Chapter 36

1. Chapter 36 External administrations: receiverships, voluntary administrations, and liquidations

2. Objectives of this lecture • Understand what it means for a company to be considered as solvent or insolvent. • Understand the different types of external administrations that can be instigated if a company is in financial distress, or is deemed to be insolvent. • Understand that accounting standards are typically developed for organisations that are assumed to be going concerns as opposed to organisations that are considered to be insolvent. • Understand when a receiver would be likely to be appointed, and understand the role and power of the receiver.

3. Objectives (cont.) • Understand what a voluntary administration is and be able to explain the phases of a voluntary administration. • Be able to explain the responsibilities and powers of a voluntary administrator. • Be able to explain what a deed of company arrangement represents and what role it plays within a voluntary administration. • Understand what a company liquidation represents, and be able to explain the difference between a members’ voluntary liquidation, a creditors’ voluntary liquidation, and a compulsory liquidation.

4. Objectives (cont) • Explain why directors need to provide a statement of solvency as part of the process of entering a members’ voluntary liquidation • Explain the different phases of a liquidation • Understand the duties and powers of liquidators • Understand the duties and powers of directors when various types of external administration are implemented • Understand the reporting requirements of receivers, voluntary administrators, and administrators

5. Objectives (cont) • Know what a report as to affairs is, know when it is required to be prepared and know how to prepare one. • Know how payments to creditors are ranked when a company is liquidated. • Know how to calculate the payment, if any, to shareholders following a liquidation. • Know how to close a company’s ledger accounts at the completion of a liquidation.

6. Solvency vs insolvency • Solvency means being able to pay debts as and when they fall due • Directors’ Declaration • Insolvency means no longer being able to pay debts as and when they fall due • Directors consider vesting control of the company in other individuals (external administration) • External administration includes the company coming under the control of: • a receiver • an administrator, or • a liquidator.

7. Overview of receiverships, voluntary administrations, and liquidations • Receivership—certain creditors, typically those with security over particular assets, appoint a receiver to look after their interests and ensure they receive repayment of their funds before the entity gets into further financial distress. • Voluntary administrations can be activated either by creditors or members (shareholders) of the company, often in situations when ultimate corporate failure is trying to be averted. • Liquidations are undertaken when a company has failed, or a choice has been made to discontinue the organisation and the company is dissolved.

8. There are no accounting standards that deal specifically with external administrations • Most accounting standards are written with the perspective that the reporting entity is a going concern • AASB 136 requires that assets are not be measured at more than their recoverable amount • Recognition of impairment losses • AASB 110 Events After the Reporting Period – impact of valuation of assets

9. When are directors responsible for preparing financial statements? • If a company is in receivership, or voluntary administration it will still need to prepare its financial statements, but the way it values its assets might need to change (consider previous slide). • However, if a company is placed into liquidation then the company directors shall no longer be responsible for preparing financial statements. • Rather, if a company is in liquidation, the liquidator is required to produce specific reports as required by the Corporations Act and submit them to ASIC. Such reports will not be in accordance with accounting standards.

10. Receivership • Debt agreement provides lenders with a promise to pay a rate of interest (usually fixed) for a defined term, identifies a date for repayment of the loan and also identifies any assets over which the debenture/bond holders (creditors) have security. • Impact on assets due to ‘technical default’ of a debt covenant • Appointment of receiver • Powers of receiver • Completion of receiver’s appointment

11. When would a company go into receivership and what is the role of the receiver? • Defaults on a borrowing agreement with secured creditors resulting in a receiver being appointed. • The receiver’s primary responsibility is to secured creditors. • A receiver is not required to call a meeting of unsecured creditors, or to directly report to them. • Receiver’s duties • Debts that arise from the receiver authorising the purchase of goods or services during the receivership • Form 524 Presentation of accounts & statement must be lodged with ASIC every six months.

12. Distribution of money generated through sale of secured assets • The most obvious way in which a receiver will obtain funds for the benefit of secured creditors is to sell assets over which the secured creditors have security. • Pursuant to the Corporations Act there is a ranking order in which received funds are to be applied. The order of payment depends upon whether the creditors are secured by a fixed charge over specific assets, or whether it is secured by a floating charge.

13. If funds are secured by a fixed charge • If money is generated from the sale of assets over which there is a fixed charge then the funds are to be paid to the secured creditor after paying the costs and fees incurred by the receiver in collecting this money.

14. If funds are secured by a floating charge • For a floating charge funds shall be applied in the following order: • receiver’s costs and fees in collecting this money • priority claims (to ‘preferred creditors’), including employee entitlements • repayment of the secured creditor’s debt. • Excess funds remaining after paying the secured creditors • Payment order of employee entitlements under a floating charge: • outstanding wages and superannuation • outstanding leave • retrenchment pay.

15. The role of directors when a receiver has been appointed • The directors continue to hold office despite the appointment of a receiver. • This can be contrasted with the appointment of an external administrator, or a liquidator, in which case the control of the directors would be surrendered to the administrator or liquidator. • When a receiver is appointed, control of the secured property is taken away from the directors. • Directors must also provide the receiver with a report about the company’s affairs and must allow the receiver access to books and records relating to the charged property.

16. Voluntary administration • Voluntary administration is an alternative to liquidation and receivership. • Voluntary administrator’s role • The main goal of instigating a voluntary administration is to attempt to maximise the likelihood that a company will remain in existence, and if this appears unlikely, to at least maximise the returns to be provided to creditors. • A mechanism for achieving these aims is through a document known as a deed of company arrangement. • Requirements to activate a voluntary administration • Restrictions on creditors during voluntary administration

17. Phases of a voluntary administration • There are three main phases to a voluntary administration: • An administrator who is deemed acceptable by the creditors is appointed to by the company directors (or in some cases, by a secured creditor or by a liquidator) to assume control of the company • An investigation is undertaken by the administrator with the view to making a recommendation to creditors about the future of the organisation, and potentially reporting inappropriate conduct to ASIC; and

18. Phases of a voluntary administration (cont.) • The final phase occurs when the creditors make a decision about the future of the organisation, perhaps based on whether they accept the plan suggested by the administrator or alternatively, whether they want to move to liquidation. • Once the creditors make their choice the voluntary administration is concluded. • To achieve the above aims, two meetings of creditors must be held during the period of the voluntary administration.

19. The first creditors’ meeting • Held within eight business days of the commencement of the voluntary administration. • Specific declarations are sent to the creditors. • The purpose of the first meeting is for creditors to consider two main issues: • whether creditors want to form a committee of creditors • whether creditors prefer to replace the existing voluntary with a voluntary administrator of the creditors’ choice. • Voluntary administrator develops a plan which is referred to as a deed of company arrangement. • Powers of the administrator

20. The second creditors’ meeting • Second meeting is held within 23 to 30 days from the date of commencement of the administration. • Administrator provides the creditors with reports about the financial affairs and position of the company. • A report should include the voluntary administrator’s opinion on each of the options available to creditors and which of the options is considered to be in the best interests of creditors. • The possible courses of action would include: • ending the voluntary administration • have the administrator prepare a deed of company arrangement • progress immediately to liquidation.

21. The deed of company arrangement The types of proposals that are to be incorporated within a deed of company arrangement are very flexible, but the deed of company arrangement must specify the following: (a) the administrator of the deed (b) the property of the company (whether or not already owned by the company when it executes the deed) that is to be available to pay creditors’ claims (c) the nature and duration of any moratorium period for which the deed provides • to what extent the company is to be released from its debts • the conditions (if any) for the deed to come into operation

22. The deed of company arrangement (cont) (f) the conditions (if any) for the deed to continue in operation (g) the circumstances in which the deed terminates (h) the order in which proceeds of realising the property are to be distributed among creditors bound by the deed • the day (not later than the day when the administration began) on or before which claims must have arisen if they are to be admissible under the deed. • Once the deed of arrangement is signed, a deed administrator is appointed who replaces the voluntary administrator.

23. The deed of company arrangement (cont) • The deed administrator is an external administrator appointed to oversee the undertaking of activities stipulated within the deed of company arrangement. • The deed administrator may, or may not be, the same party that was the voluntary administrator. • The following figure, Figure 36.1, provides a summary of the various phases of the voluntary administration.

24. Figure 36.1Phases of the voluntary administration process

25. Fees of the voluntary administrator • Payment of the voluntary administrator’s and the deed administrator’s fees. • Review of the amount of fees approved. • Request for sufficient information to enable an assessment of whether the fees claimed are reasonable. • Reimbursement for reasonable out-of-pocket expenses • Order in which creditors’ claims are paid • Employee entitlements

26. Fees of the voluntary administrator (cont.) • Payment of any debts that arise from the voluntary administrator purchasing goods or services, or hiring, leasing, using or occupying property • If there are insufficient funds available from asset realisations to pay these costs, the voluntary administrator can become personally liable for the shortfall. • The deed administrator must lodge a detailed list of receipts and payments with ASIC every six months (Form 524).

27. Powers and roles of the voluntary administrator • When the company is in voluntary administration, directors are relieved of their powers. • However, they are required to provide assistance to the voluntary administrator. • If the company goes from voluntary administration into a deed of company arrangement, the directors’ powers depend on the deed’s terms. • When the deed is ultimately completed, the directors regain full control of the company, unless the deed provides for the company to go into liquidation on completion of the deed of company arrangement.

28. Powers and roles of the voluntary administrator (cont.) • If creditors resolve that the voluntary administration should end because a satisfactory outcome has, or is likely to be achieved, then control of the company returns to the directors.

29. How does a deed of company arrangement come to an end? • The circumstances a deed of company arrangement can come to an end include: • If deed obligations are fulfilled and creditors paid • If deed conditions automatically terminates the deed • If deed termination leads to the company liquidating • if the deed administrator calls a meeting of creditors, and creditors vote to end the deed or put the company into liquidation (continued)

30. How does a deed of company arrangement come to an end? (cont.) • The deed may also be terminated if a creditor, the company, ASIC or any other interested person applies to the Court and the Court is satisfied that: • creditors were provided false and misleading information • the voluntary administrator’s report left out information that was material to the decision to accept the deed proposal.

31. Liquidations • The purpose of undertaking a liquidation of an insolvent company is to have an independent and suitably qualified person (the liquidator) take control of the company so that its affairs can be wound up in an orderly and fair way for the benefit of all creditors. • The broad responsibilities of the liquidator • The role of the Court in liquidations • A liquidator is appointed to take control of the assets of the company, and its management, and acts as an officer of the Court and company. • All powers of directors are suspended. • Once a liquidator is appointed, the contracts of all staff members are treated as terminated, unless the liquidator elects to retain specific employees.

32. Categories of liquidations • There are three broad categories of liquidation: • members’ voluntary liquidation • creditors’ voluntary liquidation • compulsory liquidation. • Voluntary liquidations requires the approval of a 75 per cent majority on a special resolution raised at a meeting of members (shareholders). A members’ voluntary liquidation can only be commenced if a company is solvent and therefore able to pay its debts, and requires little or no Court involvement. Refer to Worked example 36.1: Preparation of a declaration of solvency

33. Members’ voluntary liquidation • Because the company is solvent, all creditors will be expected to be paid. Therefore there is no need to rank the interests of creditors. The liquidator reports directly to the members. • As part of a members’ voluntary liquidation, directors are required, as a precondition for a members’ voluntary liquidation, to provide a report signed by the majority of the directors, called a declaration of solvency which indicates that the sale of company assets will realise, within the next 12 months, funds in excess of those required to pay all creditors plus the costs of the liquidator.

34. Members’ voluntary liquidation (cont.) • The declaration of solvency is a specific document, also referred to as Form 520 (available on the ASIC website) and it is reproduced as Exhibit 36.2 in the textbook. Refer to Worked example 36.1: Preparation of a declaration of solvency

35. Creditors’ voluntary liquidation • A creditors’ voluntary liquidation usually begins in one of two ways: • creditors vote for a liquidation following a voluntary administration, or a terminated deed of company arrangement, or • an insolvent company’s shareholders resolve to liquidate the company and appoint a liquidator. • The directors are required to prepare a Report as to affairson a standard form for the liquidator to present to the creditors’ meeting. This form is known as a Form 507, a copy of which is provided in Exhibit 36.3 in the textbook.

36. Creditors’ voluntary liquidation (cont.) • A statement, known as a Summary of Affairs (Form 509) would be sent out to creditors at the time as the notice of intention to hold a creditors’ meeting to consider a creditors’ voluntary liquidation. • The liquidator shall ask creditors if they wish to appoint a committee of inspection and, if so, who they would want to have to represent their interests on the committee. • Minutes of the committee of inspection meetings must be prepared and lodged with ASIC within one month of a meeting.

37. Compulsory liquidation • The third general type of liquidation to consider is a compulsory liquidation. • In a compulsory liquidation, a liquidator is appointed by the Court to wind up a company, following an application, usually by a creditor. • A compulsory liquidation, like a creditors’ voluntary liquidation, is under the control of the Court and the liquidator is deemed to be an officer of the Court. • Court-appointed liquidators have all the powers that directors would have had if the company were trading normally.

38. Responsibilities of the liquidator • Before assets can be sold they have to be identified. • In determining what assets the company owns , reference will be made to previous financial records, the Report as to Affairs of a company (Form 507) and the Statement of Solvency (Form 520). • The liquidator will then be permitted to take control of all identified assets, other than those for which a receiver has been appointed to act on behalf of secured creditors. • Once assets are found, the liquidator must try to sell them at the best price possible. • Selling the company as a going concern often generates a greater return than would be the case if assets were sold separately.

39. Identifying creditors – who are they? • The liquidator is required to pay creditors’ claims to the extent there are sufficient funds. • But what, or who, constitutes a creditor? • Creditors’ claims need to be ‘proved’ either by evidence available within the company’s records, or by way of a formal ‘proof of debt’ form that a creditor is required to submit to the liquidator. • The liquidator will attempt to discover all claims owing by the company by reviewing company’s records, receiving proof of debts forms, and writing to parties who are potentially owed funds.

40. Ranking of creditors in order of payment • If there are sufficient funds available to pay all creditors then ranking the claims of creditors would not be necessary. • Required ranking is largely stipulated within the Corporations Act. • After payment of the costs of the receiver/administrator/liquidator in respect of assets with fixed charges, the liquidator shall distribute the proceeds of realisation first to secured and priority creditors (referred to as preferred unsecured creditors and include employees), and then to unsecured creditors.

41. Preferred unsecured creditors • They are given preference by virtue of legislation – hence they are referred to as preferred unsecured creditors. • Employees rank before creditors with a floating charge over an insolvent company’s assets where the assets of the company are insufficient to meet priority creditor payments. • The Corporations Act identifies a number of preferred unsecured creditors. • Amounts payable to employees under Australian law are not capped. • Limits are placed on ‘excluded employees’.

42. Payment to shareholders on liquidation • Payments to owners (shareholders) is only made after amounts due to creditors has been fully paid. • If dividends have been declared and authorised but not paid, then these will be treated as a creditor and will be paid after other creditors have been paid. They represent deferred unsecured creditors. • The distribution of funds to shareholders is premised on the assumption that all classes of shares are treated equally, unless clear evidence to the contrary exists. • It determining how much is to be paid to shareholders, unpaid capital must also be taken into account to determine the net amount payable or receivable from shareholders.

43. Periodic reporting of the liquidator • The liquidator must submit a report each six months to ASIC, as well as at the point when their appointment is terminated. Form 524 (ASIC) provides the basis of this report and requires the liquidator to provide: • Detailed information about receipts and payments for the period • A summary of all receipts and payments since inception of liquidation • Details of the cash position of the liquidated company • Details of payments being made to creditors as well as to the liquidator.

44. Closing a company’s accounts • Before deregistering a company there is an expectation that the company’s ledger accounts be closed off. • To do this we transfer various account balances to some newly established summary accounts that are used as part of accounting for a liquidation, and then we also close off those accounts. • There is flexibility in terms of the summary accounts that are established on liquidation, but for our purposes we will create three new accounts: • a liquidation account • a receipts and payments account (and there may be more than one of these accounts) • A members’ distribution account. Refer to Worked example 36.5 – Closing the accounts of a wound-up company

45. Deregistering a company • Once all assets have been sold and all funds have been dispersed, firstly to creditors and then to members (shareholders) if there are any funds remaining, the liquidation is considered to be complete. • However, the company will continue to exist until such time as it is deregistered. This will occur when the liquidator applies to ASIC to have the company deregistered. • Formal notification of intent to deregister will then be made by ASIC (in such places as the Commonwealth of Australia Gazette), followed two months later by deregistration.

46. Summary • This chapter has explained the various types of external administrations that a company might enter. • In particular we have considered the appointments of receivers, voluntary administrators, and liquidators. • We learned that receivers are typically appointed by secured creditors when a company has defaulted on its obligations to the secured creditors. • We learned that when there is a possibility that a company might become insolvent then a voluntary administrator might be appointed to subsequently make recommendations about the future of the company.

47. Summary (cont) • The appointment of a voluntary administrator might ultimately involve the development of a company deed of arrangement which creditors can then vote to accept, or reject. If they reject the proposal then the company might advance to liquidation. • We also learned that liquidations can be classified as members’ voluntary liquidations, creditors’ voluntary liquidations, and compulsory liquidations. • Members’ voluntary liquidations can only be instigated when a company is solvent and this must be demonstrated through the production of a declaration of solvency.

48. Summary (cont) • For a creditors’ voluntary liquidation and a compulsory liquidation there is much more regulation, relative to a members’ voluntary liquidation. • This is because in these liquidations the company will typically be insolvent and therefore there is a requirement to protect the interests of creditors and to determine a ranking system wherein the payments to certain creditors are prioritised over others. • We discussed how to calculate payments to shareholders upon liquidation, albeit that in many liquidations, shareholders will ultimately receive nothing. • We learned how to close off the accounts of a company that has been liquidated.