying rent. After that he must pay rent for the rest of the voluntary administration period or vacate the property.

The administrator’s liability to the landlord ends at the conclusion of the voluntary administration or when the premises are vacated, whichever is earlier. The administrator will not be liable for rent if she does not occupy the property. However, the company may continue to incur liability for the rent as an unsecured claim. VOLUNTARY ADMINISTRATION’S EFFECT ON PERSONAL GUARANTEES

Creditors holding personal guarantees from directors cannot take action under the guarantee during the voluntary administration period. Personal guarantees can be enforced when the voluntary administration ends.

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CAN A VOLUNTARY ADMINISTRATOR DISTRIBUTE FUNDS TO CREDITORS?

No, a voluntary administrator is not permitted to pay a dividend to creditors.

A distribution or dividend to creditors can only be done by a liquidator when the company is being wound up or a deed administrator when the company is under a DOCA.

DO CREDITORS NEED TO DECIDE ON A COURSE OF ACTION AT THE SECOND MEETING?

Not necessarily. The second meeting may be adjourned for up to 45 business days for further investigations to be carried out, or for a proposed DOCA to be amended.

The Court has the power to further extend this period if there is a genuine reason for an extension - i.e. if a sale of business is progressing.

WHAT DOES VOLUNTARY ADMINISTRATION COST?

The administrator’s professional fees and disbursements are paid first out of the company’s assets. If those assets prove to be inadequate, the administrator may request funding from a DOCA

proponent or from other sources to allow the process to continue.

However, the administrator is unable to force a party, including directors, to fund the process.

Each administration is different and will therefore have a different cost depending on the work required. The work conducted can be broken into two categories: statutory and non-statutory.

Statutory work is required on every file regardless of size or complexity, and includes:

• notifying ASIC;

• issuing notices to creditors;

• issuing notices to utilities and statutory authorities, such as the Australian Taxation Office;

• conducting the first meeting of creditors;

• dealing with creditors’ enquiries;

• performing preliminary investigations into preferential payments, insolvent trading and other voidable transactions;

• preparing and issuing a detailed report to creditors;

• conducting the second meeting of creditors; and

• notifying creditors and ASIC of the outcome of the second meeting of creditors.

Non-statutory but still necessary work may include:

• trading on the business;

• dealing with secured creditors;

• dealing with finance companies;

• selling some or all of a company’s assets or the company’s business;

• more detailed investigations into potential recoveries and asset ownership; and

• considering the viability of any DOCA proposal.

WHEN DOES A VOLUNTARY ADMINISTRATION END?

The voluntary administration ends when:

• the DOCA agreement is signed. The parties to the DOCA agreement, usually the company and the proponent of the DOCA, have 15 business days to sign the DOCA, otherwise the company is placed into liquidation;

• the creditors resolve to wind up a company;

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• the creditors resolve that the voluntary administration should end (and control revert to the directors);

• the court orders that the administration is to end;

• the period for calling the second meeting ends without the meeting being called; or

• the court appoints a liquidator to the company.

CASE STUDY 1

Facts about DEF Pty Ltd (DEF):

• DEF’s directors are A, B, C, and D.

• Shareholders are A, B, E, and F and they each hold an equal amount of shares.

• The directors are in agreement that DEF is insolvent and they want to pursue liquidation as they know they may be personally liable for debts DEF is incurring.

• E and F do not want liquidation to occur as they see their investment being lost, however, they are unwilling to inject further funds into DEF to bring the company back to solvency.

• The directors are unable to source further funding for DEF

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to bring the company back to solvency.

A liquidator is appointed by special resolution of the members / shareholders, which requires 75% voting in favour of the resolution.

This option is not available to DEF as 50% of the shareholders do not agree to place the company into liquidation.

As the directors were concerned that DEF was already insolvent and therefore they could be held liable for debts being incurred, they resolved at a directors meeting to place DEF into voluntary administration instead. Only a simple majority is needed to pass such a resolution.

Appointing an administrator achieves the same thing for DEF’s directors as a liquidator in terms of preventing DEF from trading whilst insolvent.

DEF can be placed into liquidation later at the second creditors meeting by a majority resolution of its creditors (shareholders are not entitled to vote unless they are also a creditor).

CASE STUDY 2

Facts about DEF:

• DEF has 25 contracts on foot for the provision of various services.

• It entered into a 5 year lease 12 months prior and its workforce has since contracted from natural attrition and there is no requirement to refill those positions. As such, DEF is occupying about half the rented space.

• 2 of the contracts are currently making losses due to inaccurate estimates and are expected to continue to make significant losses, so much so that DEF are unable to cope with such losses. The liquidated damages clauses in those contracts make it financially unviable to default.

• DEF has made attempts to sub-lease its property to recoup leasing costs, but without success.

• The directors believe the business is viable if they can exit from the 2 unprofitable contracts and exit the leased premises, however, they have no plan that could make that happen and are concerned about impending insolvency.

As DEF is considered viable, in part, it may be appropriate for the directors to appoint a voluntary administrator to formally restructure the business whereby the following objectives are to be met:

• cancel unprofitable contracts; and

• renegotiate lease terms to better suit the business’ requirements or relocate to more suitable premises.

The above can be achieved using a DOCA. Upon completion of the DOCA’s terms, DEF is returned to its directors with a ‘clean’ balance sheet.

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WHO APPOINTS THE LIQUIDATOR?

In a creditors voluntary liquidation (as opposed to a Court appointed liquidation), it is the members or shareholders that appoint the liquidator.

The two-step appointment process occurs as follows: first, the directors, having formed the opinion that the company is insolvent i.e. unable to pay debts as they become due and payable per section 95A of the Act, convene a meeting of members. Second, at that meeting, members pass a special resolution (more than 75% of members) to wind the company up. Creditors are not required to attend those meetings.

Creditors have certain rights to change the appointed liquidator at any time. However, this is not a common occurrence. HOW TO CHOOSE A LIQUIDATOR

Before appointing a liquidator, the member(s) need to obtain a ‘consent to act’ from a registered liquidator. A registered liquidator is a financial professional registered with ASIC. The registered liquidator must also be independent of the company. This means that she must not have provided services to the company or its directors within the previous two years.

CREDITORS VOLUNTARY LIQUIDATION

WHO APPOINTS THE LIQUIDATOR?

In a creditors voluntary liquidation (as opposed to a Court appointed liquidation), it is the members or shareholders that appoint the liquidator.

The two-step appointment process occurs as follows: first, the directors, having formed the opinion that the company is insolvent i.e. unable to pay debts as they become due and payable per section 95A of the Act, convene a meeting of members. Second, at that meeting, members pass a special resolution (more than 75% of members) to wind the company up. Creditors are not required to attend those meetings.

Creditors have certain rights to change the appointed liquidator at any time. However, this is not a common occurrence. HOW TO CHOOSE A LIQUIDATOR

Before appointing a liquidator, the member(s) need to obtain a ‘consent to act’ from a registered liquidator. A registered liquidator is a financial professional registered with ASIC. The registered liquidator must also be independent of the company. This means that she must not have provided services to the company or its directors within the previous two years.

CREDITORS VOLUNTARY LIQUIDATION

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PROVING THE COMPANY IS INSOLVENT IS NOT REQUIRED

Similar to directors appointing an administrator, members can appoint a liquidator on the basis that the company is insolvent or they believe the company is insolvent now or is likely to be insolvent in the future - i.e. there is an approaching debt and the company has no resources to service that debt.

There is no requirement to obtain solvency advice prior to an appointment. However, member(s) may choose to obtain solvency advice if they feel the decision to appoint a liquidator could be challenged

A company is insolvent if it cannot pay all of its debts as and when they fall due, even if the company has an asset surplus but no way to liquidate those assets quickly.

A company can also be deemed to be insolvent when it fails to do certain things prescribed by law, for example, when it fails to satisfy a creditor’s statutory demand or fails to keep adequate books and records. CAN SOLVENT COMPANIES BE WOUND UP?

Yes. Solvent companies can be wound up by its members via a members’ voluntary liquidation.

Solvent companies can also be wound up by the court by way of an application to the court by its directors or members. Court appointments are typically sought when there is a dispute over the control or conduct of the company.

WHO MANAGES A LIQUIDATION?

Liquidations can only be administered by specialist accountants or lawyers who are registered liquidators with ASIC.

At appointment of a liquidator, directors’ powers cease. A LIQUIDATOR’S POWERS

The Act sets out the liquidator’s powers. These powers include all the powers vested in the directors of the company, plus the powers to:

• investigate and examine the affairs of a company;

• identify transactions that are potentially voidable;

• examine the directors and others under oath (via public examination);

• realise the assets of the company;

• conduct and sell any business of the company; and

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• admit debts and pay dividends to creditors.

A LIQUIDATOR’S DUTIES A liquidator’s duties include:

• identifying, protecting and realizing the assets of a company;

• communicating with secured creditors in relation to assets subject to security;

• conducting investigations into the financial affairs of the company and any suspicious transactions;

• making recoveries where commercially appropriate;

• issuing reports to ASIC and creditors;

• making distributions to creditors, where possible; and

• applying to ASIC to deregister a company.

It is important to note that the liquidator is not required to incur expenses in relation to the winding up of the company unless there are enough assets within the company to meet such costs. Accordingly, certain actions or investigations may be hindered should assets not be available to meet the liquidation costs.

WHAT HAPPENS TO A COMPANY IN LIQUIDATION?

Typically, the following occurs:

• control of assets, the business and other financial affairs are transferred to the liquidator;

• the directors cease to have authority to act on behalf of the company;

• all bank accounts are frozen and balances are transferred into a liquidation bank account controlled by the liquidator;

• employees may be terminated depending on the circumstances of the appointment; and

• at the end of the liquidation, the liquidator applies to ASIC for the company to be deregistered. Having been removed from ASIC’s register, the company will cease to exist.

CAN THE COMPANYCONTINUE TRADING?

If the company is trading at the time a liquidator is appointed, the liquidator will have the decision of whether the company should continue trading. Doing so is referred to as the business being ‘traded on’.

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A trade-on is considered if there is a strong prospect of selling the business as a going concern, or completing and selling any work-in-progress or contracts. Both outcomes are intended to result in an increase in company assets available for creditors.

A liquidator is obligated to end trading and wind up company affairs as quickly as reasonable but also in a commercially responsible and practical way.

Again, the liquidator is not obliged to incur debts unless there are enough assets to cover such costs. It follows that a liquidator may decide not to trade on a business where there is uncertainty as to whether sufficient assets would be recovered to cover the costs of the trade-on and provide a higher return to the company’s creditors.

One structure a liquidator may use to control risk and costs of a trade-on is a licensing agreement. A typical scenario is when a third party wishes to purchase the Company’s business, but settlement cannot occur for a period of time – e.g. the third party many need to negotiate a new lease or have the lease transferred. The third party is familiar with the type of business and can trade it at lower risk and for less costs than if the liquidator were to attempt to do so directly. In these circumstances, the third

party and liquidator may choose to enter into an agreement whereby the interested party trades on the business under supervision of the liquidator. There are no specific requirements of what a license agreement must incorporate. Generally, they involve:

• employees remaining employed by the company until a sale of business agreement is entered into, at which point some or all of the employees may be transferred to the new entity;

• the liquidator requiring pre-payment of wages, rent, and overhead costs prior to those expenses being incurred. The liquidator does this to prevent the company’s assets from being depleted as a result of the trade-on. This usually involves an up-front payment of estimated costs with a balancing adjustment at the end of the trade on period;

• the interested party being solely responsible for the day to day trading, profitability, and expenses incurred during the trade on of the business; and

• the liquidator retaining certain assets, such as the debtor book or parts of work in progress until they are realised or sold as part of a sale of business process.

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DIRECTORS’ DUTIES TO THE LIQUIDATOR

The directors must:

• give all information in their possession about the company’s financial affairs;

• provide a Report on Company Activities and Property referred to as a RoCAP. A RoCAP details the assets and liabilities of the company as at the date of appointment of the liquidator;

• assist the liquidator when reasonably asked; and

• deliver all company books and records and cooperate with the liquidator throughout the liquidation process.

The Act contains various offence provisions that apply to directors who do not cooperate with liquidators. INVESTIGATIONS PERFORMED BY THE LIQUIDATOR

The liquidator must investigate:

• why the company is insolvent;

• when the company became insolvent;

• if a potential insolvent trading claim exists against the directors;

• whether any offences have been committed by the company’s officers;

• if any voidable transactions, including unfair preferences, can be reversed; and

• if any other recoveries may be available.

Much of the above information is reported to ASIC. A liquidator’s powers include holding public examinations, seizing books and records and gaining access to property.

The liquidator may apply to ASIC for external funding to pursue certain avenues of investigation should there be insufficient funds within the company to undertake those investigations.

RECOVERING PROPERTY SOLD BEFORE THE LIQUIDATION The liquidator can recover money from creditors who received payments that gave them ‘preferential’ treatment in the six months before the liquidation.

In addition, the liquidator will review any sales or transfers of property in the years before

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liquidation. If property transactions appear improper, uncommercial, or were undertaken to defraud creditors, the property or its value may be recoverable. HOW DOES AN INSOLVENT TRADING CLAIM ARISE?

Directors have a duty to ensure their company does not continue incurring debts when it is insolvent.

If the directors breach that duty, the liquidator can bring an action against them, personally, for recovery of the amount of the debts incurred during the period that the company was insolvent.

ARE DIRECTORS’ PERSONAL ASSETS AT RISK?

A liquidator can only take possession of a company’s assets. Taking possession of the directors’ personal assets is not permitted.

However, if directors took company assets without paying market value for them, the liquidator can recover those assets. Similarly, if the company loaned money to the directors, the liquidator will seek to recover those funds.

Recovering assets, obtaining repayment of loans and pursuing insolvent trading claims can all lead to court proceedings. Those proceedings can result in a

director being made bankrupt, at which point his personal assets will be made available to the trustee, realised and used to satisfy the director’s debt, including those debts brought by the company’s liquidator. CAN CREDITORS ATTACK A DIRECTOR’S PERSONAL ASSETS?

Yes, but only if the director signed a personal guarantee on a contract or agreement the company entered into with a creditor.

It is common practice for directors to give personal guarantees for the company’s credit arrangements, for example:

• lease agreements;

• equipment finance or hire purchase finance - i.e. vehicles; and

• company loans.

When a director signs a personal guarantee, it becomes a personal arrangement between creditor and director, as guarantor, and it is not affected by liquidation. It follows that the liquidation cannot extinguish personal guarantees. Creditors can enforce the personal guarantee at any time during the winding up process. Note that this differs from voluntary administration where

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the moratorium also extends to personal guarantees.

It should also be noted that if more than one director provides a personal guarantee, the claim is ‘joint and several’. The creditor can pursue 100% of the claim from each director until the claim is paid. If one director pays the claim on behalf of the other directors, she will have what’s called a ‘right of contribution’ claim against the other directors. SECURED CREDITORS’ CLAIMS IN A LIQUIDATION

A secured creditor’s rights are not affected by liquidation. Commonly, the secured creditor allows the liquidator to sell the assets the subject of its security and then receive the net proceeds as payment toward the secured debt. If the proceeds from the secured assets are not enough to pay the secured creditor’s claim, the shortfall is treated as an unsecured claim. UNSECURED CREDITORS’ CLAIMS IN A LIQUIDATION?

Unsecured creditors are unable to recover funds from the company via Court proceedings during the liquidation and must wait until the liquidation is at a stage when, or if, funds are able to be distributed. Unfortunately, in most instances asset recoveries are not sufficient

to pay a return to unsecured creditors. IN WHAT ORDER DO CREDITORS GET PAID?

The liquidator must pay dividends in the order of priorities set out in section 556 of the Act.

Generally, these priorities rank as follows:

1. costs and expenses of the liquidation;

2. secured creditor and/or employee entitlements depending on the type of asset recovered – circulating or non-circulating;

3. unsecured creditors; then

4. shareholders.

CREDITORS POWERS DURING THE LIQUIDATION

Under the Insolvency Practice Schedule (Corporate) 2016, creditors have a range of rights, including:

• ‘reasonable’ requests for information from the liquidator;

• ‘reasonable’ requests for meetings;

• arranging for review or oversight of the liquidator; and

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• replacing the liquidator.

Importantly, if there are insufficient funds in the liquidation to comply with the ‘reasonable’ request for information and/or meetings’, this could deem the request as being ‘unreasonable’, unless the creditor is willing to pay the costs of such requests.

HOW LONG DOES THE LIQUIDATION LAST?

There is no set time limit for a liquidation. It is not unusual for a liquidation to span between 1 and 2 years, and possibly longer.

The liquidation lasts for as long as necessary to complete the required tasks. A liquidator will usually try to finalise the liquidation as soon as possible. HOW DOES THE LIQUIDATION END?

The liquidator may retire when she has satisfied her duties, recovered and distributed all available assets, and received confirmation that ASIC does not wish to investigate further.

At the time of retiring the liquidator usually applies to ASIC to have the company struck off the register of companies. The strike off usually occurs automatically 3 months after the application is made.

CASE STUDY

Facts about GHI Pty Ltd (GHI):

• GHI runs a profitable café in Perth.

• GHI has no long-term loans or debts. Its only liabilities are trade creditors and minor employee entitlements.

• GHI is up to date with ATO payments and superannuation payments.

• GHI’s sole director works in the café and is good at managing the café but not proficient in maintaining HR policies and procedures.

• GHI generally hires casual staff, however, has 2 full time managers who help to co-manage the business.

• When hiring staff, the director decides on a flat rate to be applied across all working days (including weekends) with the exception of public holidays.

• A former staff member has recently lodged a claim with Fair Work for approximately $15k of underpayments in wages as her hourly rate did not meet the minimum requirements for the relevant modern award.

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• GHI can meet the $15K payment

• The director, however, realises that underpayment of wages is likely to be a systemic issue, as he never checked the modern award minimum rates against the actual hourly rate for any of the employees.

• The director is concerned that GHI will likely become insolvent soon due to other underpayment of wages claims.

• The director decides to sell the business, and after 5 months on the market has received little interest.

• The director, and sole shareholder, chooses to place GHI into liquidation where the following are achieved:

i. an expedited sale of business;

ii. review and quantification of amount(s) owed to current and former employees;

iii. former, and current, employees can access outstanding payments of employee entitlements, within allowed limits, from the Commonwealth’s Fair Entitlements Guarantee scheme;

iv. employees have continuous employment until handover to purchaser;

v. creditors may be provided a greater financial return, from the sale of business, as opposed to closing the business and liquidating; and

vi. director is released from incurring further debts at a time when GHI was likely insolvent or would soon become insolvent.

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WHAT IS A MEMBERS VOLUNTARY LIQUIDATION?

A members’ voluntary liquidation (MVL) is a formal winding up process for a solvent company when its members no longer wish to retain the company’s structure, usually because the company has reached the end of its useful life and there are assets to be distributed amongst the shareholders, or to access tax benefits available only in a liquidation scenario. WHY CHOOSE MEMBERS VOLUNTARY LIQUIDATION?

A company may be voluntarily deregistered without an MVL by way of an application to ASIC and payment of an application fee. The directors must confirm, however, all of the following:

• all members agree to the deregistration;

• the company is not carrying on a business;

• the company’s assets are less than $1,000;

• the company has paid all fees and penalties payable under the Act;

• the company has no outstanding liabilities; and

• the company is not party to any legal proceedings.

The directors and members may determine the above criteria cannot be met, in which case an MVL should be used. The MVL sees that all outstanding creditors are paid in full, any surplus assets are distributed to member(s), and protects the members’ interests while the company structure is dismantled. Another reason an MVL is commonly used is to enable the members to access certain tax benefits that would otherwise

MEMBERS VOLUNTARY LIQUIDATION

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be unavailable. Where the company’s equity is made up of a mixture of retained earnings and capital profits, in certain circumstances, the Income Tax Assessment Act 1936 provides relief to members that are only available when the distributions are made by a liquidator. An MVL is the only way to fully wind up the affairs of a solvent company. A voluntary deregistration does not prevent a party from applying to ASIC to re-register the company.

STARTING A MEMBERS VOLUNTARY LIQUIDATION An MVL begins as follows:

1. the director(s) resolve to call a meeting of members to wind up the company;

2. director(s) complete a ‘declaration of solvency’ form that states the company is solvent and can pay all its debts within 12 months. The form is lodged with ASIC;

3. after the declaration of solvency is lodged with ASIC, notice of the members’ meeting can be sent; and

4. the member(s) resolve at the members’ meeting that the solvent company is to be wound up and nominate a liquidator.

DETERMINING IF THE COMPANY IS SOLVENT

Usually a company is only considered solvent if it can, broadly speaking, pay all of its debts as and when they fall due. However, this strict definition does not apply to an MVL as the appointment typically lasts for at least 12 months. The director(s) therefore need to consider whether the company can meet all its debts within a smaller time frame, which is the upcoming 12 months. If so, they can determine the company is solvent. If a liquidator subsequently forms the view that all creditors will not be paid in full within the 12-month period, the MVL must convert to a creditors’ voluntary liquidation.

SIMILARITIES BETWEEN AN MVL AND CREDITORS VOLUNTARY LIQUIDATION

The following areas are identical whether in an MVL or creditors voluntary liquidation:

• the powers a liquidator has, page 24;

• what happens to a company in liquidation, page 25;

• the company’s ability to continue trading, page 25;

• the directors’ duties to help the liquidator, page 27; and

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• the order in which creditors are paid, page 29.

A DIFFERENCE BETWEENAN MVL AND CREDITORSVOLUNTARY LIQUIDATION

A key difference between an MVL and a creditors voluntary liquidation is that the liquidator in an MVL does not have to be registered liquidator. The liquidator can even be a related party or officer of the company. However, to ensure all aspects of the law are followed, and particularly if a dispute among shareholders exists, it is recommended that a registered liquidator independent of the company and shareholders be appointed.

INVESTIGATIONS UNDERTAKEN IN AN MVL

Many of the investigations conducted in a creditors voluntary liquidation or court liquidation are not required under an MVL.

As the company is solvent and creditors should be paid in full, there is no need for any liquidator recovery actions to be initiated. Unfair preferences and insolvent trading are recovery actions that require the company to be insolvent at the time of the transaction, or if there is a loss to creditors.

Liquidators may have to verify what assets are available to them.

Commonly, some assets are loans made to shareholders and are sometimes either in dispute or insufficiently recorded. In these cases, the liquidator may have to reconstruct the loan accounts to determine the amounts and extent of the debts.

A liquidator must ensure a proper distribution is made to members through the capital accounts of the company. This distribution requires some investigation into a company’s balance sheet, particularly capital reserve accounts and franking accounts. Generally, the company’s external accountant can provide a current and detailed balance sheet showing all equity accounts. The liquidator then pays the distribution to members in the most tax advantageous way.

HOW LONG DOES AN MVL LAST?

An MVL lasts for as long as necessary. Selling assets and paying creditors usually happens within the first few months. Completing the company’s financial statements and final tax returns could potentially delay the distribution to members, particularly if there is a dispute between members. Confirmation from the Australian Taxation Office (ATO) that all returns have been lodged and of the final amount owed to the ATO are essential before distributions are made.

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CAN A LIQUIDATOR PAY DIVIDENDS?

Yes. The role of the liquidator is to sell the company’s assets and distribute them among:

1. company creditors as a dividend; and then

2. company shareholders as a distribution.

HOW DOES THE MVL END?

The MVL process ends when all creditors’ claims are satisfied, all other issues are resolved, and any surplus is distributed to the members.

The liquidator lodges relevant forms with ASIC and the company is automatically deregistered by ASIC three months after the deregistration request is lodged by the liquidator.

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WHO APPOINTS THE LIQUIDATOR?

In a court appointed liquidation the creditor, or other party, who has petitioned the winding up of the company will usually nominate a liquidator to be appointed. If the Court is satisfied with the winding up application, the Court makes orders for the nominated liquidator to be appointed over the company. If no liquidator is nominated, the Court may select the liquidator.

THE PROCESS OF A COURT APPOINTED LIQUIDATION

The liquidator follows the same process as with a creditors’ voluntary liquidation, with the exceptions of:

• additional report requirements to the Court;

• the order in which creditors are paid changes with the insertion of the petitioning creditor’s costs as follows:

i. costs and expenses of the liquidation;

ii. petitioning creditor costs as set by the Court at the time of the winding up;

iii. secured creditor and/or employee entitlements depending on the type of asset recovered;

iv. unsecured creditors; and

v. shareholders.

COURT APPOINTED LIQUIDATION

A company is placed into receivership when an independent and suitably qualified person (the receiver) is appointed by a secured creditor, or in special circumstances by the Court, to take control of some or all of the company’s assets, whichever are subject to the security of the secured creditor.

The security interest held by the secured creditor, under which the appointment of a receiver is made, may comprise:

• a non-circulating security interest (e.g. a security interest in land, plant and equipment); and/or

• a circulating security interest in assets that are used and disposed of in the course of normal trading operations (e.g. a security interest in debtors, cash and stock).

The difference between a receiver and a receiver and manager is that a receiver and manager’s powers include the management of the business. The powers granted under the appointment are set out in the security agreement and the Act.

It is possible for a company in receivership to also be in provisional liquidation, liquidation, voluntary administration or subject to a deed of company arrangement. DIRECTORS’ POWERS AND DUTIES DURING RECEIVERSHIP The directors’ powers and duties continue during receivership.

A receivership does not affect the legal existence of the company. The directors continue to hold office, but their powers over assets depend on the powers of the receiver and the extent of the assets over which the receiver is appointed.

RECEIVERSHIP

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A company is placed into receivership when an independent and suitably qualified person (the receiver) is appointed by a secured creditor, or in special circumstances by the Court, to take control of some or all of the company’s assets, whichever are subject to the security of the secured creditor.

The security interest held by the secured creditor, under which the appointment of a receiver is made, may comprise:

• a non-circulating security interest (e.g. a security interest in land, plant and equipment); and/or

• a circulating security interest in assets that are used and disposed of in the course of normal trading operations (e.g. a security interest in debtors, cash and stock).

The difference between a receiver and a receiver and manager is that a receiver and manager’s powers include the management of the business. The powers granted under the appointment are set out in the security agreement and the Act.

It is possible for a company in receivership to also be in provisional liquidation, liquidation, voluntary administration or subject to a deed of company arrangement. DIRECTORS’ POWERS AND DUTIES DURING RECEIVERSHIP The directors’ powers and duties continue during receivership.

A receivership does not affect the legal existence of the company. The directors continue to hold office, but their powers over assets depend on the powers of the receiver and the extent of the assets over which the receiver is appointed.

RECEIVERSHIP

Control of the assets which the receiver is appointed over is taken away from directors. This may, and often does, include the company’s business.

Directors must provide the receiver with a report about the company’s affairs and must allow the receiver access to books and records relating to the collateral he was appointed over. THE RECEIVER’S ROLE

The receiver’s role is to:

• collect and sell enough of the charged assets (collateral) to repay the debt owed to the secured creditor. This may include selling all of the company’s business;

• pay out the money collected in the order required by law; and

• report to ASIC any possible offences or other irregular matters they come across.

The receiver’s primary duty is to the secured creditor that appointed them.

The main duty owed to unsecured creditors is an obligation to take reasonable care to sell collateral for not less than its market value or, if there is no market value, the best price reasonably obtainable. This is a high standard, higher

than that expected of a liquidator or administrator.

A receiver also has the same general duties as a company director.

The receiver has no obligation to report to unsecured creditors about the receivership, either by calling a meeting or in writing. However, the receiver will usually write to all of the company’s suppliers to inform them of their appointment, advise them of the treatment of amounts owed to them at the time of the receiver’s appointment and possibly request the creation of new credit accounts.

Unsecured creditors are not entitled to see the receiver’s reports to the secured creditor.

PLACING THE COMPANY IN LIQUIDATION OR VOLUNTARY ADMINISTRATION DURING RECEIVERSHIP Directors and members will likely consider whether the company, once in receivership, should be placed in liquidation or voluntary administration. The answer to this question depends on the powers that the receiver or receiver and manager possess and what assets they have taken control of.

If the receiver controls a key income producing asset - i.e. the entire business or key plant and

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equipment, then the following issues should be considered:

• the company will inherently become insolvent, if it is not already, as there is little to no prospect that the company will be able to service any future debts;

• if the company is left without assets to pay current creditors and employees, directors and members will likely have to answer incoming queries from creditors; and

• legal action may be commenced or continued against the company despite the appointment of a receiver.

It follows that the directors or members should act quickly to consider liquidation or voluntary administration to avoid incurring debts that the company is unable to pay.

In the event that the receiver has not taken control of a key income producing asset and ordinary business debts are able to be met, then the company may not require external administration. DISTRIBUTING FUNDS IN A RECEIVERSHIP The most common way a receiver will obtain money from the assets they are appointed over is to sell them. In the case of a company’s

business, the receiver may continue to trade the business until they sell it as a going concern.

The money from the realisation of assets is distributed as follows:

• money from the sale of non-circulating assets is paid to the secured creditor after the costs and fees of the receiver in collecting this money have been paid

• money from the sale of circulating assets is paid out in the following order:

i. the receiver’s costs and fees in collecting this money;

ii. certain priority claims, including employee entitlements (if the liability for these hasn’t been transferred to a new owner); then

iii. repayment of the secured creditor’s debt.

In both cases, any funds left over are paid to the company or to its liquidator or administrator, if one has been appointed.

If the receiver is appointed under a security interest comprising both non-circulating and circulating security interests (which is common), there will be costs and fees of the receivership that

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cannot be directly assigned to realising the non-circulating assets or circulating assets. Such costs are allocated in proportion to the dollar amount realised from the non-circulating assets and circulating assets.

If employee entitlements are to be paid by the receiver under a circulating security interest, the payments must be made in the following order:

• outstanding wages and superannuation;

• outstanding leave of absence (annual leave and long service); then

• retrenchment pay.

Each class of entitlement is paid in full before the next class is paid. If there are insufficient funds to pay a class in full, the available funds are paid on a pro rata basis (and the next class or classes will be paid nothing).

The receiver has no obligation to pay any other unsecured creditors for outstanding pre-appointment debts.

PRE-EXISTING CONTRACTS IN A RECEIVERSHIP

The appointment of a receiver does not automatically terminate pre-receivership contracts with the company. However, the law

surrounding the survival and obligations of contracts is complex and usually legal advice is sought to deal with such issues.

It is worth noting that it is possible for the contract to remain in place without the receiver taking personal liability for the company’s obligations under the contract.

COMMENCING LEGAL ACTION DURING RECEIVERSHIP

Legal action may be commenced or continued against the company despite the appointment of a receiver. This means that an unsecured creditor can apply to the Court to have the company put into liquidation on the basis of an unpaid debt.

Unsecured creditors may choose to commence legal proceedings if:

• there is an expectation that there will be money or property left over after the secured creditor is repaid;

• there are possible recoveries that may be available to a liquidator for the benefit of unsecured creditors, which are not available to a receiver;

• there is a desire for a liquidator to investigate potential offences by those associated with the company; or

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• there is a desire for a liquidator to review the validity of the appointment of the receiver and of the security interest, and to monitor the progress of the receivership.

CAN A LIQUIDATOR REMOVE A RECEIVER? If a liquidator is appointed over a company in receivership, she will review the validity of the security interest and of the appointment of the receiver. If she determines the receiver was not validly appointed, or the secured creditor had no right to appoint, then the liquidator can bring an application in Court to remove the receiver and possibly sue the receiver for trespass.

ENDING A RECEIVERSHIP

A receivership usually ends when the receiver has collected and sold all of the collateral or enough collateral to repay the secured creditor, completed all their receivership duties and paid their receivership liabilities. Generally, the receiver resigns or is discharged by the secured creditor.

Unless another external administrator has been appointed, control of the company and any remaining assets go back to the directors.

CASE STUDY

Facts about JKL Pty Ltd (JKL):

• JKL is in default with its secured creditor.

• JKL’s secured creditor has security over 100% of the assets JKL owns and operates.

• The secured creditor appoints a receiver and manager over JKL and they take control of certain assets that the secured creditor holds security over.

• JKL is left with no assets to produce income.

• JKL is continuing to incur liabilities.

The director, and sole shareholder, may choose to place JKL into voluntary administration or liquidation as:

• the receiver and manager has taken possession of JKL’s income producing assets, JKL therefore has no ability to generate income to pay its debts.

• it is possible that JKL is still incurring debts.

• there is little chance that JKL will receive any funds back after the receiver and manager has finalised their position.

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Appointment type How the appointment occurs Who appoints an external administrator?

Voluntary administration

Either: ● the director(s) resolve that the entity is, or is likely to be, insolvent and resolve that the entity should appoint a voluntary administrator; or ● a secured creditor appoints a voluntary administrator after financial agreements have been breached; or ● a liquidator appoints a voluntary administrator should the circumstances be appropriate to do so.

For a director appointment, the director(s) resolve to appoint an administrator and specify who that administrator is to be. For a secured creditor appointment, the secured creditor appoints an administrator. For a liquidator appointment, the liquidator nominates a voluntary administrator which is usually the liquidator.

Creditors voluntary liquidation

Member(s) resolve that the entity is, or is likely to be, insolvent and resolve that the entity should be wound up.

Member(s) resolve to appoint a liquidator and specify who that liquidator is to be.

Members voluntary liquidation

Member(s) resolve that the entity should be wound up.

Member(s) resolve to appoint a liquidator and specify who that liquidator is to be.

Court appointed liquidation

Generally, a creditor has taken legal action to have the company wound up due to unpaid debts. The Court orders the appointment of a liquidator.

Court specifies, in the orders, who the appointed liquidator is to be. Usually the liquidator is nominated by the creditor petitioning the winding up.

Receivership N/AA secured creditor appoints a receiver or receiver and manager to get in and realise assets they hold security over.

SUMMARY COMPARISON

Appointment type How the appointment occurs Who appoints an external administrator?

Voluntary administration

Either: ● the director(s) resolve that the entity is, or is likely to be, insolvent and resolve that the entity should appoint a voluntary administrator; or ● a secured creditor appoints a voluntary administrator after financial agreements have been breached; or ● a liquidator appoints a voluntary administrator should the circumstances be appropriate to do so.

For a director appointment, the director(s) resolve to appoint an administrator and specify who that administrator is to be. For a secured creditor appointment, the secured creditor appoints an administrator. For a liquidator appointment, the liquidator nominates a voluntary administrator which is usually the liquidator.

Creditors voluntary liquidation

Member(s) resolve that the entity is, or is likely to be, insolvent and resolve that the entity should be wound up.

Member(s) resolve to appoint a liquidator and specify who that liquidator is to be.

Members voluntary liquidation

Member(s) resolve that the entity should be wound up.

Member(s) resolve to appoint a liquidator and specify who that liquidator is to be.

Court appointed liquidation

Generally, a creditor has taken legal action to have the company wound up due to unpaid debts. The Court orders the appointment of a liquidator.

Court specifies, in the orders, who the appointed liquidator is to be. Usually the liquidator is nominated by the creditor petitioning the winding up.

Receivership N/AA secured creditor appoints a receiver or receiver and manager to get in and realise assets they hold security over.

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Status of the entity at entry of liquidation Notes

Insolvent or likely to be insolvent in the future.

Commonly used when the business is salvageable, or there is an interested party who wishes to purchase the entity, where liquidation is not viable, i.e. winding up proceedings are already on foot, or where liquidation is not desirable.

Insolvent or likely to be insolvent in the future.

This type of liquidation cannot be entered if winding up proceedings have already commenced. If winding up proceedings have commenced, the entity may only be placed into voluntary administration. The Court proceedings survive the appointment and are dealt with by the administrator.

Entity is solvent

The entity usually has no useful purpose remaining and/or requires a liquidator to distribute the assets, usually for tax purposes. The appointed liquidator does not have to be a registered liquidator or independent of the company being liquidated.

Believed to be insolvent due to the unpaid debts.

Director(s) and member(s) have no say in who is appointed liquidator.

N/A

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Liquidator Recoveries

Insolvent trading claims against directors 46

Voidable transactions 50

Unfair preferences 51

Unreasonable director related transactions 56

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Insolvent trading is when directors allow their company to incur debts when the company is insolvent. Section 95A of the Act states:

1. A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable.

2. A person who is not solvent is insolvent.

For the purposes of section 95A, a person also means a company.

Insolvent trading is against the law. A director may be held personally liable to compensate creditors for the amount of the unpaid debts incurred from the time the company became insolvent to the start of the external administration. If the director was reckless or dishonest and that behaviour contributed to the insolvent trading, then criminal charges may also apply.

A LIQUIDATOR COMMENCES THE INSOLVENT TRADING CLAIM

Only a liquidator can sue a director for insolvent trading. Administrators and receivers cannot. STATUTE OF LIMITATIONS FOR INSOLVENT TRADING CLAIMS

Liquidators have 6 years from the beginning of the liquidation to commence an action for insolvent trading.

A statement of claim must be lodged with the Court within that 6 year period. It is not sufficient to just issue a letter of demand. However, it is common for liquidators to initially write to directors outlining their claim and seek an out of Court settlement.

INSOLVENT TRADING CLAIMS AGAINST DIRECTORS

HOW DIRECTORS BECOME LIABLE FOR INSOLVENT TRADING

Section 588G of the Act sets out the director’s duty to prevent insolvent trading and sets the parameters by which a liquidator can initiate the process for making a claim against a director.

Directors breach this section of the law by allowing the company to incur a debt when they are aware, or a reasonable person would have been aware, of grounds to suspect the company was insolvent. The reasonable person test is important because it changes the question from what the director actually knew to what he ought to have known.

When directors breach their duty in respect of insolvent trading, the provisions of section 588M of the Act allow the liquidator to recover compensation from the director equal to the value of the debts incurred whilst the company was insolvent. WHO ARE CONSIDERED TO BE DIRECTORS? Individuals appointed as director are not the only ones who may be liable for insolvent trading. ‘Shadow’ or de facto directors, or other parties that controlled the company at the time the company was insolvent can also be exposed to an insolvent trading claim.

The Act defines a ‘director’ as:

a. a person who:

i. is appointed to the position of a director; or

ii. is appointed to the position of an alternate director and is acting in that capacity; regardless of the title of their position; and

b. a person who is not validly appointed as a director if:

i. they act in the position of a director; or

ii. the directors of the company or body are accustomed to acting in accordance with the person’s instructions or wishes.

The definition excludes people who give advice as part of their normal professional role. For example, accountants, solicitors and other paid consultants. THE ELEMENTS OF AN INSOLVENT TRADING CLAIM Aside from the company being in liquidation, the elements for an insolvent trading claim are:

1. The company must have been insolvent when the debts were incurred;

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2. The debts must remain unpaid at the time of the liquidation (and at the time the claim is made by the liquidator);

3. The claim must be made against people who were company directors at the time debts were incurred; and

4. There were reasonable grounds for the director to suspect the company was insolvent.

WHAT ABOUT DEBTS THATHAVE BEEN ACCRUED?

For an insolvent trading claim, the debt must be incurred, not just accrued, when the company is insolvent.

Incurring a debt is the legal creation of a debt that did not previously exist - for example, when a service is rendered or when delivery of goods is accepted. Accrued debts, on the other hand, usually relate to ongoing contractual agreements. An accrued debt is an incurred debt if the corresponding contract was entered into after the company became insolvent. If the contract was signed before the date of insolvency then the accrued debts will not be incurred. For this reason, rental arrears are usually excluded from an insolvent trading claim.

ASIC’S VIEW OF INSOLVENT TRADING

Insolvent trading is an offence that is reported to ASIC as part of a liquidator’s reporting requirements. Depending on the depth and breadth of the offence, ASIC may request further investigations and possible civil and/or criminal prosecution and/or director banning.

Reporting between a liquidator and ASIC is confidential. There is no requirement that their communications be shared with the directors. In fact, the liquidator is specifically prevented from sharing such information as doing so may compromise further actions ASIC may wish to take.

ASIC can fund the liquidator to further investigate director-related offences in accordance with the Act. However, ASIC will not fund the liquidator to sue the director. The funding is purely for investigative purposes. DEFENDING AN INSOLVENT TRADING CLAIM

The Act provides statutory defences for directors faced with an insolvent trading claim. However, the directors have the burden of proving the defences apply. This is different from the liquidator having to prove the defences do not apply. Statutory defences include:

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1. the director had reasonable grounds to expect (not just suspect) the company was solvent;

2. a reasonable, competent person produced information, on which the director relied, that would reasonably lead to a belief that the company was solvent;

3. the director had a good reason for not taking part in the company management at the relevant time; and

4. the director took all reasonable steps to stop the company incurring the debt, including attempting to appoint a voluntary administrator to the company.

In cases brought before the Courts, the decisions have made it clear that the position of director carries certain responsibilities which cannot be avoided, including the duty to keep herself informed about the company’s solvency.

A voidable transaction is essentially a deal, contract, or transaction that is harmful to the company. It usually occurs at a time when the company was insolvent. Some transactions are voidable even if they occurred when the company was solvent. For reasons explained below, a liquidator can pursue the reversal of such transactions.

The transaction in question could involve a payment of money, transfer of property, entering into an unfair contract, or transfer of the company’s assets to a related or unrelated third party for consideration below market value. If the transaction meets the relevant criteria, the liquidator will seek to address the harm suffered by the company by obtaining payment and/or return of the relevant assets for the benefit of the company’s creditors.

The following are types of voidable transactions:

• unfair preferences;

• transactions where the consideration is given to a third party and not the company;

• uncommercial transactions;

• unfair loans to a company;

• unreasonable director-related transactions;

• transfers to defeat/defraud creditors;

• circulating asset security interests registered within 6 months of external administration; and

• vesting of security interests registered on the PPSR outside of time.

In this guide, we will review unfair preferences and unreasonable director-related transactions.

VOIDABLE TRANSACTIONS

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An unfair preference refers to a transaction where a creditor receives payment or other assets in the following circumstances:

a) whilst the company was insolvent;

b) the creditor suspected or ought have suspected the company was insolvent;

c) the creditor’s claim is unsecured; and

d) the payment results in the creditor receiving a higher payment against her claim compared to the dividend she would have received if the payment had been retained and added to the company’s assets.

The Act allows liquidators to unwind and recover such payments.

Unfair preferences commonly arise where a creditor is able to exert significant pressure, compared to other creditors, in retrieving amounts owed to them. They are the loud squeaky wheel. If the creditor is an unrelated party, the payment or payments will be recoverable if they occurred within the 6-month period leading up to the date, which is usually the commencement of the liquidation. If the creditor is a related party, the 6-month timeframe increases to 4 years.

RECOVERING AN UNFAIR PREFERENCE

Recovering an unfair preference generally begins with the liquidator writing to the creditor in question. In the letter the liquidator outlines the reasons why he believes the creditor received an unfair preference, details the amount of the preference, and requests repayment.

A liquidator may commence Court proceedings to recover an unfair preference should a request for payment be ignored or negotiations to settle are unproductive.

UNFAIR PREFERENCES

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An unfair preference refers to a transaction where a creditor receives payment or other assets in the following circumstances:

a) whilst the company was insolvent;

b) the creditor suspected or ought have suspected the company was insolvent;

c) the creditor’s claim is unsecured; and

d) the payment results in the creditor receiving a higher payment against her claim compared to the dividend she would have received if the payment had been retained and added to the company’s assets.

The Act allows liquidators to unwind and recover such payments.

Unfair preferences commonly arise where a creditor is able to exert significant pressure, compared to other creditors, in retrieving amounts owed to them. They are the loud squeaky wheel. If the creditor is an unrelated party, the payment or payments will be recoverable if they occurred within the 6-month period leading up to the date, which is usually the commencement of the liquidation. If the creditor is a related party, the 6-month timeframe increases to 4 years.

RECOVERING AN UNFAIR PREFERENCE

Recovering an unfair preference generally begins with the liquidator writing to the creditor in question. In the letter the liquidator outlines the reasons why he believes the creditor received an unfair preference, details the amount of the preference, and requests repayment.

A liquidator may commence Court proceedings to recover an unfair preference should a request for payment be ignored or negotiations to settle are unproductive.

UNFAIR PREFERENCES

PROVING AN UNFAIR PREFERENCE

The following elements, explainedin further detail below, are to beproven in an unfair preference claim:

• a transaction was entered into (usually a payment of monies);

• the transaction was between the company (or a party on behalf of the company) and a creditor of the company;

• it happened when the company was insolvent;

• it happened within the statutory period (usually 6 months, 4 years if the creditor is a related party) before the liquidation started;

• the transaction gave the creditor an advantage over other creditors;

• the creditor suspected, or ought to have suspected, that the company was insolvent;

• the debt is an unsecured debt; and

• in a continuing business relationship, the payment results in a reduction in the amount owed.

A transaction was entered into There must be a transaction involving the company and creditor. Commonly, a transaction is a payment from a company’s bank account, although any asset passing from a companyto a creditor is enough to establish a transaction.

For example, the return of stock that is not subject to the Personal Property Securities Act 2009 (PPSA), or assignment of a debt could qualify as an unfair preference. The transaction was between the company and a creditor

The transfer of property or cash payment must have been done at the company’s direction and that transaction must satisfy a debt that was due and payable at the time. Where a supplier supplies goods on COD (cash on delivery) or cash before delivery plus a payment towards an existing debt, the paying down of the existing debt is deemed preferential and is therefore recoverable by a liquidator. However, the COD or cash before delivery portion is not preferential.

An advance payment for future works, or the future supply of goods, is not preferential because there is no debtor / creditor relationship. The advance

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payment, however, would need to be repaid if the services/products have not been used by the company. It happened within the statutory period before the liquidation started The transaction must have occurred during a specific period before the ‘relation back-day’, being:

• six months for non-related parties; and

• four years for related parties.

The relation-back day is the date that the liquidation is deemed to have started or otherwise:

• for a liquidation that follows a voluntary administration or Deed of Company Arrangement (DOCA), it is the day that the administrator was appointed;

• for other voluntary liquidations, it is the date of the members meeting that the liquidator was appointed; and

• for a Court appointment it is the day that the winding up application was filed in the Court.

It follows that the further the relation back date is, the greater the period of time the liquidator

can examine in terms of identifying possible unfair preferences. The transaction gave the creditor an advantage over other creditors

The creditor must have received more than they would have received if they refunded the monies and proved for that amount in the liquidation process. If the creditor did not receive more by way of the payment than they would have received from a dividend, there is no advantage or preferential treatment. It happened when the company was insolvent

For a creditor to be party to a preference payment the company must have already been insolvent.

It is up to the liquidator to prove that the company was insolvent at the time that the creditor purportedly received a preference payment. The creditor suspected, or ought to have suspected, that the company was insolvent The liquidator reviews whether the creditor received or may have known of any information or circumstance that would lead them (or a reasonable person in their position) to suspect that the company was insolvent. It is not necessary to prove the creditor knew, believed, or suspected

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that the company was insolvent. If the liquidator is unable to do so, but can instead show that a reasonable person would have suspected, that will be enough to prove the claim.

Events typically giving rise to a creditor suspecting an customer was insolvent include:

• dishonoured cheques;

• requesting payment agreements;

• knowing of other creditors that are unpaid;

• pressing for payment; and

• issuing legal demands.

Debt must be unsecured

A preference has not occurred if the creditor holds a valid and existing security interest over company assets pursuant to the PPSA, and the value of the assets secured is greater than the payment amount.

However, if the security interest is not properly created or registered, the liquidator may decide the security interest is invalid and the corresponding claim is unsecured. In that case, the payment would be an unfair preference. Similarly, if the value of the security is less than the payment amount,

the excess would be an unfair preference.

A debt associated with a security interest over circulating assets (cash, debtors and stock) created during the six month period before the beginning of the liquidation is also treated as unsecured.

DEFENDING AN UNFAIR PREFERENCE CLAIM

Section 588FG of the Act provides defences that may be available to creditors who received preferential payments. To rely on a defence, a creditor must satisfy all three conditions of the defence. The onus of proving the defence is on the creditor; it is not for the liquidator to initially disprove them.

The three conditions of the statutory defence are:

1. the creditor gave valuable consideration for the payment i.e. they have given something of value in consideration for receiving the payment;

2. the creditor received the payment in good faith - i.e the creditor acted under normal trading conditions. Examples that may indicate no good faith include: commencing legal proceedings or issuing statutory notices; ceasing supply; changing to cash on delivery terms, or forcing

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payment by any form of threat or action; and

3. the creditor had no reason to suspect the insolvency of the company – commented on above at “The creditor suspected, or ought to have suspected, that the company was insolvent.”

RUNNING BALANCE DEFENCE

The ‘running balance defence’ refers to a continuing business relationship between a company and a creditor and usually applies when there is a number of transactions between the two parties in the ordinary course of business - i.e. the balance of the account fluctuates with invoices received and payments made.

The liquidator should take into account all transactions that occurred between relevant dates and whether the owed debt increased or decreased to the creditor during that period.

If the balance owing decreased, this amount is the potential preference amount, with all other factors being considered. If the balance owing increased, there is no preference as the creditor is actually disadvantaged by the transactions, in total. The liquidator determines the start date of the review and concludes on the date the winding up commenced.

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WHAT IS AN UNREASONABLE DIRECTOR-RELATED TRANSACTION?

On review by a liquidator, there may be transactions identified as having little or no benefit to the company which were made by a director or close associate (as defined by the Act) of the company. In the event that the transaction was detrimental to the company, it may be categorised as ‘unreasonable director-related transactions’.

The Act provides the liquidator with the power to recover the asset or recover funds from the director or associate. In recovering such assets, it seeks to return the company to a position as if the transaction had not occurred. If it’s not practical to recover the asset, the liquidator may instead seek payment of the difference between the value given by the company and the consideration it received.

A critical distinction with this type of voidable transaction is that the liquidator does not need to prove the company was insolvent at the time the transaction occurred.

TYPES OF UNREASONABLE DIRECTOR-RELATED TRANSACTIONS

This type of transaction might include:

• selling an asset of the company for less than market value;

• forgiving a debt where it could reasonably be recovered; or

• transferring an asset for no value.

UNREASONABLE DIRECTOR RELATED TRANSACTIONS

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WHAT MUST THE LIQUIDATOR PROVE?

The liquidator must prove 3elements:

1. a transaction was entered into;

2. a director or close associate of the director was involved in the transaction; and

3. either there was no benefit to, or there was a detriment to the company.

WHO IS A CLOSE ASSOCIATE? The Act provides that a close associate is:

• a relative or de facto spouse of a director; or

• a relative of a spouse or of a de facto spouse, of the director.

A relative is a spouse; parent or remoter lineal ancestor; son, daughter or remoter issue; or brother or sister of the person.

TIME LIMIT TO MAKE A CLAIM The liquidator has four years from the relation-back date to make a claim against a director or associate. Issuing a demand letter within that period is not sufficient. Legal proceedings must be commenced.

Recall that there are three possible dates for the relation-back day:

1. For a liquidation following a voluntary administration, the relation-back day is when the administrator was first appointed to the company.

2. For a creditor’s voluntary winding up, the relation-back day is the date of the members’ meeting that resolved to wind up the company.

3. For a Court appointment, the relation-back day is the day the winding up application was filed.

THE COMPANY SOLVENCY AT THE TIME OF THE TRANSACTION

Importantly, the Act does not require the company to be insolvent at the time of an unreasonable director-related transaction for a liquidator to pursue its reversal.

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Director PersonalExposure

Director liabilities for company debt 60

Director penalty notice (DPN) 62

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There are instances where the corporate veil is pierced and directors become liable for debts, for example:

• a liquidator bringing an insolvent trading compensation claim;

• an unreasonable director-related transaction;

• PAYG taxation debts, superannuation guarantee charge (SGC), and commencing 1 April 2020, GST; and

• personal guarantees.

By far the biggest issue we see directors face, in terms of unknown risk, is around personal guarantees – directors are often unaware of what guarantees they have signed and therefore unaware of the extent of the company’s debts they have guaranteed. The above types of liabilities can be distinguished based on:

1. who has the right to make a claim;

2. whether or not the company must be in liquidation; and

3. how the liability arises.

DIRECTOR LIABILITIES FORCOMPANY DEBTS

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For liquidations:

• insolvent trading claims can be made by liquidators or creditors (section 588M and 588R of the Act respectively).

• unreasonable director-related transactions are pursued by liquidators, under section 588FDA of the Act.

• employee entitlement claims are made by liquidators or creditors (section 596AC and 596AF of the Act respectively).

• PAYG taxation debts, SGC claims, and after 1 April 2020, GST debts, are pursued by the ATO via the directors penalty notice (DPN) regime.

• personal guarantees can be enforced by creditors holding guarantees under their agreement document.

For an entity not in liquidation:

• PAYG taxation debts, SGC claims, and after 1 April 2020, GST debts, are pursued by the ATO via the DPN regime.

• personal guarantees can be pursued by creditors holding guarantees under their agreement document.

Insolvent trading claims were discussed earlier at pages 46 to 49. DPNs are described in more detail in the next section.

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A Director Penalty Notice (DPN) is a powerful tool used by the ATO to convert certain debts of the company to a director’s personal debt. A DPN can arise from unpaid PAYG, SGC and GST. GST’s addition to this group is effective 1 April 2020. WHEN A DIRECTOR BECOMES LIABLE

A director becomes liable to a penalty at the end of the day the company is due to meet its obligation but fails to do so. At this time, the penalty is created automatically. The ATO does not need to take any action to create the penalty. The ATO may then, at its discretion, issue a DPN to a director seeking payment of the penalty amount.

The Commissioner, however, must not commence proceedings to recover a director penalty until 21 days after a DPN is issued.

There are two types of DPNs: non-lockdown penalty notices and lockdown penalty notices. Both are explained further below.

DIRECTORS’ LIABILITY FOR PAYMENT?

Directors can be liable to pay the company’s debts, under a DPN, if they:

• were a director when the company failed to pay the relevant amounts on the date they were due; or

• became a director after the date the payment was due and are still a director 30 days after the amount was due but is still unpaid. Liability for tax debts accruing before the individual became a director is therefore possible.

NON-LOCKDOWN DPNs

Non-lockdown DPNs are issued to company directors that:

DIRECTOR PENALTY NOTICE

• lodged the company’s business activity statements and instalment activity statements within three months of the due date for lodgement; and

• lodged SGC statements within one month and 28 days after the end of the quarter that the superannuation contribution relates to but the PAYG withholding, GST and/or SGC debts remain unpaid.

The notice gives directors 21 days to:

a. pay the penalty;

b. appoint an administrator; or

c. place the company in liquidation.

On day 22, the penalty, by law, becomes a debt of the director. There is no discretion on this point. LOCKDOWN DPNs

Lockdown DPNs were introduced to deal with directors seeking to conceal ATO obligations by simply not lodging. Use of these notices become available to the ATO when a company fails to lodge its business activity statements and instalment activity statements within three months of the due date for lodgement. In relation to superannuation, the SGC statement is due within one month after the date the superannuation contributions were due to be paid.

This is demonstrated in the table below:

The penalty permanently locks down on the director on the lockdown day and there is no ability to avoid the penalty, other than by paying the debt in full. Placing the company into administration or liquidation does NOT provide a defence for a lockdown DPN.

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* may be a later date if lodged by tax agent. ** GST will be added to the DPN scheme on 1 April 2020.

For period ended 30 June 21-Jul* 28-Jul 28-Aug 29-Aug 21-Oct 22-Oct

PAYG & GST**

Due for lodgement and payment

Last day for lodgement Lockdown

Superannuation Due for lodgement and payment

Last day for lodgement of SGC Lockdown

THE PROCESS OF ISSUING A DPN

Some important aspects of the ATO issuing and recovering a DPN:

• director penalties are automatically created pursuant to the workings of the Taxation Administration Act 1953 (Tax Act). However, the Commissioner of Taxation must follow a specific procedure before starting proceedings to recover that debt;

• if the Commissioner determines it is ‘fair and reasonable’ for a director to pay the outstanding tax, they will issue a DPN;

• the Commissioner will not start proceedings to recover the debt until 21 days after the DPN is issued;

• DPNs are issued to directors individually. Directors are jointly and severally liable for the debt and will each owe the same amount of money under the DPN;

• if the company pays all or a portion of the debt causing the DPN to arise, the debt due from the director will decrease by that amount;

• a DPN notice is issued on the day it is posted to the director’s address listed in the company records maintained by ASIC. If the address listed with ASIC is no longer current, the DPN is still considered to be validly issued; and

• the ATO may send a copy of the DPN to the director’s registered tax agent as an additional way of bringing the penalty to the director’s attention; however, if the tax agent does not bring the notice to the director’s attention, the notice is also still considered to be validly issued.

Note that the ATO can collect tax in other ways, for example by withholding a tax refund or issuing a garnishee notice. The ATO has the power to issue a garnishee notice to any third party that owes or holds any money on behalf of the company. A garnishee notice requires the third party to pay money directly to the ATO.

A garnishee notice can require payment of a percentage of the debt, or funds held, or may seek payment of a lump sum amount amount up to the ATO’s debt. For businesses, the ATO can issue a garnishee notice to a financial institution or any trade debtor. DEFENDING A DPN

The director penalty regime

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provides a number of statutorydefences which outlinecircumstances in which a directoris not liable for director penalties.

A director will have a defenceand not be liable for a directorpenalty if he can prove:

• he did not take part (and it would have been unreasonable to expect them to take part) in the management of the company during the relevant period because of illness or for some other good reason;

• he took all reasonable steps, unless there were no reasonable steps that could have been taken, to ensure that one of the following three things happened:

a. the company paid the amount outstanding;

b. an administrator was appointed to the company; or

c. the directors began winding up the company.

In terms of reasonable steps,unacceptable defences include:

• the company had insufficient funds to pay the tax; or

• a consensus to appoint an administrator could not be reached.

CAN PREVIOUS DIRECTORS BE LIABLE?

The ATO can issue a DPN to a director who has resigned, but was a director at the time the debt was incurred.

SATISFYING THE DPN Director penalties will be withdrawn if the company pays the outstanding tax at any time.

Director penalties will also be withdrawn if, at any time on or before 21 days after a DPN is issued:

• the company reported its PAYG withholding and GST within three months of the due date for lodgement and lodged its superannuation guarantee statements within one month after the superannuation contribution was due (i.e. it is a non-lockdown DPN); and

• the company goes into voluntary administration or liquidation.

As mentioned above, if the company fails to report its PAYG withholding, GST or SGC liabilities within the above time periods, the director penalties cannot be revoked even if an administrator or a liquidator is appointed. The DPN regime imposes a lockdown on a director for liabilities that are

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unpaid and unreported within their required lodgment periods.

WHAT IF THE DPN CONTAINS ESTIMATES BY THE ATO?

Where the company has failed to meet its reporting requirements for PAYG withholding, GST and SGC, the ATO may issue a DPN based upon the ATO’s estimate.

Directors can submit a statutory declaration or an affidavit to verify the actual amount of the liability, which may reduce or revoke the liability.

NOT PAYING THE DPN

If the director is unable to pay the DPN then the ATO may petition her into bankruptcy. If this is likely to occur, it may be preferable for her to voluntarily enter into bankruptcy and select the bankruptcy trustee.

CAN THE DIRECTOR WHO PAYS THE ENTIRE DPN RECOVER AMOUNTS BACK FROM THE OTHER DIRECTORS?

The legislation outlines the rights of a director who pays a company liability as against the other directors who were also liable to pay the penalty.

To deal with the potential unfairness associated with recovering different amounts

from company directors, a right of indemnity and contribution allows directors to recover amounts paid on the company’s behalf against the company or its other directors.

The right of indemnity and contribution seeks to ensure that any one individual, particularly an associate, is not solely responsible for the financial burden caused by the company’s failure to comply with its obligations.

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Phoenix Activity

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Illegal phoenix activity is where a new company is created to continue the business of an existing company that has been deliberately liquidated, or abandoned, to avoid paying outstanding debts, including taxes, creditors and employee entitlements.

This illegal practice usually happens when company directors transfer the assets of an existing company to a new company without paying market value, leaving the liabilities with the old company. Once the assets have been transferred, the old company is placed in liquidation either voluntarily or by Court order via a winding application by a creditor (often the ATO). When the liquidator is appointed, there are no assets remaining and therefore creditors cannot be paid.

The ATO and ASIC are targeting phoenix activity and funding liquidators to investigate such activity to report back to the ATO and ASIC to unwind and take legal action for such practices.

WHAT IF I WANT TO SELL MY BUSINESS BUT THERE WILL BE A SHORTFALL OF FUNDS TO PAY CREDITORS?

Phoenix activity is where assets are transferred for no consideration (no payment received) or inadequate consideration.

It is not considered phoenix activity where a proper sale process has been followed yet the amount received is unable to fund all creditors. A proper sale process may include:

• a company broadly advertises the business for sale;

• the company seeks and reviews all offers - i.e not closed to only receiving an offer from a related party;

• the sale process is documented;

PHOENIX ACTIVITY

• the sale process is open to the wider public; and

• the best sale price is chosen for the business.

The best sale price may not necessarily be the highest dollar value, but whatever best suits the company and its creditors at the time of the sale. For example, the company may choose to accept a lower value sale price where the due diligence and settlement date occurs quicker in comparison to a higher value sale price.

CAN I BUY THE BUSINESS OUT OF LIQUIDATION?

Yes. The Liquidator will ordinarily go through a sale process and as long as your offer is the most desirable you may purchase the business and assets out of Liquidation into a new entity. This is not considered phoenix activity.

CAN I START UP A NEW BUSINESS EVEN THOUGH MY PREVIOUS COMPANY FAILED?

Generally yes, unless you are banned from being a director by either:

• an ASIC banning order; or

• you are currently bankrupt.

in which case you are unable to bea director of a company.

You are entitled to earn a livingand use your skills to earn thatliving. Stamping out phoenixactivity is not preventing you fromdoing so.

However, certain items arereviewed when considering if theassets of one company are utilisedto start another, such as:

• whether the intellectual property has been moved or duplicated, for example, training manuals, policies and procedures, template reports or letters. This type of activity may be considered phoenix activity, as an asset of the old company is being utilised by the new company;

• whether customers of the company in liquidation have been moved prior to or after liquidation, and if so, how were they moved? For example, if those customers were courted prior to the liquidation to move to a new company, then this may be considered phoenix activity as an asset is being moved; and

• if customers have moved from company X to company Y, then how did that move occur and how has it been treated? For example, if a customer has moved to the new company,

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company Y, but the debts relating to that customer sit within company X, then this may be considered phoenix activity.

WHAT IF MY ADVISOR RECOMMENDS SOMETHING THAT SOUNDS LIKE PHOENIX ACTIVITY?

ASIC’s ‘untrustworthy advisor’warnings signs include:

• unsolicited contact;

• reluctance to provide their advice in writing;

• suggestions of destroying books and records or withholding or delaying providing them to the company’s liquidator, if appointed;

• suggestions of transferring company assets into another company without paying for them;

• Recommending using a ‘friendly’ liquidator to wind up your company - i.e a liquidator that will not undertake proper investigations or proffer that he will not take any action against a director for breaches of the Act.

ASIC’s website warns directorsfrom taking this tainted advice,which might cause them to break

the law or breach director dutiesand can result in “large fines oreven imprisonment”. Further,taking ‘bad’ advice “can damagethe claims of the company’screditors”.

Any such activity can be reportedto ASIC or the ATO.

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glossary

Act Corporations Act 2001

ASIC Australian Securities and Investments Commission DOCA Deed of Company Arrangement DPN Director Penalty Notice

PPSA Personal Property Securities Act 2009 PPSRPersonal Property Securities Register

SGC Superannuation Guarantee Charge

March 2020

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