A Guide to Insolvency Law for Individuals and SME’s

If an individual or a company is no longer able to pay their debts when they become due and payable it maybe insolvent. There are a number of tests which the courts can use to determine whether a company is insolvent including a cash-flow and balance sheet test.

When a party becomes insolvent, an insolvency practitioner may be appointed to manage the affairs of that party this can take the form of bankruptcy, liquidation or receivership.

To help understand insolvency law obligations and relief which may be available in these circumstances, we have created a simple and easy to follow guide to insolvency.

1. Safe Harbour Provisions

The Corporations Act 2001 (Cth) provides protection for directors from insolvent trading liability in certain circumstances. Ordinarily, directors of companies may be held personally liable for debt incurred from trading whilst insolvent and can face a range of penalties.

Safe Harbour provisions provide an exception to these rules in some circumstances including where a director is in the process of developing a course of action which is ‘reasonably likely’ to lead to a better outcome for the company than administration or liquidation and where the debt incurred is directly or indirectly linked with that course of action in a specific time period.

These provisions effectively encourage directors to take early intervention and formulate a recovery plan. Directors seeking to rely on this regime should be aware, however, that they will have the evidential burden of proving a reasonably possibility of the existence of a better outcome in continuing to trade.

These provisions will not be available for directors who do not:

Keep proper books and records
Provide employee entitlements
Maintain up to date tax reporting
Obtain advice from an appropriately qualified restructuring advisor

3. Receivership

When secured creditors are owed money from a company that is in default under a loan provided by the bank or under agreements with either suppliers or leasing providers they may appoint a receiver.

Secured creditors are those who hold a security interest in some or all of the company’s assets and may be owed money by a company for supplying goods or services or loans to a company.

A receiver is independent officer of the court appointed to collect and sell enough of the secured assets to repay debt owed to the secured creditor. They have various duties under the Corporations Act to report possible offences and other irregular matters to ASIC as well as obtain market value for any assets sold.

4. Liquidation

Liquidation is where a liquidator is appointed to wind up the company’s financial affairs and dismantle the company’s structure in an orderly way. This person is usually appointed by creditors or shareholders.

A liquidator’s role is to investigate any valuable assets that can be sold and conduct a review of the affairs of the company as to whether there are any previous transactions that may be avoided for being unfair, and is initiated by a court order.

Liquidation is the only way to completely wind up a company and shut it down.

5. Bankruptcy

Bankruptcy is the legal process in which a trustee is appointed to a individual to manage an estate. This process provides relief to individuals and companies not able to pay debts by discharging them of most debts and stopping debtors having to deal with the individual personally.

A trustee managing the bankruptcy will typically take control of debts, income and assets which they can sell to pay off debts and enforce compulsory payments from the bankrupt individual if their income exceeds a certain amount.

This process occurs when a person or company either voluntarily makes an application for bankruptcy or where a creditor initiates bankruptcy proceeding for money owed to them.

6. Guide to insolvency relief

In response to COVID-19, the Federal Government has introduced a number of measures which also act as a guide to insolvency relief and assist businesses facing economic hardship. This includes a temporary elimination of action against directors for personal liability incurred in the ordinary course of business when trading whilst insolvent. This will not apply to criminal penalties where the debt has been incurred dishonestly or fraudulently during the period.

The Australian Securities and Investment Commission (ASIC) also has the power to offer relief for some provisions or to not take action for failing to comply with provisions of the Corporations Act.

Notably, the minimum amount of debt required for statutory demands has also been increased. A statutory demand is a document issued by a creditor under Section 459E of the Corporations Act which demands payment of a debt owed. Originally the debt required for this to be issued was $2,000 which has now been increased to $20,000 and companies have six months instead of 21 days to respond to such a notice.

For bankruptcy, the debt threshold for applying a bankruptcy notice, or a demand for the payment of money by a creditor, has similarly been increased from $5,000 to $20,000 and debtors will have also six months rather than 21 days to respond to such a notice.