Times are tough at the moment and many businesses are struggling financially.
Insolvency occurs when your business cannot pay its debts, which can result in your business closing down. Different insolvency procedures apply to individuals and companies.
Personal Insolvency applies to sole traders and individuals in a partnership. First of all you should talk to the people or organisations you owe money to, as they could give you more time to pay, agree to re-negotiate repayments or accept a smaller amount in payment to settle the debt.
If you are unable to manage your debts, the Bankruptcy Act 1966 (Cth) provides formal options for dealing with unmanageable debt:-
- Debt agreements – this is a binding agreement between you and your creditors where creditors agree to accept a sum of money you can afford;
- Personal insolvency agreement – legally binding agreement with creditors where you offer to pay them in full or part by instalments or a lump sum;
- Voluntary bankruptcy – you cannot reach a compromise or settlement with your creditors, you can become bankrupt.
Bankruptcy is a legal status of a person that cannot repay the debts it owes to creditors. You can voluntarily lodge a petition to become bankrupt (called a debtor’s petition) or a creditor may take action to have you declared bankrupt by order of the Court (called a sequestration order).
Legal alternatives to bankruptcy from a creditor’s perspective include the ordinary means of obtaining and enforcing judgment for debt through the Queensland Civil and Administrative Tribunal (“QCAT”), or through the courts.
Declaring bankruptcy is a serious decision. There will be a permanent record of your bankruptcy on the National Personal Insolvency Index (“NPII”), which is an electronic register of all personal insolvency proceedings. The NPII can be accessed by any person and will include some personal information about you, including your name, date of birth and address. Commercial credit reporting agencies can keep a record of your bankruptcy on your credit report for up to five (5) years, or longer in some circumstances.
A trustee is appointed to administer the bankruptcy. The duties of a trustee are specified in legislation and trustees have to adhere to certain standards while administering your estate. In order to pay creditors, your trustee will:-
- sell your assets, including those you acquire or become entitled to during your bankruptcy (although you will be able to keep certain types of assets);
- recover any income you earn over a certain limit;
- investigate your financial affairs and may, in certain circumstances, recover property that you have transferred to someone else prior to your bankruptcy.
During and after your bankruptcy, you have certain obligations and face certain restrictions.
Bankruptcy may last up to three (3) years or more and will affect your ability to:-
- borrow money;
- travel overseas;
- perform certain jobs.
Company Insolvency – an insolvent company is one that is unable to pay its debts. Directors of Companies have a duty to ensure their company does not incur debts they are unable to pay while the company is insolvent. Directors breach this duty and expose themselves to personal liability if the person is a Director at the time the company incurs a debt and the company is already insolvent, or becomes insolvent by incurring that debt, and there are reasonable grounds for suspecting the company is or would be become insolvent at that time.
Some signs that your company may be trading while insolvent are the following:-
- Cash flow difficulties;
- Difficulties selling stock or collecting debts owed;
- Creditors not being paid on agreed terms or requesting Cash-on-Delivery;
- Ongoing trading losses;
- Overdue Commonwealth and State Taxes;
- Holding back cheques for payment, or issuing post-dated cheques which may be dishonoured;
- Legal action against the company or judgments for outstanding debts.
The potential consequences for the Director of a company that is trading insolvent are the following:-
- Compensation – Directors can be personally liable to pay creditors the amount of the debt incurred while the company was insolvent;
- Civil Penalties – the court can disqualify the Director from managing companies, and impose a penalty up to $200,000 and order the payment of compensation for any loss or damages to creditors;
- Criminal Penalties – if the Directors failure to prevent the company from trading insolvent was dishonest, the court can impose a fine of up to $220,000 imprisonment for up to five (5) years, or both.
Directors have a defence against a claim for insolvent trading if they can prove they had every reason to expect that the company could pay the incurred debts, which may or may not be based on incorrect information from competent persons, or they took all possible steps to prevent the company incurring debt, or at the time the debt was incurred they had a good reason why they were not contributing to the management of the company at that time.
Types of Company Insolvency – The three most common types of corporate insolvency are voluntary administration, liquidation and receivership.
Voluntary administration is where the Directors of a financially troubled company or a secured creditor with a charge over most of the company’s assets appoint an external administrator called a ‘voluntary administrator’ whose role is to investigate the company’s affairs, to report to creditors and to recommend to creditors whether the company should enter into a deed of company arrangement, go into liquidation or be returned to the Directors.
A Deed of Company Arrangement is a binding arrangement between a company and its creditors governing how the company’s affairs will be dealt with, which may be agreed to as a result of the company entering voluntary administration. It aims to maximise the chances of the company continuing, or to provide a better return for creditors than an immediate winding up of the company.
Liquidation – In some situations, insolvent companies may go into liquidation. Liquidation is the orderly winding up of company business. It involves stopping all operations and sales, selling company assets to pay creditors and distributing any surplus funds among shareholders.
There are three (3) types of liquidation:-
- court liquidation – usually initiated by a creditor’s application to the court;
- creditors’ voluntary liquidation – liquidation initiated by the company;
- members’ voluntary liquidation – initiated by shareholders.
Receivership – A company most commonly goes into receivership when a receiver is appointed by a secured creditor who holds security or a charge over some or all of the company’s assets. The receiver’s primary role is to collect and sell enough of the company’s charged assets to repay the debt owed to the secured creditor.
If you are struggling to pay your debts then you should seek professional advice as to which of the above options is the most appropriate in your situation.