The appointment of an insolvency practitioner can be a great cause for concern for the creditors, as it is usually an indication of the end of a company. The debtor company is most likely in serious financial strife at this point, and so it is important to know the key differences between voluntary administrations, liquidations, receiverships, and bankruptcy, and how, if at all, these different situations can affect creditors of a fiscally insecure company.
The main difference between receivership and other means of dealing with an insolvent company is that a bank or other form of ‘secured’ creditor normally chooses the receiver. This means that the bank can ensure they get paid. Therefore, it is the primary role of the appointed receiver to act solely on behalf of the secured creditor and not on behalf of all other creditors. For the majority of cases, the appointment of a receiver occurs under the provisions of a security instrument, which stipulates the functions of the receiver. Ordinarily, a court order is not necessary to appoint a receiver. Depending on what kind of security, a receiver may be appointed for the sale of secured assets, or, additionally, to take over from the directors in controlling the company to continue business on behalf of the insolvent company. Although receivership is clearly a bad indication for the unsecured creditors, it doesn’t always indicate that the company won’t survive. Practically speaking, however, it is not uncommon for an administrator or a liquidator to be appointed as a representative of those unsecured creditors during the receivership stage of a company.
A company in administration is either about to become insolvent, or already insolvent (i.e. cannot service its debts). Administrators, more often than not, receive appointment when the directors of the company pass a resolution, although they can also be appointed by a liquidator, secured creditor or via a court order. The job of a voluntary administrator is to inspect the company’s books, to communicate with creditors on these findings and to make a recommendation to these creditors as to what the company should do. In practice, when a company enters voluntary administration, there are generally two probable outcomes:
- Arrange for the company to enter into a deed of company arrangement (“DOCA”). This is a formal agreement between a company and its creditors outlining how the company’s affairs will be handled, which may be agreed to as a consequence of the voluntary administration of the company. Or;
- Enter into liquidation.
The other, more seldom, outcome is that, upon evaluation of the company’s affairs, the administrator suggests the company be returned to the directors. The creditors, at a meeting that takes place around 26 days after having appointed the administrator, eventually decide the outcome of the company. Whether the company enters into a DOCA or goes into the liquidation stage is decided by the creditors’ majority vote. The number of votes, as well as the value of the holding in the company, measures this ‘majority’, and the decision is made at this meeting. A DOCA can result in a number of outcomes. For example, it might lead to:
- a continuation of the company’s trading;
- the directors or other parties making funding contributions;
- the refinancing of company debts; Or,
- the sale of company assets
The principal goal for a company using a DOCA is to ensure a larger return to creditors than they could secure in liquidation.
Liquidation occurs when a company is ‘winding up’ or finishing its operations. It involves a liquidator accounting all of the company’s assets, the company ceasing to operate, and the distribution of funds to creditors and shareholders (when possible). The moment a company goes into liquidation (by voluntarily electing or by court order), it is more likely than not that the company won’t survive. The liquidator is given the task of:
- turning the company’s assets into cash; and
- sharing the proceeds between the creditors.
The distribution of these funds to the creditors is determined by the priority of interests stipulated in the Corporations Act 2001 (Cth). This, however, is subject to change if there are secured interests at play. Normally, these creditors only salvage a portion of the debt owed to them by the company. Once all of the funds have been accordingly dispensed between the creditors and the activities of the company have been concluded, the liquidator will have ASIC take the company off its register.
Bankruptcy is another insolvency procedure, however, it only applies to a person, not a company. A person becomes bankrupt when they have been declared bankrupt under the provisions of the Bankruptcy Act. To avoid being made bankrupt, an individual may enter into a Personal Insolvency Agreement, which is an agreement with the creditors. It is worth noting that once an individual becomes bankrupt, according to the Corporations Act, he or she will become disqualified from directing or managing a corporation, unless a court says otherwise. For legal advice on the various business structures, contact LegalVision on 1300 544 755.