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What is Insolvency

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This may sound like a pretty simple question, but honestly, it is a very confusing event when this happens to your debtor.

Insolvency refers to a company that can’t pay its debts when they fall due.

It is an offence of the Corporation Act to run a company that is not solvent.
There are three procedures that are generally taken out when a company becomes insolvent.

These procedures may be self-imposed or imposed by external forces. The following refers only to a company.

1. Voluntary Administration: This is when either the directors or a major creditor appoints an external administrator to sort out the affairs of the company. An administrator will make recommendations to creditors in regards to the financial status of the company and work towards a resolution. Being under administration is not the end of the company. At this stage they are brought in to assist in getting the company back on track. The outcome may be that the company is handed back to the directors, or the company may have no option but to enter liquidation, or the company may enter into a Deed of Company Arrangement with the creditors.

While a company is under administration unsecured creditors cannot commence or continue legal action against the company. If there are lease agreements for machinery or equipment that are unsecured with the company these will be ceased by the administrators and cannot be recovered. A court application to put the company into liquidation cannot be commenced. If a creditor has a personal or directors guarantee they cannot act on this without the courts permission.
The role of the administrator is to give the company breathing space while the affairs of the company are sorted out.

2. Liquidation: This is the orderly winding up of a company, whereby decisions are made as to what will happen to the company’s assets, the distribution of proceeds from sale of assets, and the cessation or sale of the company. The Liquidator’s role is to provide a professional, orderly and fair manner of winding up the company.

After a company goes into liquidation unsecured creditors can no longer continue or commence legal action against the company unless they have permission from the court. If the liquidator suspects the company directors have acted illegally they can report this to ASIC for investigation.

A liquidator may investigate all payments made to creditors in the previous six months of being appointed to determine if any creditor has received unfair payments. If they believe this is the case then a creditor may be required to return payments to the company to be fairly distributed. Unfair payments to creditors are deemed so if the creditor was aware the company was trading insolvent at the time of the payment, putting them at an unfair advantage to other creditors.

3. Receivership: This is when a secured creditor appoints a receiver to the company to sell or liquidate assets for the sole purpose of paying out the secured debt in their charge. A receivership only deals with their debt. Once their debt is paid the receivers hand back the company to the directors. Once again if the receivers believe there has been an offence committed by the company they are required to report this to ASIC.

The receivers are responsible for ensuring that any assets are sold for their market value as to not disadvantage the company and any creditors.

It is possible that a company can be in receivership and under administration at the same time.

An unsecured creditor can commence legal action or continue legal action against a company when it is in receivership. This means that an unsecured creditor can commence winding up procedures and have the company put into liquidation for unpaid debts through the courts.

In the process of insolvency a Dead of Company Arrangements may be entered into. This is a binding agreement between the company and its creditors as to how the proceeds of the company will be distributed. The aim of this is to maximise the company’s chances of trading out of insolvency, to enable a better outcome for creditors and to prevent immediate winding up procedures.

When a person becomes insolvent the procedure is generally Bankruptcy.


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