Corporate Insolvency: Consequences and Processes

1. Week 6: Corporate Insolvency LAW2457 Law of Investments and Financial Markets

2. Questions / clarifications

3. This week’s readings • Chapter 5

4. Some important concepts • Receivership • Voluntary administration • Liquidation

5. What are the consequences for an investor when a company suffers financial difficulties? • Loss in value of their investment • Investors who have partly paid shares may become liable to contribute towards the company’s debts. • Investors need to know the consequences of deregistration and to ensure they aren't deprived of their legal rights though failure to act or • the elapsing of time.

6. Receivership • Secured creditor appoints a receiver • This arises because there is default • A receiver appointed by a secured creditor takes possession of secured property, sells it, repays the secured creditor and accounts for any surplus to the company. • This can be achieved without going to court. • A company is in receivership when a receiver is appointed over some or all of the company’s property.

7. Who is a receiver ? • A receiver is a person who receives the income and pays the outgoings of property. • The receiver’s primary role is to collect and sell sufficient of the company’s charged assets to repay the debt owed to the secured creditor.  A receiver is a liquidator registered with ASIC

8. Appointment • Receivers are appointed by the secured creditors • They are thus responsible to the secured creditors • However they can also be appointed by: • Minority shareholders if there is oppression • ASIC for the purpose of investigation • Court

9. Powers of a receiver • The powers of the receiver are derived from the charge / debenture / loan document • Section 420(1) of the CA outlines a general power (all things necessary and convenient) • Section 420(2) of the CA outlines specific powers (possession, lease, repair, take out insurance, execute documents)

10. Duties of a receiver A receiver has duties to their appointor but must also act in good faith towards the company. • Controller must serve notice of appointment on company: s 429(2) • Copy of notice must be given to ASIC within 7 days: s 427(2) • All public documents must state receiver has been appointed: s 428 • Controller must open and maintain a separate bank account: s 421 • Report to ASIC any misappropriations, negligence, breach of duties or breach of trust: s 422

11. Duties continued … • Officer of the company liable for common law duties under s 180, 181, 182 and 183 • Section 420A – must take reasonable care in selling assets • Section 423 – if any breach of duties, ASIC can investigate.

12. Liability of receiver • A receiver is an officer of the company -> breaches may result in civil penalties • Considered an agent of the company • Can be liable for breach of officers’ duties: ss 180-184 • Supervision of controllers by ASIC or court: s 423

13. Termination of receiver • The receivership is terminated when the objective is achieved and the monies are paid back to the lender. • If there is any surplus on sale of assets this goes to the company • If circulating security interest: receiver must pay employee wages and entitlements before paying appointor: s 433

14. What happens to unsecured creditors?

15. Receivership process summary Jeffrey F Fitzpatrick et al, Business and Corporations Law (LexisNexis, 2nded, 2014) 619

16. Voluntary administration • Once a company has been in receivership, what are the financial consequences? • The company has lost assets, which have been sold BUT • no cash has come into the company. • The company is likely to be in a hopeless financial position and is very likely insolvent now or likely to be in the short term.

17. The company directors are faced with a dilemma. • Do they continue on trading but run the risk of insolvent trading • OR • Should they wind up the company?

18. Voluntary Administration • The directors would likely seek the advice of their accountants who recommend the appointment of a voluntary administrator under s 436A; VA does not need the approval of: • shareholders, • creditors or • the court.

19. Why would directors of a company appoint an administrator? • To maximise the chances of the company continuing, or • if not possible, to achieve better returns to creditors or shareholders than immediate winding up: s 435A CA • To avoid insolvent trading and • be personally liable: s 588G

20. Process • An administrator is appointed by directors or secured creditor • Administrator must be registered liquidator: s 1282 • The administrator takes control of company for a short period of time • Administrator investigates financial affairs – creditor meetings (preliminary & meeting to decide) • Report back on whether arrangement can be entered into or if company should be liquidated.

21. Diagram of process Page 546 of textbook

22. Powers of an Administrator Section 437A(1) outlines powers of an administrator: • Control the company’s business, property and affairs; • Carry on business and manage property • Terminate or dispose of business or dispose of property • Can perform any function or any power that company can perform

23. What can creditors decide ? Section 439C outlines 3 options for creditors: • Company can execute a deed of company arrangement; or • That administration should end; or • That the company should be wound up.

24. Deed of Company Arrangement • Procedure that sees the company making compromises or arrangements that are binding on all of the creditors • Its effect is to terminate the voluntary administration – binding on company and creditors • Majority of creditors must approve • s 444D CA

25. What is liquidation? • Liquidation involves a liquidator selling off the company’s assets and distributing the proceeds among the company’s creditors and if any funds are left over then they are distributed to the members. • The terms liquidationand winding-up tend to be used interchangeably but mean the same. How is liquidation different to bankruptcy? Bankruptcy is the term used for individuals when they are unable to pay their debts when they are due and payable

26. Types of winding-up of a company There are two forms of winding-up: • Voluntary winding-up • Members’ voluntary winding-up • Creditors’ voluntary winding-up • Compulsory winding-up • Ordered by a court If company is solvent If company is not solvent

27. Voluntary winding-up A members’ voluntary winding-up can only take place if the company is solvent. The process is: • The directors must declare in writing that the company is able to pay its debts in full within 12 months of winding up per s 494 CA, • A special resolution must be passed by the members (more than 75%), • The members appoint a liquidator Why would the members want to wind up a solvent company? If the liquidator is of the view that the company cannot pay debts in full within the 12 month period, it can • Apply to court for winding up or, • Appoint administrator (converts to voluntary administration) or, • Call a meeting of the company’s creditors (coverts to creditors’ voluntary winding up)

28. Creditor’s voluntary winding up • A creditor’s voluntary winding up may be the consequence of administration. • Two options: • Company’s members pass a special resolution that the company be wound up, where the directors have not made a solvency declaration: s 491 and s 494; or • Creditors vote to wind up the company: s 446A

29. What are the consequences of a voluntary winding up? • The company stops business from the time of resolution, and the liquidator is appointed. • Any transfers of shares are void unless liquidator or court approves the transfer. • The directors lose all management powers from the time of the liquidator’s appointment. • The liquidator’s job is now to realise the company’s assets and to pay out the creditors in certain order.

30. Compulsory winding-up • A compulsory winding-up is commenced and conducted under the control of the court. • It arises because a creditor has made application to the court to wind up a company that is insolvent or • there has been a falling out between directors and they cannot work together and the most suitable option is to liquidate the company.

31. What are the grounds for a compulsory winding-up? If there is no insolvency, refer to the following grounds: • the company has not commenced business within one year from its incorporation: s 461(1)(c) • the company has no members: s 461(1)(d) • the directors have put own interests before company affairs of company have been conducted in an oppressive manner: s 461(1)(e) • the court believes it is just and equitable to wind up the company: s 461(1)(k) • If a company is insolvent then court can order that an insolvent company be wound up: s 459A • Section 459P contains a list of people who can apply to have a company wound up

32. What is insolvency? The term is defined in s 95A CA. (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.

33. What does unable to pay debts mean? • In order to decide whether the company is unable to pay debts, the courts look at the cash flow test. • This test basically means does the company have any money from anywhere to pay the debts when they become due and payable. • How does this differ from short term liquidity issues? • Short term liquidity normally means that there is cash sufficient to cover the creditors but it will not arise for a period of time. Insolvent means there is no cash at all. What are the factors that a court will look for as signs of insolvency?

34. Presumptions of Insolvency To assist the court in proving insolvency s 459C(2) CA provides for several presumptions of insolvency. If a company meets any of the following then the court can presume the company is insolvent and order it to be wound up: • If the company does not comply with a statutory demand, • If the company fails to comply with any other court order o • A receiver of the company is appointed or, • An order was made for the appointment of a receiver of the company.

35. Statutory Demand • Failure to comply with a statutory demand is the most common presumption of insolvency per s 459C(2)(a) CA. • A statutory demand is a form setting out the debt owing as per s 459E(2) CA. • The specific requirements are: • The debt must be at least $2,000. • It must be in writing and signed by person claiming money. • It must be accompanied by affidavit confirming the above is true and correct. • Payment is demanded within 21 days of service of the notice. • Notice should be served at the registered office and not the place of business which may be the accountant’s office. • If the company fails to comply with the statutory demand then company is presumed insolvent by the court.

36. Appointment of the liquidator • A liquidator must be a registered liquidator (registered by ASIC) and appointed by the creditors, members or the court. • Who are disqualified from acting as liquidator? The liquidator must not have a conflict of interest: s 532(2) CA

37. What are the duties and functions of a liquidator? • they must conduct impartial investigation of the company’s affairs • they must take possession of company assets • they must realise the company’s assets • they must keep proper financial accounts • they must lodge notices with ASIC regarding his appointment • they must report if there are any breaches of CA • they must prepare a statement of financial position every 6 months • they must determine the debts payable by the company

38. Duties and functions continued … • they must distribute the proceeds amongst those with legitimate claims • they must distribute any surplus to the members • they must arrange to deregister the company • they can sell the company property • they can carry on the company’s business but only to the extent necessary to wind up the business • they may make a compromise or arrangement with the creditors, but court approval is needed for amounts over $20,000 • they can bring or defend legal action in company’s name • they can make calls on contributories • they can get information about the company.

39. What are the effects of a compulsory winding-up? • The impact of a winding up on the directors and officers under s 471A CA is that they cannot perform or exercise the functions or powers as a director. • Persons cannot take proceedings against the company or its property under s 471B CA. • The company cannot proceed with any legal action or be party to any legal action against it. • The members cannot transfer their shares. • The company continues on but is subject to the control of the liquidator and cannot carry on business. • All public documents of the company must have the words “in liquidation”. • The unsecured creditors cannot take action to recover their debt but the rights of secured creditors not affected under s 471C CA.

40. What property of the company is available to the liquidator? • any property owned by company at the time of the winding-up order or passing of resolution to wind up the company • any property after the commencement of the winding-up, for example, ‘antecedent voidable transactions’ • amounts due from contributories e.g. partly paid shares • compensation recovered from officers for breach of duties • property recovered from officers pursuant to action for fraud or negligence under s 598 CA • any void dispositions of property as per s 468 CA.

41. What are voidable antecedent transactions? • These are transactions that were entered into by the company and another person e.g. a creditor or related party such as a director, shareholder or family member before(antecedent) the company was wound up. • The liquidator can apply to court to make pre-liquidation transactions voidable and recover the value of the property to benefit the unsecured creditors. • Pursuant to s 588FC it is a transaction that was entered into when the company was insolvent

42. Types of antecedent voidable transactions under s588FE Example: Paying one creditor in full whereas the other creditors receive 15c in the dollar. • unfair preference: s 588FA(1) • uncommercial transaction: s 588FB(1) • transaction to defeat creditors: s 588FE(5) • unfair loan: s 588FD(1) • unreasonable director related transactions: s 588FDA Example: Buying an asset for more than market value or selling an asset for less than market value Example: Taking out a loan with an extraordinary high interest rate e.g. 8% a month Example: A few months before liquidation, directors approve a large bonus payment to two managing directors

44. Time frames • unfair preference – 6 months or 4 years if a related party • uncommercial transaction – 2 years • transaction to defeat creditors – 10 years • unfair loan – Void anytime • unreasonable director related transactions – 4 years

45. A few matters to note • Defences to creditors if liquidator demands repayment: s 588FG • Court can make orders in relation to voidable transactions: s 588FF • How do creditors prove the amount they are owed? Proof of debt form –form 535

46. Distribution to Creditors • Once the liquidator has collected all the assets it is their job to now distribute the funds. There is an order in which the liquidator will distribute. • The order of distribution is: • Secured creditors that are non-circulating security interest holders • Preferential creditors • Costs of recovery and realising the property • Costs of application to wind up • Costs of orderly winding up • Fees of liquidator • Employees entitlements (but limits on amounts payable to a director: ss 556(1A) and 556(2) CA) • Secured creditors that are circulating security interest holders • Unsecured creditors • Members/Investors/Shareholders

47. Example of a distribution • EXAMPLE: • Assume the liquidator collects $5 million • Non-circulating secured creditors $2m • Preferential creditors+ $1m • Circulating secured creditors $1.5m • Balance left $.5m

48. Example continued … • The total of unsecured creditors who proved their debts are: Debt Distribution • Wages $25,000 $15,310 • Directors fees $4,692 $2,873 • Accountant $13,784 $8,441 • Creditor A $85,000 $52,052 • Creditor B $158,000 $96,757 • Creditor C $250,000$153,097 • Creditor D $280,000 $171,470 Total: $816,476 $500,000

49. Paripassurule • Latin – on equal footing • The distribution in the previous example is approximately 0.61239c in the dollar ($500,000/$816,476) • This is known as the paripassu rule which allows for an equal sharing of the remainder amongst the unsecured creditors as set out in s 555 CA.

50. Deregistration of a company • Once the liquidator has distributed the final amount the next task is to deregister the company under s 601AD(1) CA. • Once deregistered the company ceases to exist but the directors and officers are still liable for things done when the company was in existence.