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PERSONAL FACTSHEETS

The following outlines the FAQs in Personal Insolvency administration matters.

What is bankruptcy?
Bankruptcy is a legal process where a trustee is appointed to administer an insolvent person’s affairs, in order to provide a fair distribution of that person’s assets to their creditors. Bankruptcy is a legitimate and just way for a debtor to solve their debt problems, and it is one way for creditors to take action against someone for unpaid debts.

Why choose bankruptcy?
The Bankruptcy Act 1966 exists to protect debtors (i.e. the bankrupt) and creditors.

The debtor is protected from being pursued by creditors and, with limited exceptions, is released from their debts at the end of the bankruptcy. Bankruptcy provides a debtor with a fresh start.

Bankruptcy protects creditors’ interests by having an independent, qualified accountant control and investigate the bankrupt’s affairs, and collect and distribute the bankrupt’s assets.

How does a person become bankrupt?
A person may become bankrupt in one of two ways.

1. Self-initiated: debtor’s petition

A person can bankrupt themselves by filing a ‘debtor’s petition’ and a Statement of Affairs with the Official Receiver. This process is referred to as ‘lodging a debtor’s petition’. A person is made bankrupt when the Official Receiver processes the debtor’s petition and issues an estate number.

2. Creditor-initiated: creditor’s petition

A creditor can apply to the Federal Court through a ‘creditor’s petition’. In most instances, a creditor must have a court judgment on their debt and served a ‘bankruptcy notice’ on the debtor. If the debt remains unpaid at the bankruptcy notice’s expiry, the creditor may file a creditor’s petition with the Federal Court seeking a sequestration order—bankrupting the debtor.

What is a statement of affairs?
A Statement of Affairs must be completed by all bankrupts and sets out their personal and financial information. A Statement of Affairs is an important document for two reasons:

1. It is the financial disclosure of a bankrupt’s assets and debts, and this information is used by the trustee in administering the estate.

2. The date the Statement of Affairs is lodged will determine when the bankruptcy ends (i.e. the date of discharge).

Can a debtor be made bankrupt if their assets exceed their debts?
Yes. A person is legally insolvent if they are unable to pay their debts when they fall due. If a debtor owns sufficient assets to cover their debts, but is unable to liquidate them (i.e. sell them or borrow against them) to actually pay the debts, they can be bankrupted. Technically, a debtor is legally insolvent if they do not satisfy a bankruptcy notice, regardless of whether they can pay the debt or not.

However, the Official Receiver has the discretion to not accept a debtor’s petition if they believe that the debtor is solvent and could satisfy their debts.

Who looks after a bankrupt estate?
When a person is made bankrupt, a bankruptcy trustee is appointed to administer the bankrupt’s estate.

The trustee is an appropriately qualified and registered specialist accountant who is either an officer of the Federal Court (i.e. a registered trustee) or a public servant (i.e. the Official Receiver).

A person presenting a debtor’s petition or a creditor’s petition can obtain consent from a registered trustee of their choice. If no consent is obtained, the Official Receiver will be the trustee.

What are the trustee’s powers?
A trustee has the power to:

  • sell any divisible property of the bankrupt
  • investigate the affairs of the bankrupt
  • examine the bankrupt and others under oath
  • conduct and sell any business of the bankrupt
  • admit debts
  • distribute dividends.

The trustee can exercise all the rights and powers that the bankrupt had before they became bankrupt. In addition, the trustee has recovery powers that the bankrupt does not have.

In summary, the trustee will:

  • find and protect the assets of the bankrupt
  • realise those assets
  • conduct investigations into the financial affairs of the bankrupt and any suspicious transactions
  • make appropriate recoveries
  • report to creditors
  • report offences to the Australian Financial Security Authority (AFSA)
  • distribute surplus funds to creditors.

How does bankruptcy affect someone?
A person is an ‘undischarged bankrupt’ from the date of bankruptcy until they are either discharged or their bankruptcy is annulled.

During this period a bankrupt:

  • cannot act as a company officer
  • cannot trade under a registered business name without advising people that they are bankrupt; however, they can trade under their own name
  • must make all of their divisible assets available to the trustee
  • cannot incur credit over an indexed amount ($5,485) without disclosing to the lender that they are bankrupt
  • must handover any passport and obtain permission to travel overseas
  • must make all books, records and financial statements available, including those of associated entities (e.g. companies and trusts).

Can a bankrupt continue to earn income?
Yes, a bankrupt may continue to earn an income, and should be encouraged to do so.

If income earned during bankruptcy exceeds the indexed threshold limits (as prescribed by the AFSA), a contribution from this income must be paid by the bankrupt to the estate. Income under these provisions includes personal income, certain benefits provided by third parties and income from superannuation and trusts. The total income over the threshold limit is then reduced by income tax payable, appropriate business expenses, and child support payments.

The liability to pay a contribution to the estate survives after the discharge of the bankruptcy and is enforceable by the trustee. A trustee can garnishee the bankrupt’s wages, or use the supervised account regime to collect contributions. The bankrupt may be re-bankrupted by the trustee for non-payment of contributions.

How does bankruptcy affect property?
A bankrupt’s assets includes property that is defined under the Bankruptcy Act as ‘divisible’, i.e. property that can be divided among creditors. A trustee controls all of a bankrupt’s divisible property. This includes all property owned at the time of bankruptcy and all property received after the date of bankruptcy, but before discharge. This latter property is called ‘after-acquired property’.

Some property is not divisible. Divisible property excludes:

  • necessary clothing and household items
  • tools of trade to an indexed amount ($3,700)
  • a motor vehicle to an indexed amount ($7,600)
  • life assurance or endowment policies (subject to some limitations)
  • certain damages and compensation payments
  • sentimental property (as defined in the Bankruptcy Act)
  • superannuation payments (subject to certain limitations).

Can a trustee recover property sold before bankruptcy?
Maybe. A trustee will consider any sales or property transfers within the five years before bankruptcy. If these transactions appear improper, undervalued, or had the purpose of attempting to defeat creditors, that property or its value may be recovered from the recipient.

A trustee may also recover monies from creditors who received payment of their debts in the six months before bankruptcy. Such payments are commonly referred to as ‘preferential’ or ‘preference payments’.

How does bankruptcy affect jointly owned real property?
A bankruptcy trustee may place their name on a title deed in place of the bankrupt. This is called ‘entering transmission’. Usually, a trustee invites the property’s co-owner to either buy the bankrupt’s interest, or join in selling the property.

If the co-owner does not cooperate with the trustee, or if they cannot agree on a satisfactory arrangement, the trustee can force the sale of joint property.

Can bankruptcy affect a family trust?
Yes. A trustee can recover any property that a bankrupt has given or sold to a trust at less than its true value. A trustee will also receive any monies owed to the bankrupt by a trust, and receive any distribution due to the bankrupt.

Usually, a trustee of a discretionary trust will not make distributions to someone who is bankrupt. However, trustees of unit trusts do not have this discretion.

What is the effect on creditors?
When a person is made bankrupt, their creditors exchange the right to enforce their claims for a right to prove for a dividend in the bankrupt estate. All creditors with a claim at the date of bankruptcy can prove for a dividend.

Are the rights of secured creditors affected?
Bankruptcy does not affect secured creditors’ rights relating to their security. They can enforce their charges or securities and prove for any deficiency in a bankruptcy. Special provisions outline how secured creditors may prove for shortfalls before the secured assets are sold.

What are non-provable debts?
Certain debts—called non-provable debts—cannot be claimed in bankruptcy, and they are not released at the end of the bankruptcy. These debts include:

  • some portion of a HECS debt (Higher Education Contribution Scheme)
  • court-imposed fines
  • the remainder of maintenance agreements under the Family Law Act 1975.

Full details of provable debts are set out in section 82 of the Bankruptcy Act.

Can the trustee pay dividends?
Yes. Ultimately the trustee’s role is to distribute the bankrupt’s assets to creditors—if the bankrupt has assets. Section 109 of the Bankruptcy Act sets out the order of priorities under which dividends must be paid. Certain payments and debts must be paid before dividends are paid to unsecured creditors.

When does bankruptcy end?
The bankruptcy period automatically ends (i.e. the bankrupt is discharged) three years after the filing date of the Statement of Affairs. However, the administration of the estate may continue for some time afterwards.

A bankruptcy’s term can be extended for up to five years. To extend a bankruptcy, a trustee lodges an objection to discharge with the Official Trustee. A trustee may object to a bankrupt’s discharge if the bankrupt fails to cooperate, leaves Australia without permission, manages a company (without the leave of the court), or engages in misleading conduct relating to an amount over an indexed sum.

What is an annulment of bankruptcy?
An annulment is a cancellation of bankruptcy and reinstates a debtor’s affairs—as if no bankruptcy had occurred. An annulment can be obtained by:

  • a court order on the basis that the bankruptcy should not have occurred
  • the bankrupt’s debts and the administration’s costs are paid in full
  • a section 73 proposal being accepted by creditors.

Can a trustee be changed?
Yes. The Bankruptcy Act allows two ways to change a trustee:

1. The creditors can vote for a change, at any time, for any reason.

2. The court may replace a trustee if convinced it is proper to do so. Usually, the court only forms this opinion if the trustee has done something wrong and a new trustee needs to take over the estate.

If a trustee retires or dies, the Official Receiver will replace the trustee.

Government charges (ARC and IRC)
Bankrupt estates attract government charges. An Asset Realisation Charge (ARC) is payable at 7 percent of gross monies received into the estate, less payments to secured creditors, trade on costs and other minor amounts. Monies held by trustees for an estate must also be held in interest-bearing accounts with any interest earned (Interest Realisation Charge—IRC) being payable to the government.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

What is Part X of the Bankruptcy Act?
Part X (part 10) of the Bankruptcy Act 1966 allows a debtor to enter into a personal insolvency agreement (PIA) with their creditors to satisfy their debts without being made bankrupt.

What is a personal insolvency agreement?
A personal insolvency agreement (PIA) is a formal agreement between a debtor and their creditors that sets out how the debtor will satisfy their debts. Once executed by the debtor and their trustee—and when creditors accept the proposal—it forms a deed.

The proposal can contain almost any lawful term and condition. Usually, it will provide for the repayment of monies over time and in some cases, the sale of assets. It also usually contains a moratorium (or freeze) from creditor’s claims for the term of the agreement, and payment of a sum that is less than the full amount in full satisfaction of their claims.

Why choose a Part X agreement?
A debtor may use a personal insolvency agreement to:

> get relief from their debts
> ensure a fair distribution of their assets to creditors
> provide a higher dividend than would be available in bankruptcy
> maintain their source of income that may be affected by bankruptcy
> avoid the restrictions of bankruptcy.

How is the process started?
A debtor must choose a controlling trustee (e.g. a solicitor or a registered trustee in bankruptcy) and provide them with three documents:

  1. An authority under section 188 of the Bankruptcy Act giving the controlling trustee control over their assets and requiring them to call a meeting of creditors to consider the proposal.
  2. A Statement of Affairs detailing all assets, liabilities and other personal information.
  3. A draft personal insolvency agreement detailing the terms of the proposal to be made to creditors.

The controlling trustee will sign a ‘consent to act’ and forward the documentation to the Australian Financial Security Authority (AFSA) for registration on the official record (the National Personal Insolvency Index). AFSA will then allocate an ‘estate number’ to the PIA.

How is the proposal accepted?
Once appointed, the controlling trustee must hold a meeting of creditors within 25 business days. At the meeting, the creditors will decide whether to accept or reject the proposal. For the proposal to be accepted there must be a majority in both the number of the creditors and more than 75 percent in value (ie creditors holding over 75% of the debt) in favour. This type of vote is called ‘a special resolution’.

If the required majority does not accept the proposal, the creditors may resolve that the debtor become bankrupt, but they cannot actually bankrupt the debtor at that meeting. However, creditors can resolve that the debtor be released from the control of the controlling trustee, which allows creditors to commence recovery action or bankruptcy proceedings.

Is signing a section 188 authority an act of bankruptcy?
Yes. During the Part X process a debtor will commit a number of ‘acts of bankruptcy’, including signing the section 188 authority, calling a meeting of their creditors and obtaining a special resolution by creditors. Any creditor can use these actions to apply to the court to have the debtor made bankrupt if the proposal is not accepted.

How are creditors affected by the personal insolvency agreement?
Secured creditors’ rights under their securities remain intact. They can exercise their rights regardless of the whether the proposal is accepted or not. Unsecured creditors with debts provable in bankruptcy exchange their right to enforce their claims for a right to share in the PIA proceeds. If the proposal is accepted by the required majority, all unsecured creditors will be bound by the agreement regardless of whether they attended the meeting, and regardless of whether or not they voted in favour of the proposal.

How does the agreement affect the debtor’s property and income?
Only property that is included in the PIA is affected. Property that is excluded from the agreement is not available to creditors. The debtor is only required to contribute part of their income if the agreement includes terms requiring them to. When applicable, the debtor will make the same type of contribution from their income as they would if they were bankrupt.

Can the trustee pay dividends?
Yes. The trustee will make distributions in accordance with the agreement terms. When dividends are paid will depend on the agreement duration and when funds become available. If the duration is expected to be short, the trustee will usually pay a dividend when all of the assets have been realised and all funds collected. If the agreement extends over a long period, the trustee may make interim distributions as funds become available.

When does a personal insolvency agreement end?
The agreement ends when the debtor satisfies the deed’s requirements in full.

What happens if the debtor does not comply with the agreement terms?
If the terms of the agreement are not satisfied, then the agreement will be considered to be in default. Usually, a default notice is issued to the debtor within a few days and, if not rectified, the agreement will be breached and may be terminated by one of these methods:

> The provisions of the agreement, automatically terminating the agreement.
> The trustee terminating the agreement with the consent of creditors.
> The passing of a special resolution at a meeting of creditors.
> An application to the court to terminate the agreement and possibly bankrupt the debtor.

Who administers a personal insolvency agreement?
The proposal for an agreement must include the appointment of a registered trustee or the Official Receiver to administer the agreement. If no one is nominated, the Official Receiver will be the trustee. Their powers and obligations will be set out in the agreement and in conjunction with the Bankruptcy Act. Fundamentally their role is to enforce the terms of the agreement, sell any assets, collect any monies and make a distribution to creditors.

Does signing a section 188 authority affect a credit rating?
Yes. Credit agencies will record that the debtor has signed a section 188 Authority. But this may be more favourable to the debtor than having outstanding writs, defaults, and a bankruptcy on their file.

Can a debtor continue to act as a director of a company?
No. A debtor cannot act as a director while subject to the terms of a PIA. This restriction is lifted when the agreement has ended.

Government realisation charge
The administration of a PIA attracts a government charge known as an ‘Asset Realisation Charge’ (ARC). This charge is payable at the rate of 7 percent of gross monies received into the estate, less payments to secured creditors and trade on costs (ie normal business trading expenses). The realisation charge is payable in priority over any dividend payable to creditors.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.08.2015

What is a Debt Agreement?

Part IX (Part 9) is a part of the Bankruptcy Act that allows someone in financial difficulty to enter into to an arrangement with their creditors to satisfy their debts without being made bankrupt. This arrangement is called a Debt Agreement.

Why choose a Debt Agreement?

A debtor will usually use a Debt Agreement to:

(i) get relief from their debts;
(ii) ensure a controlled distribution of assets or funds to their creditors;
(iii) provide creditors with a higher dividend than would be payable if they became bankruptcy;
(iv) maintain their source of income; and
(v) avoid the restrictions of bankruptcy.

Who can propose a Debt Agreement?

A debtor cannot utilise the Part IX provisions if they have been a bankrupt, a party to another debt agreement, or a debtor under Part X of the Bankruptcy Act in the previous 10 years.

Further their:

1. after tax income must not exceed the prescribed amount;
2. unsecured creditors must not exceed the prescribed amount; and
3. divisible property (that is, property which would be available if the debtor were to be made bankrupt) must not exceed the prescribed amount.

How is the process started?

A debtor fills out a Part IX Statement of Affairs and a Debt Agreement proposal that:

1. identifies the property or the funds to be made available to creditors;
2. specifies how the property or funds are to be dealt with (sold or transferred);
3. specifies a person to administer the Debt Agreement; and
4. specifies how that person will be paid.

The Debt Agreement proposal and Statement of Affairs is lodged with AFSA (Australian Financial Security Authority). The proposal may contain an authority for AFSA to delegate the duties of putting forward the proposal to creditors and monitoring the debtor’s compliance with the agreement. A registered trustee or a debt agreement administrator would then control the process.

What can be proposed to creditors?

Proposals can allow for payments from the debtor’s income, or the payment of a lump sum whether from funds of the debtor or from a third party. It may include the sale of real property, plant & equipment, stock or other assets. It also may include:

(a) a moratorium from creditor’s actions;
(b) payment of a sum less than the full amount in full satisfaction of claims;
(c) the transfer of specified property to specified creditors;
(d) periodic payments over time of a specified amount; or
(e) any combination of the above.

How is the proposal accepted?

Once the proposal and Statement of Affairs have been lodged with AFSA, the Official Receiver or the nominated person will prepare and issue a report to creditors. The report will set out the terms of the proposal and will compare the return that creditors could expect under the Debt Agreement to the return they would expect if the debtor were made bankrupt.

A meeting of creditors may be called, but usually voting is done by mail. Creditors have 25 working days after AFSA accepts the proposal to lodge their vote. All creditors will receive a report and all of the forms necessary to vote. For the proposal to be accepted, it must be accepted by a majority in value of those creditors who participate in the vote.

If the proposal is accepted, it binds all creditors with debts that existed at the date of the acceptance, including any creditors who did not take part in the voting process, or who voted against the proposal.

Is lodging a proposal with ITSA an act of bankruptcy?

If the proposal is not accepted or fulfilled, any creditor may file a creditor’s petition with the Federal Court and bankrupt the debtor.

How are creditors affected?

Secured creditor’s rights under their securities remain intact.

All unsecured creditors with debts that would be provable in a bankruptcy are bound by the acceptance of a proposal irrespective of whether they voted or not. They can take no further action against the debtor or their property, they cannot start fresh proceedings, and cannot present or further a creditors petition. Upon acceptance of the Debt Agreement, the debtor is released from any debts that would be released in a bankruptcy.

What is the effect of the debt agreement on the debtor’s property?

That depends on the terms of the agreement. If the agreement calls for the sale of assets or transfer of specific assets to certain creditors, then the person administering the agreement has the responsibility of realizing or transferring those assets. There is no effect on property that is not mentioned in the Debt Agreement.

What is the effect on the debtor’s income?

The agreement will not affect the debtor’s income, unless it provides for the debtor to pay a percentage of his income under the Debt Agreement.

What are the debt administrator’s powers?

The powers and obligations of the debt administrator will be set out in the Debt Agreement and Part IX of the Bankruptcy Act. They essentially will be to enforce the terms of the agreement and make a distribution to creditors.

What if the debtor fails to satisfy the terms of the debt agreement?

The debt administrator must inform creditors of any default and provide them with the opportunity of terminating the agreement. This will reinstate the position of all of the creditors. Alternatively, a creditor may apply to the Court for an order terminating the Debt Agreement if:

(a) the creditor can show that the debtor has not carried out the terms of the agreement and that the termination is in the best interests of creditors;
(b) the continuation of the agreement would cause injustice or undue delay to the creditor; or
(c) there are other reasons and it is in the creditor’s interests.

Can the debt administrator make distributions?

The person administering the agreement will make distributions either under the terms of the agreement, or if the agreement is silent as to when distributions are to be made, when practical.

What are the costs?

The fees of the person administering the agreement are set out in the proposal accepted by creditors and are usually paid from the funds paid by the debtor under the agreement.

When does a debt agreement end?

A debtor’s obligations end when he or she fully satisfies the requirements of the agreement or it is terminated due to a breach of any of its terms.

Does a debt agreement affect a credit rating?

The fact that the debtor has entered into a Debt Agreement will be noted by credit agencies. But this may be more favorable than outstanding writs, defaults and a bankruptcy on the debtor’s file.

Government Realization Charge

The administration attracts a government charge. This charge is payable at the prescribed rate on monies received into the estate, less payments to secured creditors, trade on costs and on surplus money received. It is payable in priority to any dividend to creditors.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

Introduction
In simple terms, bankruptcy trustees sell the assets of a bankrupt and distribute the proceeds to the bankrupt’s creditors. This Guide looks at which assets can be sold by the trustee. It does not look at assets that may be recovered from other parties through other provisions relating to void transactions under the Bankruptcy Act 1966.

Not all of the bankrupt’s assets are available to a trustee. The Act defines ‘divisible’ assets (assets available to a trustee) from ‘non-divisible’ assets (assets that are not available to a trustee). Understandably, whether or not an asset is divisible is often a contested issue.

Items that are held on trust or loaned to a bankrupt—or that do not belong to a bankrupt—do not vest in a trustee. They are not the bankrupt’s assets and cannot be divisible.

Vesting of the ‘property of the bankrupt’
Upon bankruptcy, any property of the bankrupt automatically vests in the trustee. Under section 58 of the Bankruptcy Act, a trustee is not required to take any action for this ‘vesting’ to occur. Where applicable, legal title to some property may have to be registered in the trustee’s name, but equitable title will vest automatically, e.g. real property.

Assets acquired by a bankrupt after the bankruptcy commenced but before discharge may also vest in the trustee when they are acquired. These are called ‘after-acquired property’.

After-acquired property includes any property acquired by or inherited by the bankrupt on or after the date of the bankruptcy, and before discharge, being property that is also divisible among their creditors. Non-divisible, after-acquired property does not vest in the trustee.

There are two important factors in defining after-acquired property:

1. The property must have been acquired during the term of the bankruptcy.

2. The property would otherwise be classified as divisible property.

If existing owned property is not deemed as ‘divisible’ at the commencement of bankruptcy, it is not divisible if acquired during bankruptcy. One purpose of section 58 of the Bankruptcy Act is to immediately protect assets from individual creditors who attempt recovery of their debts by exercising securities against assets. Creditors cannot take these assets from a bankrupt, or from the estate, under enforcement actions. Once an asset has vested in a trustee, only the trustee may deal with that asset, as a bankrupt is no longer the legal owner. This allows for an orderly and fair distribution of the bankrupt’s assets between the proper creditors.

Bankruptcy Act 1966 – section 58
Vesting of property upon bankruptcy—general rule:

(3) Except as provided by this Act, after a debtor has become a bankrupt, it is not competent for a creditor:

(a) to enforce any remedy against the person or the property of the bankrupt in respect of a provable debt; or

(b) except with the leave of the Court and on such terms as the Court thinks fit, to commence any legal proceeding in respect of a provable debt or take any fresh step in such a proceeding.

There are two exceptions that allow creditors to commence or continue action against property:

1. Secured creditors have a right to exercise their security over any asset covered by their security. Section 58 of the Bankruptcy Act only provides protection to divisible assets that are not covered by a valid security.

2. Creditors can exercise their rights against non-divisible property for debts under maintenance orders or agreements. Non-divisible property does not fall under the control or protection of the trustee, as it does not vest in the trustee.

Bankruptcy Act 1966 – section 58
Vesting of property upon bankruptcy—general rule:

(5) Nothing in this section affects the right of a secured creditor to realise or otherwise deal with his or her security.

(5A) Nothing in this section shall be taken to prevent a creditor from enforcing any remedy against a bankrupt, or against any property of a bankrupt that is not vested in the trustee of the bankrupt, in respect of any liability of the bankrupt under:

(a) a maintenance agreement; or

(b) a maintenance order; whether entered into or made, as the case may be, before or after the commencement of this subsection.

All divisible property that is not secured to a particular creditor is solely under the control of the trustee. But deciding what is divisible property is not always straightforward.

Registration of interests
In some cases, registration is necessary to record vesting of property in the trustee. This is usually the case with real property, where the title of the property needs to be transferred to the trustee in order for the trustee to be able to legally deal with the property.

This process is known as ‘entering transmission’ (i.e. transmitting legal ownership). The equitable interest will vest in the trustee; however, the legal interest will also need to be transferred.

Usually, in the case of real property, a trustee will initially protect the estate’s interest by lodging a caveat on title—vesting of the property provides a ‘caveatable’ interest. However, a trustee will only be able to sign transfer documents when the property title is transferred into their name.

New trustees
Occasionally, a bankruptcy trustee will change during a bankruptcy. Any remaining property in an estate automatically vests in the new trustee when the change of trustee takes effect. The same transmission rules apply, so the new trustee may have to enter into ‘transmission’ of the relevant property into their name.

Changes in trustees are uncommon, but the procedural mechanism is in place to allow a smooth transfer of the rights to property to any new trustee.

What is divisible property?
Section 58 does not define what is or is not divisible property, only that all divisible property vests in the trustee. A trustee considers divisible property as all of the property of the bankrupt, then, eliminates non-divisible assets from the list.

The Act broadly defines divisible property as covering the following:

  • All property owned at the time of bankruptcy, or acquired during the bankruptcy.
  • Any rights or powers over property that existed at the date of bankruptcy, or during the bankruptcy.
  • Any rights to exercise powers over property.
  • Any property that vests because an associated entity received the property as a result of personal services supplied by the bankrupt (section 139D of the Bankruptcy Act).
  • Monies recovered from an associated entity due to an increase in the net worth of the entity as a result of personal services supplied by the bankrupt (section 139E of the Bankruptcy Act).

Section 116 of the Act lists what classes of assets are divisible among creditors.

Bankruptcy Act 1966 – section 116
Property divisible among creditors

(1) Subject to this Act:

(a) all property that belonged to, or was vested in, a bankrupt at the commencement of the bankruptcy, or has been acquired or is acquired by him or her, or has devolved or devolves on him or her, after the commencement of the bankruptcy and before his or her discharge; and

(b) the capacity to exercise, and to take proceedings for exercising all such powers in, over or in respect of property as might have been exercised by the bankrupt for his or her own benefit at the commencement of the bankruptcy or at any time after the commencement of the bankruptcy and before his or her discharge; and

(c) property that is vested in the trustee of the bankrupt’s estate by or under an order under section 139D or 139DA; and

(d) money that is paid to the trustee of the bankrupt’s estate under an order under section 139E or 139EA; and

(e) money that is paid to the trustee of the bankrupt’s estate under an order under paragraph 128K(1) (b); and

(f) money that is paid to the trustee of the bankrupt’s estate under a section 139ZQ notice that relates to a transaction that is void against the trustee under section 128C; and

(g) money that is paid to the trustee of the bankrupt’s estate under an order under section 139ZU; is property divisible amongst the creditors of the bankrupt.

What is non-divisible property?
Determining what is not divisible property is a difficult area. The Bankruptcy Act provides that some property types will not be divisible. Section 116(2) of the Act summarises what is not classified as property divisible among creditors.

The list of non-divisible assets is extensive but, in most cases, these assets rarely appear. Some of them are very common and are non-divisible because they are necessary for the bankrupt’s ability to live. These can be grouped into the following areas:

1. Property held by the bankrupt in trust for another person (i.e. not owned by the bankrupt).

2. The bankrupt’s household property prescribed by Regulation 6.03 or identified by a resolution passed by the creditors before the trustee realises the property.

3. Personal property that has sentimental value for the bankrupt and is identified by a special resolution passed by the creditors before the trustee realises the property.

4. The tools of trade that the bankrupt uses in earning income by personal exertion— subject to the value limit prescribed by the regulations.

5. A vehicle used by the bankrupt as a means of transport—subject to the value limit prescribed by the regulations.

6. Policies of life assurance or endowment assurance covering the life of the bankrupt or their spouse, whether the proceeds are received on or after the date of the bankruptcy.

7. The bankrupt’s interest in a regulated superannuation fund (or approved deposit fund or an exempt public sector superannuation scheme). And any payment to the bankrupt from such a fund (received on or after the date of the bankruptcy) if the payment is not a pension within the meaning of the Superannuation Industry (Supervision) Act 1993. Certain conditions apply.

8. A payment to the bankrupt under a payment split under Part VIIIB of the Family Law Act 1975, where the eligible superannuation plan is a fund or scheme covered by the Act and the payment is not a pension within the meaning of the Superannuation Industry (Supervision) Act 1993.

9. Money held in the bankrupt’s retirement savings account (RSA)—or a payment to a bankrupt from an RSA received on or after the date of the bankruptcy—if the payment is not a pension or annuity within the meaning of the Retirement Savings Accounts Act 1997.

10. A payment to the bankrupt under a payment split under Part VIIIB of the Family Law Act where the eligible superannuation plan involved is an RSA, and the splittable payment involved is not a pension or annuity within the meaning of the Retirement Savings Accounts Act.

11. Any right to recover damages or compensation for personal injury or wrongdoing or regarding  the death of the spouse or member of family of the bankrupt.

12. Amounts paid under a scheme approved by the:

  • States Grants (Rural Reconstruction) Act 1971.
  • States Grants (Rural Adjustment) Act 1976.
  • States and Northern Territory Grants (Rural Adjustment) Act 1979.
  • States and Northern Territory Grants (Rural Adjustment) Act 1985.
  • States and Northern Territory Grants (Rural Adjustment) Act 1988.
  • Rural Adjustment Act 1992 for re-establishment support under the Rural Adjustment Scheme.
  • Farm Household Support Act 1992 for re-establishment grant under the farm help re-establishment grant scheme.
  • Farm Household Support Act 1992 for a dairy exit payment.

13. Property that was funded either wholly or substantially with protected money. Note: What is considered ‘protected money’ is limited, as some non-divisible assets lose their protection when converted into cash, particularly before bankruptcy.

14. An outlay for property that is part protected money; a trustee will pay the bankrupt out of the proceeds (in realising the property) the value that can be fairly attributed to that protected money.

Exempt assets
Some divisible property is subject to statutory value limits. Property valued under these limits is exempt or non-divisible to the extent of the limit. These limits change periodically, as prescribed by the Australian Financial Security Authority (AFSA).

The limits are designed to allow the bankrupt to maintain a standard of living (the household property limitations), and maintain some employment (the tools of trade and motor vehicle limitations).

Sentimental property
The Bankruptcy Act defines what is sentimental property, and whether it is exempt. Sentimental property must be non-monetary, have real sentimental value to the bankrupt, or be an award for sporting, cultural, military or academic achievement. If it does not fall into these categories, it cannot be classified as sentimental and usually becomes divisible.

Creditors must also resolve by special resolution at a meeting of creditors (or a virtual meeting) that this property is sentimental. If the creditors do not approve it as sentimental property, it becomes divisible property to the estate.

Time limits for realisation
Section 129AA sets out the periods that divisible assets must be dealt with. A trustee must realise any divisible assets disclosed by a bankrupt within six years after the bankrupt is discharged. This period can be extended up to three years at a time by giving written notice to the bankrupt prior to the six-year expiry. There is no limit on how many extensions a trustee can seek.

For after-acquired property disclosed to the trustee during bankruptcy, the trustee has six years after the bankrupt’s discharge date to deal with the property. For any after-acquired property disclosed by the bankrupt after discharge, the trustee has six years commencing on the date of disclosure to realise the property. Again, a trustee can extend these periods.

If the assets are not dealt within the required period, they can revest to the bankrupt.

Section 127 of the Bankruptcy Act outlines that a trustee has 20 years from the date of bankruptcy to deal with the property of the bankrupt. After the 20 years’ expiry the property revests to the bankrupt.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 27.01.2016

Can a bankrupt work during their bankruptcy?
Yes. In most cases, a bankrupt is able to earn an income during their bankruptcy. Subject to some provisions and exceptions, a bankrupt is encouraged to earn an income, as there is no logical reason why they should not be entitled to earn an income and benefit from it. TheBankruptcy Act 1966 states a bankrupt must pay contributions from their income to their estate if the amount earned is over the relevant threshold prescribed by the Australian Financial Security Authority (AFSA).

What are income contributions?
Under section 139P of the Bankruptcy Act, a bankrupt may be liable to make a contribution—subject to thresholds and number of dependents—to their bankrupt estate from income earned during their bankruptcy. It is fitting that some of the income from the bankrupt’s efforts during the bankruptcy are used to satisfy their past debts.

What income is assessed for contributions?
A bankrupt’s income is assessed to determine whether contributions must be paid. Section 139L of the Bankruptcy Act sets out the definition of income to be assessed.

The definition of ‘income’ is the same as under the Taxation Acts, but it also includes amounts that have not been earned from physical exertion or investments, and amounts that may not even be taxable income. These ‘other incomes’ include loans made to the bankrupt, items that fall under the Fringe Benefit Tax provisions, annuities and pensions, as well as some insurance payments.

Is all money earned income?
No. Many amounts are not income for contribution assessment purposes. These are set out under paragraph (b) of section 139L of the Bankruptcy Act.

Are any amounts deductible from after-tax income?
Yes. Deductions are available for payments made to support a child, if paid under a Family Law Act 1975 maintenance agreement or order. Deductions are also available for certain business expenses under section 139N of the Bankruptcy Act.

How does the trustee obtain information about a bankrupt’s income?
A bankrupt is required under the Bankruptcy Act to provide their income details to their trustee. Usually, a trustee will send a form to the bankrupt on each bankruptcy date anniversary. This form must be completed and returned with any documentation supporting the income earned and deductions claimed.

What if the bankrupt does not complete the form?
Under the Bankruptcy Act, it is an offence if a bankrupt does not cooperate with their trustee and complete their income assessment form. If a bankrupt does not cooperate, the trustee can object to the bankrupt’s discharge from bankruptcy (i.e. extend their bankruptcy period) and estimate the bankrupt’s income and assess it accordingly.

Can the trustee investigate the bankrupt’s income information?
Yes. While a trustee can make an assessment on what they reasonably believe is a bankrupt’s income, in practise they investigate thoroughly before making an assessment. If the bankrupt supplies inadequate or questionable information, a trustee will seek further information.

If appropriate, a trustee can conduct an examination and request that the bankrupt provide further information to clarify any matter. If further information is not forthcoming, the trustee can make the assessment on what they reasonably believe the income is, putting the onus on the bankrupt to disprove the assessment.

How is the income contribution calculated?
The contribution calculation is made on assessed income, which is the amount of income left after tax, the Medicare levy and proper deductions. A contribution is payable if the assessed income is more than AFSA’s current statutory threshold. The threshold amounts are based on the number of dependents that the bankrupt had during that assessment period—refer to our Thresholds webpage (www.worrells.net.au/thresholdsresources/thresholds.aspx).

A trustee is entitled to receive one-half of the balance over the threshold amount (i.e. the ‘over threshold after tax income’ is divided equally between the bankrupt and trustee). The formula is:

(Assessed Income – Actual Income Threshold Amount) ÷ 2

How is the assessment made?
The trustee makes an assessment of the estimated income based on information the bankrupt supplies at the beginning of the assessment period. An assessment (called a ‘determination’) is made on these estimates and the bankrupt becomes liable to pay any contributions to the trustee from the assessment date.

At the end of the assessment period, the bankrupt must supply the past year’s actual income amount, along with their estimates for the next year. The past year’s assessment is adjusted if necessary, then a new assessment is made for the next year’s estimated income and the process starts again.

How often are the assessments made?
Each assessment period runs from the date of the bankruptcy or its anniversary, and ends on the day before the next anniversary. Assessment periods continue until the bankrupt is discharged, including when a bankruptcy is extended through an objection to discharge.

What happens to the money paid under an assessment?
Money paid under these provisions is paid into the estate funds for the benefit of the bankrupt’s creditors.

What obligations does the bankrupt have?
A bankrupt must provide information about their income and deductions, and give the trustee access to all required books and records. If the bankrupt refuses or fails to supply requested books or records, the trustee can lodge an objection to the bankrupt’s discharge and AFSA may prosecute the bankrupt for an offence.

How does the bankrupt get a notice of the assessment?
Once a determination is made, the trustee gives a notice to the bankrupt setting out the amount payable and particulars on how the determination was calculated. Usually, a trustee will include a schedule of contribution payments over the remaining months of the assessment period.

Is an assessment notice a legal obligation?
Yes. Issuing an assessment notice creates a legal obligation to pay the contribution. A trustee can nominate when the payments are due and can be collected from the bankrupt as a debt due. These rights remain after the bankrupt has been discharged, which means that the bankrupt can be re-bankrupted for non-payment of any contribution.

Can the assessment be reviewed?
Yes. The Act provides a mechanism for any assessment to be reviewed by the Inspector-General, but the request must be made within 60 days of the assessment. Upon receipt the Inspector-General has 60 days to decide whether the assessment should be reviewed and make a ruling. The decisions handed down by the Inspector-General can be reviewed by the Administrative Appeals Tribunal.

What can the trustee do to enforce collection?
If an assessment is made and the bankrupt refuses or fails to pay, the trustee can:

> issue notices to employers or other people that owe the bankrupt money to garnishee those monies (i.e. order third parties to withhold monies owing to the bankrupt)
> issue an objection to the discharge of the bankrupt, extending the bankruptcy period
> prohibit the bankrupt from travelling overseas
> re-bankrupt a discharged bankrupt, if the refusal to pay occurs after the bankrupt has been discharged
> issue a notice under the Bankruptcy Act’s supervised account regime provisions.

What is the supervised account regime?
Trustees may determine that the supervised account regime is needed. This requires a bankrupt to open a supervised account where they must deposit all of their income. The trustee then supervises all withdrawals from that account to ensure that income contributions are made.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.08.2015

Why are meetings of creditors called?
Meetings are held so that creditors can find out the status of an estate, ask questions, give suggestions about how the file is handled and approve the appointee’s remuneration. The Bankruptcy Act outlines the rules about how and when meetings are to be called and run, as well as how issues are to be decided at the meeting.

What are the basic steps?
The meeting process is similar to most other organised meetings of clubs, associations or corporations. There is a logical order to the events surrounding the meeting and certain things must be done before, during and after the meeting.

  1. Creditors should receive adequate notice of the time and place of the meeting. They should be given a report that contains all of the information needed for them to make informed decisions on the matters to be discussed and resolutions being put to that meeting.
  2. The meeting should be run according to a formal agenda set out in the notice of meeting.
  3. The president (chairperson) of the meeting will be elected by those attending.
  4. Resolutions will be decided by a vote of those creditors attending the meeting and who are entitled to vote. Resolutions are determined in favour of the prescribed majority. What constitutes a majority may differ according to the type of meeting or the type of resolution sought.
  5. The participants may adjourn the meeting by putting forward a motion to that effect and having the resolution ‘passed’ by the creditors.
  6. All matters during a meeting will be recorded as minutes of the meeting and distributed within the prescribed time.

Who may call a meeting of creditors?
Only the trustee in bankruptcy can call meetings of creditors. A trustee in bankruptcy may call meetings at any time, but must call meetings when:

  • Whenever the creditors so direct by resolution; and
  • Whenever so requested in writing by at least 25% of the value of creditors;
  • Whenever so requested in writing by less than 25% of the value of creditors, where creditors have lodged sufficient security for the costs of the meeting.

What period of notice must be given?
The period of notice is prescribed by the Acts and varies dependent upon the type of meeting being called. It is usually about 14 days but some meetings, particularly voluntary administration meetings, have shorter notice periods.

What should be sent to creditors when a meeting is called?
The following should be sent to creditors:

  • A notice calling the meeting and setting out the agenda for the meeting;
  • Particulars of any resolutions that are to be dealt with at that meeting and sufficient information in order to make an informed decision on the resolution;
  • A proof of debt form; and
  • A proxy form and if applicable a voting slip.

Creditors should obtain any missing documents from the external administrator who is calling the meeting.

Will a report to creditors be issued?
A report from the external administrator will generally accompany the notice of meeting and the other documents. The report should outline the current position of the estate and the investigations undertaken contain details about further examinations and the potential actions to be taken by the external administrator, all relevant information and recommendations on any decisions that are to be made at the meeting.

Do creditors need to attend meetings?
Creditors do not lose any rights to prove for dividends if they do not attend meetings. However they will not have a say in the conduct of the estate nor on any resolution. It is prudent to encourage creditors to at least attend by proxy to ensure that a quorum is formed and the meeting can proceed without adjournment.

Where and when are meetings held?
Meetings should be held at a time and place convenient to the majority of the creditors. A convenient time is generally during business hours on a normal business day. A convenient place is generally in the town or city centre where a majority in number of the creditors conduct their business.

Who runs the meeting?
A chairperson or a president runs the meeting.

A president must be chosen to control meetings called under the Bankruptcy Act. The president can be anyone at that meeting, but is usually the trustee or some person associated with the trustee as they have experience in conducting meetings. Some of the actions taken and decisions made may not be enforceable if they are not handled in the technically correct manner, so it is beneficial to have an experienced person control the meeting.

Is there an agenda?
Only the matters on the agenda can be decided upon at the meeting. The agenda is generally set by the relevant Act but may be amended. The agenda should be set out in the notice of meeting issued to creditors.

When should creditors lodge their claims?
Creditors should lodge a claim prior to or at the meeting otherwise creditors will not be able to vote at the meeting, as only creditors who have proved that they are owed creditors in the estate may vote. Creditors should follow these rules:

  • Attach copies of invoices or other documentation detailing the amount owed and how it arose, or indicate that these records are available if required to prove the debt;
  • Submit a claim before or at the commencement of a meeting and have it noted on the register of attendance; and
  • If the claim is not admitted for any reason, make sure an objection is noted in the minutes.

Do creditors have to lodge a proof of debt to be able to vote?
For meetings under the Bankruptcy Act; no – section 64D provides that a written statement setting out the claim is advisable, but it is not necessary for a proof of debt to be lodged.

How is a proof of debt admitted?
The external administrator will decide whether or not to admit the proofs of debt or claim for voting by examining the material attached to the proof of debt and comparing it to the information contained in the company records. The decision is final at the meeting but can be challenged in the court after the meeting has been held. If such a challenge is successful, the outcome of the meeting itself may be challenged if the use or otherwise of that claim would have definitely changed the outcome of the meeting.

If a claim is rejected, the creditor should have a statement read into the minutes disagreeing with the decision and reserving the right to challenge the decision in an appropriate forum. At this point however, there is nothing more that the creditor can do to influence the meeting, but they may remain in attendance until the meeting is closed.

Can creditors ask questions?
A meeting of creditors is a forum for creditors to ask questions. Questions should always be addressed to the chairperson or president, who in turn will put the question directly to the relevant person if required. Alternatively, creditors may ask questions of the chairperson, trustee or liquidator directly.

How can creditors attend the meeting?
Creditors will have to decide how to attend a meeting. They may attend in person, by proxy or attorney, or by participating over the phone. The distinction between a proxy and an attorney is that a proxy will usually only vote in accordance with instructions and directions given to them. An attorney can decide how to vote, and can respond to changing circumstances during a meeting.

Who can be a proxy?
Almost anyone over the age of 18 can act as a proxy.

How are resolutions decided?
A vote of creditors is called a resolution – the creditors resolving a proposal or motion. Most resolutions are ordinary resolutions, which under the Bankruptcy Act requires a simple majority in value only.

There are provisions for some proposals at meetings to require a ‘special resolution’, being more than 50% in number and 75% in value.

Can resolutions be passed without a physical meeting?
The Bankruptcy Act allows single resolutions to be passed by creditors without a meeting being called. This is known as a virtual meeting. Voting is done through the mail with creditors indicating their acceptance or rejection of the motion, or they can object to the vote being taken in that format and request a meeting to be called to decide the matter.

Though there are no corresponding virtual meeting provisions in the Corporations Act, effectively meetings can be held with only proxies and special proxies being held in the name of the chairman, and with no creditor physically attending the meeting. The result is one or more resolutions passed without a ‘physical’ meeting of people.

Can meetings be adjourned?
Anyone may propose a resolution for an adjournment of the meeting. At times the chairperson or president may adjourn the meeting to better consider proofs of debt and voting rights. The type of meeting will determine the maximum time period allowed for any adjournment.

Who will keep the minutes?
Minutes are kept by a minutes secretary. The Corporations Regulations provide that the chairperson must cause minutes to be filed and they will determine who will be the minutes secretary. The Bankruptcy Act requires creditors to appoint the minutes secretary. It will usually be a staff member of the trustee.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

What are preferential payments?
Preferential payments or ‘preferences’ are payments or asset transfers to creditors that give them an advantage over the other creditors. Bankruptcy trustees can recover these payments or transfers under the provisions of the Bankruptcy Act 1966. Preferences are usually payments of money, although a variety of transfers of assets can be deemed as preferential.

Who may recover preferential payments?
In personal insolvency administrations, only trustees of bankrupt estates and personal insolvency agreements—where the agreement allows—can claim the return of preferential payments.

Why do trustees void preferential payments?
The trustee’s main role is to distribute a bankrupt’s assets fairly between their creditors. To do so a trustee must identify whether any creditor received a distribution—prior to the bankruptcy—that was not equitable when compared to the distribution to other creditors in the bankruptcy. Trustees can void transactions that involve one creditor to make a more equitable distribution to all creditors.

What are the elements of a preferential payment?
Before a court will void a payment or transfer, it must be satisfied that:

  • a transfer of property was made (usually a payment of money)
  • something passed from the bankrupt to a creditor, or on the creditor’s instructions
  • it occurred at a specific time when the bankrupt was insolvent
  • it occurred within the relevant period before the bankruptcy
  • the transaction gave the creditor an advantage over other creditors—usually determined by the creditor receiving more than if they had proved for that amount in the bankrupt estate
  • the creditor suspected—or should have suspected—that the bankrupt was insolvent at the time.

When is someone insolvent?
The Bankruptcy Act defines being insolvent as “not being able to pay all your debts as and when they become due and payable”. To have a preference voided, the bankrupt must have been insolvent at the time of the transfer or payment. The reasoning is that a solvent person has the capacity to pay all their debts (regardless of whether they actually did), and therefore no creditor could have been advantaged over other creditors by receiving the transferor payment.

Who has to prove insolvency?
The onus of proving insolvency is on the trustee.

Must there be a debtor–creditor relationship?
Yes. The transaction must involve or have been done at the direction of a bankrupt’s creditor, and must have satisfied a debt that would have been provable in the estate if the transaction had not been undertaken.

Must there be a transfer of an asset?
Yes. There must have been a transfer of some property between the parties. Commonly a transfer is a payment of money, but any asset passing from the bankrupt to the creditor—even an asset that is created by the transaction, e.g. a security—is sufficient to be a transfer of property. The amount of the preference claim is the value of the asset transferred.

What is the relevant period?
The transfer of the asset must occur during a specific period before bankruptcy, which depends on how the bankruptcy was commenced:

  • Creditor’s petition—six months before it was filed.
  • Debtor’s petition—six months before it was presented.
  • Debtor’s petition where a creditor’s petition is pending—on the commencement of bankruptcy, which is the earliest act of bankruptcy within the six months before the creditor’s petition was filed.

Must the debt be unsecured?
Yes. A preference cannot be given to a creditor holding a security over assets. However, if the security was not properly created (i.e. not valid), or the value of the security is less than the payment amount, then the transfer, or the excess value over the security’s worth, may be deemed as preferential.

How is preferential treatment determined?
The creditor must have received more than if they had refunded the monies and proved for that amount in the bankruptcy. This is purely a mathematical calculation. If the creditor did not receive more in the payment than they would have received from a dividend in the bankruptcy, there is no advantage or preferential treatment.

What statutory defences are available to creditors?
There are three conditions of statutory defence:

1. The transfer was in the ordinary course of business.

2. The recipient acted in good faith.

3. The recipient gave market-value consideration, or at least market value.

The creditor must prove all three conditions of the defence, otherwise the entire defence fails. The transfer is not voidable if it was made following a maintenance agreement or order under the Family Law Act 1975, or was made under a Part IX debt agreement under the Bankruptcy Act.

What is the ordinary course of business and good faith?
The creditor must not have acted in any manner that would give the impression that they were not acting in good faith or under normal trading conditions. For example, actions that may refute good faith are issuing proceedings or statutory notices to the debtor (prior to being a bankrupt), or ceasing supply of goods and services. The creditor must not have forced the payment by way of threat or action.

What is market value consideration?
Usually the easiest condition to prove is that a creditor gave market-value consideration. If the creditor is a trade creditor, the initial supply of goods or services that created the debt provides the market-value consideration. A loan creditor can rely upon the initial loan to the bankrupt. A creditor will only have to show that they have given something of similar value in consideration for receiving the payment.

When will the statutory defences not be available?
A creditor cannot rely on the statutory defences when they knew—or had reason to suspect—that the bankrupt was insolvent and that the transaction would give them a preference over the other creditors.

What should creditors do if a trustee claims a preferential payment?
Broadly, creditors should make sure that:

  • the transaction happened within the relevant period
  • they are not a secured creditor
  • they were a creditor when the payment was made and that it was not a cash-on-delivery type transaction
  • the trustee shows that they received an advantage over the other creditors.

The following points are more detailed and complex to determine:

  • Whether the creditor gave extra credit to the debtor after the payment in question was received. The claim may be reduced, or eliminated, by the amount of extra credit the creditor granted. This is commonly known as the ‘running account defence’.
  • That the trustee can show insolvency at the time of, or before, the payment was received.
  • Whether the creditor is likely to convince a Judge that all three of the statutory defences are available to them.

What can creditors do if they have to refund money to a trustee?
Creditors that refund preferences can lodge a proof of debt in the bankruptcy for the amount refunded. Creditors may also have rights under any guarantees given by other parties that support that debt.

How long does the trustee have to make a claim?
A preference claim must be commenced within six years after the bankruptcy commenced. A trustee must issue legal proceedings within the six-year period—not just make a formal demand.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 27.01.2016

What are the provisions designed to do?
Trustees of bankrupt estates investigate pre-bankruptcy transactions when they suspect the transaction improperly transferred assets away from the bankrupt that would otherwise be available to creditors. The Bankruptcy Act 1966 will in some cases allow voiding these transactions and require the other party to return an asset, or make a payment, to the trustee.

Who may recover money under these provisions?
Trustees of bankrupt estates and personal insolvency agreements (PIA) may use the provisions to void transactions. However, a PIA must give the trustee this right, as it may be excluded in some agreements.

What must the trustee do to be able to make a recovery?
To void a transaction, the trustee must do the following:

1. Identify the transaction.

2. Identify the other party to the transaction.

3. Prove the transaction occurred within a specific period, or while the bankrupt was insolvent (i.e. as a debtor pre-bankruptcy).

4. Prove the transaction was either undervalue, or had the required intention.

5. Show the transaction did not involve protected property.

Why do trustees void some transactions?
One of a trustee’s roles is to ensure that all of a bankrupt’s divisible assets are available to distribute to creditors. Part of this role is to find whether the bankrupt entered into a transaction that reduced the amount of assets available for distribution. The trustee seeks to recover these assets and void any transaction that provided an advantage to any creditor, so that they can make a more equitable distribution to all creditors.

Sometimes when debtors face bankruptcy, they try to protect some of their assets by hiding, moving or transferring assets to a third party to hold during the period of bankruptcy. The provisions attempt to deter debtors from moving assets at their creditors’ expense, and to allow rightful recovery.

What type of transactions may be voided?
The Bankruptcy Act enables the trustee to void:

  • undervalued transactions (under section 120 of the Bankruptcy Act)
  • transfers done with the intention to defeat creditors (under section 121 of the Bankruptcy Act)
  • transfers where the consideration was paid to a third party (under section 121A of the Bankruptcy Act).

UNDERVALUED TRANSACTIONS – SECTION 120

What are undervalued transactions?
Asset transfers at less than market value are deemed ‘undervalue’. Sometimes a debtor will sell or transfer assets to third parties shortly before their bankruptcy and attempt to make the transaction look commercial. Undervalue transactions may take the form of the following:

  • A sale for less than the asset’s market value—moving a valuable asset to another party.
  • A purchase of something at a greater consideration than its value, thus moving money to another party.

Examples of these transactions include a debtor:

  • selling their share of their home to their spouse for $1 or ‘natural love and affection’
  • granting a mortgage or security to a party in exchange for monies that were lent previously
  • purchasing an asset of limited worth, but paying a price well over market value.

A trustee can void property transfers—including money—within five years before the bankruptcy’s commencement.

Are some transfers of assets protected?
Yes. The Bankruptcy Act protects some transfers from being voided when all three of these conditions are present:

1. The transfer occurred over two years prior to the bankruptcy’s commencement.

2. The transfer did not involve a party related to the debtor.

3. The debtor was solvent at the time of the transfer, and remained solvent after the transaction.

Transactions undertaken with non-related parties while the debtor was solvent should be protected, as this would not be prejudicing creditors by transferring these assets. The transaction’s other party has the onus of proving that the bankrupt was solvent at the transaction time and remained solvent immediately thereafter.

Is the timing different if the other party is related to the bankrupt?
Yes. The two-year period extends to four years (i.e. prior to bankruptcy) if the other party to the transaction is related to the bankrupt.

This means that any undervalue transactions that took place four years before the bankruptcy’s commencement are automatically void if they involve related parties, as defined as ‘related entities’ in the Bankruptcy Act.

Is insolvency important?
A person is solvent if they are able to pay all of their debts as and when they become due and payable. A person who is not solvent is therefore insolvent.

A transfer under section 120 of the Bankruptcy Act is not void against a trustee if it took place more than two years before the commencement date of the bankruptcy and the debtor was solvent. That being the case, a trustee needs to demonstrate that the bankrupt was insolvent where the transfer took place between three and five years before the commencement of the bankruptcy. For related party transactions, this two-year period is extended to four years. A court will usually look to the trustee to provide some evidence to substantiate the insolvency at the time of the transfer. Consequently, the onus of defending these claims and therefore declaring solvency lies with the party seeking to rely on a defence.

The Bankruptcy Act provides for a presumption of insolvency if the debtor did not keep proper financial records during that period, but this presumption is rebuttable (i.e. it can be disproved by positive evidence of solvency). This can be quite difficult if there are truly no records of the bankrupt’s financial affairs.

Are some transfers exempt?
Yes. Some transfers of property will not be void. The Bankruptcy Act protects tax payments, payments made under family law agreements, and payments under Part IX debt agreements (i.e. Part 9 of the Bankruptcy Act).

A transfer is exempt when it is:

  • a tax payment under Commonwealth, State or Territory law
  • a transfer to meet all, or part, of a liability under a maintenance agreement or order
  • a transfer of property under a Part IX debt agreement
  • a transfer of a kind described in the Bankruptcy regulations
  • a transfer made under maintenance agreements or orders made in the Family Court of Australia.

The Family Court would have to overturn an original maintenance order before a trustee could make any recovery under section 120 of the Bankruptcy Act. Getting the Family Court to overturn its decision to allow a trustee to recover assets from an ex-spouse is very difficult.

The trustee must refund the consideration received
Section 120 of the Bankruptcy Act voids the entire transaction, not just the recovery of an asset or money. This means that to get the transferred asset back, the trustee must refund any consideration received by the bankrupt as part of that transaction. Consequently, each party is back to the position they held before the transaction was undertaken. Otherwise the estate would have both the consideration provided by the other party, and the asset that was transferred.

What is not consideration?
Some things are not deemed consideration and cannot be refunded. These include:

  • the transferee being related to the transferor
  • the transferee being a spouse or de facto spouse of the transferor
  • the transferee’s promise to marry or to become the de facto spouse of the transferor
  • love or affection
  • the transferee granting a spouse a right to live at the transferred property.

How long does the trustee have to take the recovery action?
A trustee must commence recovery action within six years of a person becoming bankrupt.

Transfers to defeat creditors – section 121 what are transfers to defeat creditors?
Sometimes debtors transfer property primarily to protect it from their creditors. The Bankruptcy Act allows such transfers to be voided where the bankrupt’s intention was to stop divisible assets becoming available to creditors, or to defeat or delay the proper distribution of assets to creditors.

What makes a transfer fall into this category?
To be a transaction to defeat creditors, it must involve the following:

  • Property that in all likelihood would have become part of the estate—or been available to creditors—and is made unavailable to the trustee because of the transfer.
  • The intention of making that property unavailable to creditors, permanently or temporarily.

What types of transactions are caught?
There must be a transfer of property. Something must pass from the bankrupt that would have become a divisible asset in the estate. However, a transfer can also be property created by the debtor that results in someone becoming the owner of something that did not previously exist. For example, the creation of a mortgage, securities, or other interests over property owned by the bankrupt, where the security would stop the property becoming available to the trustee.

How do you determine the bankrupt’s intention?
One of the transaction’s main purposes must be to protect the asset from creditors. This is subjective and usually inferred from the transaction’s circumstances, the bankrupt’s financial position at that time, and the result of the transaction.

However, intention can also be deemed by the debtor’s actual or impending insolvency (i.e. if it can be shown the bankrupt was—or was about to become—bankrupt at the time of the transaction). If the debtor was solvent at the time and remained solvent thereafter, it may be difficult to connect the transaction to the knowledge of insolvency.

Is insolvency important?
A person is solvent if they are able to pay all of their debts as and when they become due and payable. A person who is not solvent is insolvent. A court will usually look to the trustee to provide some evidence of insolvency at the time of the transfer if the trustee is using the deeming provisions.

Transfers are not void if done in good faith
The Bankruptcy Act protects transfers where the transferee acted in good faith. To be able to rely on the good faith defence, the other party to the transfer must show all three of these conditions:

1. Provided consideration at least to market value, calculated at the time of the transfer.

2. Had no knowledge of—or could not have reasonably inferred—the bankrupt’s intention.

3. Could not have inferred at the time that the transferor was insolvent, or about to become insolvent.

To be able to use this defence, the other party must have been completely unaware of the debtor’s financial position and intention. As many of these transactions are done with relatives or other related parties, this lack of knowledge may be difficult to prove. Transactions examined under section 121 of the Bankruptcy Act are rarely undertaken with complete strangers.

How long does the trustee have to take the action?
Actions under section 121 of the Bankruptcy Act can start at any time after the trustee discovers the transaction. Unlike other recovery provisions under the Bankruptcy Act, a section 121 transaction involves fraud and can be pursued vigorously.

TRANSACTIONS WHERE CONSIDERATION GIVEN TO A THIRD PARTY – SECTION 121A

Who else may be involved in these actions?
Third parties that are not directly involved in a transaction between the bankrupt and another party can be subject to a trustee’s recovery actions. Section 121A allows a trustee to collect money from a third party where that party received money that should have been paid to the bankrupt.

In these third-party scenarios, it is not essential that the original transaction was undervalued or intended to defeat or delay creditors, as it is the payment of consideration to the third party that is examined. For example, did the third party give valuable consideration to the bankrupt for the money, or was the bankrupt’s intention to direct the payment to the third party done to defeat creditors?

What can be done?
The Bankruptcy Act deems that when a third party receives consideration, it should be viewed as a transfer of property by the bankrupt. That consideration therefore constitutes that the property transferred and the transfer may be reviewed under sections 120 and 121 of the Bankruptcy Act. If that payment of consideration is considered void for the reasons set out in the sections above, the consideration will be recoverable from the third party.

A trustee can take action against the original party to the transaction and separately against the third party that received the consideration.

PROTECTION OF CERTAIN TRANSFERS

What protection does the Bankruptcy Act provide?
The Bankruptcy Act provides some protection to people transacting with a debtor before bankruptcy. A transaction is not automatically void because the debtor becomes bankrupt. Essentially, people who had no knowledge of the impending bankruptcy and acted in normal business circumstances can be protected.

Who gets this protection?
Section 124 of the Bankruptcy Act protects an innocent, unknowing party who entered in a commercial transaction in ordinary dealings with the bankrupt, if the following conditions are met:

  • The transaction happened before the bankruptcy—as the bankrupt does not have the right to deal with their assets after bankruptcy.
  • The other party was unaware of the impending bankruptcy.
  • The transaction was done in good faith and in the ordinary course of business.

The conditions of ‘good faith’ and ‘ordinary course of business’ may be difficult to prove. The other party must not have acted in any manner that would give the impression that they were not acting in good faith. The ordinary course of business must be held in the ordinary course of the relevant industry, not the ordinary course of the particular creditor.

The burden of proof rests with the party attempting to gain this protection.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 27.01.2016

Introduction
Trustees of bankrupt estates investigate pre-bankruptcy transfers or transactions when they believe the transaction improperly dissipated or removed assets that would otherwise be available to creditors. The Bankruptcy Act 1966 will in some cases permit voiding these transactions and require the other party to return an asset, or make a payment, to the trustee. Sometimes contributions made by or on behalf of the bankrupt (pre-bankruptcy) to superannuation funds fall into this category.

To void this type of transaction, the trustee must show:

1. A transaction was entered into.

2. They can identify the other party to the transaction.

3. The transaction occurred within a specific period, or while the debtor was insolvent.

4. The transaction was either undervalue, or had the required purpose of improperly removing assets from a bankrupt estate.

5. It does not involve protected property.

This Guide deals with contributions that are made prior to bankruptcy that have all of these factors.

Reasons for voiding these transactions
One of a trustee’s roles is to ensure that all of a bankrupt’s divisible assets are available to distribute to their creditors. Part of this role is to find whether a bankrupt entered into a transaction before they became bankrupt that reduced the assets available for distribution. For this reason, the trustee seeks to recover these assets. The Bankruptcy Act provisions give trustees the power to recover monies paid to eligible superannuation plans in the period before the bankruptcy.

Occasionally when debtors face bankruptcy, they try to protect some of their assets by hiding, moving or transferring assets to a third party to hold during the period of bankruptcy. Sometimes debtors make payments to their superannuation plan, as superannuation is generally an exempt asset.

The provisions attempt to deter debtors from moving assets into their superannuation plan at their creditors’ expense, and allow trustees to recover the money from the fund when payments fall under the relevant conditions.

Voiding the bankrupt’s superannuation contributions
Various sections of the Bankruptcy Act are designed to void transactions, or transfers, of property in order to provide a fair distribution of a bankrupt’s assets to their creditors. Section 121 ‘Transfers to defeat creditors’ is designed to void transfers where the intention of that transfer is to remove the property out of reach of the trustee or creditors.

Subdivision B of Division 3 of Part VI of the Bankruptcy Act is aimed at voiding transfers of property to eligible superannuation plans where the intention of the transfer was to defeat creditors. The main provisions are very similar to section 121, but target superannuation plans, as the Bankruptcy Act generally excludes monies in superannuation plans from being divisible property.

Under section 128B of the Bankruptcy Act, transfers made by a debtor are void if they occurred after 28 July 2006, and:

  • they are made to eligible superannuation plans of the bankrupt
  • the property would have formed part of the bankrupt estate if the transfer had not been made
  • the main purpose of the transaction was to keep an asset from falling into the trustee’s hands and being available to creditors.

Most people will initially consider payments as transfers, but any property transfers can be subject to these provisions. Section 128B goes one step further to include any transaction that creates new property. This is usually in the form of securities or equitable/legal interests over assets the bankrupt still owns i.e. creating a charge in favour of the superannuation plan may be deemed a transfer of property.

A trustee will examine payments to superannuation plans and any other assets created, and will assess whether the payment falls within the provisions. The inherently difficult part to determine is the debtor’s intention at the time of the transfer.

Contributions by a third party
Transfers to superannuation plans made by third parties on the debtor’s behalf may also be caught under these provisions. Third parties may also hold assets that belong to the debtor, or owe money to the debtor. Paying that money into a superannuation plan on the debtor’s instruction will be a transaction that can be examined. Again, the intention of the transfer must be to defeat creditors.

Under section 128C, transfers made by third parties are void if:

  • They are made to eligible superannuation plans of the bankrupt.
  • The property would have formed part of the property available to creditors in a bankrupt estate (usually as a debt due) if the transfer had not been made.
  • The transfer occurred under a scheme that the debtor was a party to—effectively, it was done under the debtor’s direct or implied instructions.
  • The main purpose of the transaction was to keep that asset from falling into the trustee’s hands and becoming available to creditors.

Intention
One of the main purposes of the transaction must be to protect the asset from creditors—to defeat the creditors’ interest in the property. This intention only needs to be one main purpose of the transaction, not the only purpose. This is subjective, and is usually inferred from the transaction circumstances, the debtor’s financial position at that time, and the result of the transaction.

This intention can be deemed by the debtor’s (i.e. pre-bankrupt) actual or impending insolvency, but only if it can be shown that the debtor was—or was about to become—bankrupt at the time of the transaction. If the debtor was solvent at the time and remained solvent for some time after the transaction—with no indication of an impending bankruptcy—it would be difficult to connect the eventual insolvency to the transaction.

It is common for debtors to undertake transactions with this intention when legal action against them is pending and it appears likely or inevitable that judgment will be brought against them. Alternatively, a loan or other agreement that has been breached could lead to a demand that a debtor cannot meet. In these circumstances, showing or deeming that the intention existed may be quite easy. Most bankrupts who undertake transactions to protect assets, usually only do so close to the time of bankruptcy.

The trustee will also examine the debtor’s history of personal contributions to eligible superannuation funds. If the payment is one of a series of similar payments over a long period, there could be an argument that the required intention did not exist. If the payment is a once-off large payment—especially if significantly larger than any previous payments—it is likely that the intention existed.

Third party contributions
The same deeming provisions apply to transfers by third parties. If it can be shown that the debtor was insolvent, or was about to become insolvent at the time, the intention can be deemed. The same indicators can determine the debtor’s intention. There is no requirement for the other party to know or suspect the insolvency, as there is no claim against that other party.

Insolvency
The debtor does not have to have been insolvent at the time of the transaction for it to be void. As detailed in Section 128B, it is the debtor’s intention that is important, and showing insolvency or pending insolvency is a key means of showing that intention. If the trustee relies on that deeming provision, the court will require evidence of insolvency.

The Bankruptcy Act provides for a presumption of insolvency if the debtor did not keep proper records of their financial affairs during that period. That presumption is rebuttable, i.e. it may be disproved by positive evidence of solvency. This may be quite difficult if there are truly no records on the debtor’s financial affairs. The same rebuttable presumption of insolvency applies to transfers made by third parties.

The rebuttable presumption is designed to stop bankrupts from avoiding their past transactions being overturned by simply destroying or hiding the records needed to examine the transaction. In essence, the presumption deems that the debtor is insolvent at a particular time, unless there are records that prove otherwise. As a consequence of that deemed insolvency, the transactions under examination can be said to have been done under the required intention.

Protection of other parties
The Bankruptcy Act goes to some lengths to ensure that innocent parties to void transactions are not prejudiced any more than necessary. The provisions that relate to the voiding of superannuation contributions are no different. The Bankruptcy Act provides protection for two parties: the bankruptcy trustee and the superannuation plan trustee.

The first party is the trustee of the eligible superannuation plan. When a contribution is received, certain taxes and other charges are deducted and paid to the government, fund managers, etc. The bankruptcy trustee will seek the voiding of the transfer (i.e. the entire amount of the contribution). Payment of the entire contribution would leave the superannuation trustee (the plan) out of pocket to the extent of the taxes and charges. Section 128B of the Bankruptcy Act provides that when an amount of the superannuation contribution is recovered, the amount of taxes and charges that applied to that contribution must be paid to the superannuation trustee, to ensure that they are not left with a shortfall.

Interestingly, this protection only applies to payments that are made to the bankruptcy trustee under a section 139ZQ notice. It is debatable whether this protection applies if the superannuation trustee voluntarily returns the contribution to the bankruptcy trustee, or even if the bankruptcy trustee obtains a court order for the contribution to be returned.

Innocent parties are protected when they receive title to any property in good faith (i.e. without any knowledge of the intention of the transfer).

Third party contributions
This protection also applies to superannuation trustees when contributions are made by other parties, but are voided under the appropriate Bankruptcy Act provisions. The provisions in section 128B and 128C also apply to third party contributions, except they are referred to as ‘contributions’ by other parties. Section 128C(8) of the Bankruptcy Act provides protection to parties that obtain title to property without knowing the intention of the transfer when the contribution is made by another party.

Protection against criminal and civil prosecution
Section 128L of the Bankruptcy Act protects superannuation trustees from criminal and civil prosecution for acts done in good faith. These acts include complying with a superannuation account-freezing notice (section 139ZQ notice under the Bankruptcy Act) or a court order.

Superannuation account-freezing notices
Section 128E of the Bankruptcy Act gives bankruptcy trustees certain powers to help them make these claims. One is the power to issue a superannuation account-freezing notice. The Official Receiver issues the notices when the bankruptcy trustee has satisfied to the Official Receiver that there are “reasonable grounds” that a contribution to a superannuation plan is void under Sections 128B or 128C. The notice comes into force when it is given to the trustee of an eligible superannuation plan.

These notices affect the superannuation plan trustee’s rights to deal with the funds in the plan, except in limited circumstances. The notices are designed to ensure that money is not paid out, or otherwise disbursed, before potential void transactions are resolved.

One important point is that the notice is either directed at the money paid into the plan from the contribution under examination (the money must be traced and identified in the plan at the time of issuing the notice), or the bankruptcy trustee must apply for to the court for an order under section 139ZU in relation to rolled-over superannuation interests.

The trustee can also apply to the Official Receiver to issue a notice under section 139ZQ whereby the Official Receiver can seek repayment from the recipient of the funds. Because the notice is given by the Official Receiver and affects the rights of the bankrupt on what would be otherwise exempt (non-divisible) property, the notice must set out why the Official Receiver believes that the contributions to the superannuation plan are void.

A superannuation account-freezing notice is not an open-ended right for a bankruptcy trustee. Section 128F of the Bankruptcy Act states that the Official Receiver can revoke the notice at any time. The notice is automatically revoked if the money is claimed under a revoked 139ZQ notice, or if the court sets aside the 139ZQ notice.

For example, if the superannuation account-freezing notice was supporting a section 139ZQ notice and that notice is satisfied or revoked, the freezing notice is also automatically revoked.

The bankruptcy trustee has 180 days to take, or conclude, their action after the Official Receiver issues a freezing notice. If a bankruptcy trustee cannot provide sufficient evidence within 180 days to satisfy to the Official Receiver that a section 139ZQ notice should be issued, the freezing notice will be revoked.

Similarly, if a bankruptcy trustee seeks relief through a section 139ZU order, then the court may order:

  • compliance with that order
  • that the order be set aside or dismissed.

If the application for the order is withdrawn within the 180-day period, the freezing notice will be automatically revoked.

The notice is also revoked if no order under section 139ZU is made within the 180-day period. The trustee is bound by a 180-day period, but may be extended by applying to the court.

Section 139ZU orders
The provisions that allow bankruptcy trustees to recover money paid into eligible superannuation plans also contemplate the transfer of money (the rollover of superannuation interests) between more than one plan, or between one or more people. These provisions allow the tracing of the void money into a second plan. Section 139ZU of the Bankruptcy Act allows the court to order a payment from the second plan to the bankruptcy trustee, but there are limitations.

The first limitation is that the contribution to the first plan must be void under sections 128B or 128C. But if the money has been transferred (rolled-over) to another plan, there may be insufficient funds in the first plan to satisfy a claim.

If there is sufficient money in the first plan to pay the claim, this provision will not be necessary, but there may be a shortfall. The money, or part of it, would now be in a second plan.

The shortfall contemplated in section 139ZU is the shortfall between the money remaining in the first plan and the bankruptcy trustee’s claim amount. Only the shortfall amount may be claimed from the second plan. Essentially, the trustee can keep tracing the money into the new plan and recover the shortfall.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 27.01.2016

Introduction
Dividends are the conclusion to most insolvency appointments. Dividends are distributed in accordance with statutory time limits, and any necessary examinations and investigations are conducted to admit or reject proofs of debt.

The Bankruptcy Act 1966 sets the minimum period to pay a dividend. If there are no complications, a personal insolvency dividend will take about two months to distribute.

If there is a complexity in relation to the admissibility of proofs of debt, the payment of the dividend can be delayed, particularly if a creditor applies to the court for a review of the trustee’s decision to reject their proof of debt.

Dividends in detail
When there are funds to distribute, the payment of a dividend is often the only tangible output from an insolvent estate.

A trustee withholds sufficient monies to complete the estate. They also determine the most appropriate time to pay dividends when considering any further anticipated realisations and the costs related to paying a dividend.

Dividends must be declared in accordance with the requirements of the Bankruptcy Act, and be paid to creditors in order of their priority.

Steps in paying dividends
The four basic steps required to pay dividends are as follows:

  1. Calling for proofs of debt—every known creditor must have the opportunity to lodge a proof of debt and participate in the dividend.
  2. Admitting proofs of debt—verify that the debt is proper and has been ‘proved’ to the trustee’s satisfaction.
  3. Rejecting proofs of debt—to ensure only legitimate creditors participate in the dividend.
  4. Paying the dividend—the trustee distributes the cheques.

1. Calling for proofs of debt
All creditors must be given the opportunity to lodge their claim in the form of a proof of debt. A proof of debt is a formal document used to prove that a debt exists and it sets out the amount of the debt. Without sufficient proof that the debt exists, it will not be admitted for the stated amount—or might not be admitted at all.

Proofs of debt are a prescribed form under the Bankruptcy Act. A trustee may not admit claims that are insufficiently detailed on the correct form, which may result in a creditor being excluded from a dividend.

Creditors can lodge proofs of debt at any stage in an administration. They do not need to wait until a dividend is called. Creditors should ensure that their claim has been lodged and appears in any list of proofs of debt received by the trustee. If creditors are in any doubt that their claim has been lodged, they should contact the trustee’s office.

Periods for calling for proofs of debt
The trustee must formally notify all known, or potential, creditors of the intended dividend and request that proofs of debt be lodged by a certain time.

The Bankruptcy Act states that creditors must be given ‘a reasonable period’ to lodge proofs of debt. Usually a 21-day period is considered reasonable.

Definite periods to lodge proofs of debt are important to expedite dividend payments or to ensure dividends are not challenged while cheques are being drawn. The cut-off date for proofs of debt is final and the provisions of the Bankruptcy Act set out the creditors’ and trustee’s rights if a proof of debt is not lodged in time.

Notices to be issued for calling for proofs of debt
The Bankruptcy Act does not require trustees to advertise a dividend; it only requires a notice to be sent to all known creditors that have not lodged proofs of debt. A trustee advertises a dividend when they suspect there may be creditors not disclosed—particularly when a Statement of Affairs has not been lodged, and when a trustee applies to the court to pay a dividend.

Dates for payment of dividends
The Bankruptcy Act does not set a maximum period after the intended date of declaring a dividend, but says that dividends cannot be paid until 21 days after the lodgement date for proofs of debt. Therefore a trustee must wait 21 days to receive proofs of debt and, without further complication, wait another 21 days before they can issue dividend cheques.

Non-lodgement of proof of debt
Under section 144 of the Bankruptcy Act creditors that miss the proof of debt cut-off date can lodge a proof of debt for the next dividend distribution, and they will be paid the first dividend they missed out on (a catch-up dividend), as well as the upcoming dividend. If there are insufficient funds to pay a second dividend (a second dividend is never declared), creditors will not receive a dividend at all. Therefore, it is imperative that creditors lodge their proofs of debt before the cut-off date.

2. Admitting proofs of debt
Under section 83 of the Bankruptcy Act creditors have the burden to prove the existence and amount of their debt. The trustee does not need to disprove a debt.

The trustee assesses the creditors’ supporting evidence and determines the validity and amount of the debt. If the trustee believes that all or part of the debt is not sufficient, they will seek further clarification and material from the creditor. Without further information, the trustee may reject the proof of debt in full or in part. The trustee is not required to locate sufficient information.

Creditors should attach copies (not originals) of all appropriate documents to their proof of debt.

Trustees must review proofs of debt within 14 days of the lodgement date and decide to admit or reject the claim, or seek further information.

3. Rejecting proofs of debt
Under section 102 of the Bankruptcy Act, if a proof of debt is rejected because a creditor does not provide sufficient evidence, a trustee will provide a notice outlining the reasons for rejecting the proof of debt. The creditor has 21 days to appeal the decision.

Appeals against decisions
Creditors’ rights are set out in section 104 of the Bankruptcy Act. Creditors can have the court review the trustee’s decision to reject their proof of debt, but have a strict and limited time to apply for adjudication. A trustee can amend their decision to reject a proof of debt when sufficient information is given if it is still within the required timeframe.

The court may allow an application for adjudication after the time limit period expires, but creditors should not rely on it being granted. Creditors should seek legal advice as soon as a rejection is received.

Creditors have the burden to prove to the court that the claim should be admitted in the bankruptcy. Creditors must show that the decision to reject the proof of debt was incorrect based on the information provided to the trustee.

Revoking a decision to admit or reject
A trustee can reverse their admittance or rejection of a proof of debt under section 102 of the Bankruptcy Act.

When a trustee reverses their initial decision to reject a proof of debt, they must give the affected creditor notice of the new decision and, if appropriate, adjust the dividend to be paid or, if necessary, pay a catch-up dividend.

4. Paying the dividend
Dividends are paid after the proof of debt lodgement date expires, after all the proofs of debt have been admitted or rejected, and after any appeals on rejections have been heard in court. The trustee will forward a cheque to the creditor with a Form 2, which outlines the realisation and distribution of the bankruptcy estate.

If dividend cheques are not banked within a reasonable period, or if creditors cannot be located, the trustee will hold monies for six months following payment, and then forward these monies to the Australian Financial Security Authority (AFSA). The creditor must then request the money from AFSA.

Priorities in the payment of dividends
Subject to specific priorities under section 109, all creditors will rank equally in insolvent estates and will be paid ‘pro-rata’ dividends. If there are insufficient funds to meet the estate’s debts in full, they are paid proportionately.

The Bankruptcy Act gives priority to outstanding employee limited wages (e.g. $1,500 per employee or such greater amount as prescribed by the regulations), long service leave, annual leave, sick leave etc. An employee creditor must clearly indicate that they are claiming as an employee and use the required proof of debt form for that purpose.

Joint bankruptcy estates
Section 110 of the Bankruptcy Act provides for joint and separate bankrupt estates. It applies when two or more bankrupts have joint and several assets and liabilities. For example, bankrupt business partners have joint partnership assets (i.e. held together), and individual assets (i.e. held separately). They may also have individual and joint creditors. How joint and individual assets are divided among the joint and individual creditors in bankrupt estates is sometimes complex. Joint assets are used to pay joint creditors, and each bankrupt’s individual assets are used to pay their individual creditors. When there are no surplus assets in either estate, the issue is irrelevant.

If there is a surplus in either individual estate, it can be used to pay joint creditors to the necessary limit of joint claims. When there is a surplus after paying both individual and joint creditors, the bankrupt is annulled from bankruptcy, and the surplus money is paid to them.

Alternatively, if there is a surplus in the joint estate, it is divided proportionately to the individual estates, and can be used to pay individual creditors. If either individual estate has sufficient monies to pay the individual creditors and still has a surplus, that bankrupt will be annulled from bankruptcy and the surplus is paid to them.

Surplus assets in one individual estate cannot be used to pay creditors in the other individual estate.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.08.2015

Introduction
Normally, a person’s bankruptcy ends with the bankrupt being discharged—called a ‘discharge from bankruptcy’. Unless an ‘objection to discharge’ is lodged, discharge occurs automatically three years after the bankrupt’s Statement of Affairs is filed with the Australian Financial Security Authority (AFSA). Discharge releases the bankrupt from the bankruptcy; however, the bankrupt estate (property, assets etc.) continues until all matters are satisfactorily concluded. This means the discharged bankrupt is still obligated to cooperate with the trustee.

Alternatively, a bankruptcy can be annulled. Discharge and annulment do not have the same legal result.

A discharge concludes the legal status of a person being a ‘bankrupt’, while the trustee completes their duties to the bankrupt estate. Whereas an annulment reverses the bankruptcy entirely—as if it never happened, thereby removing the person from bankruptcy and ending the bankrupt estate completely.

The Bankruptcy Act 1966 allows a bankruptcy to be extended for a total of five or eight years when a bankrupt has not cooperated with their trustee, or when an offence has been committed. If an objection to discharge is lodged against a bankrupt, the discharge date occurs at the end of the granted extended period.

Discharge from bankruptcy
Commonly, a person’s bankruptcy automatically ends three years after their Statement of Affairs is filed with AFSA, under section 149 of the Bankruptcy Act. If the bankruptcy commenced via a debtor’s petition (i.e. a person voluntarily bankrupts themself), the Statement of Affairs must have been filed at the same time. Therefore, without an objection to discharge being lodged, the bankruptcy ends three years after the debtor’s petition was accepted.

If the bankruptcy commenced via a sequestration order (i.e. an order of the court), the Statement of Affairs would not have been filed at that time. The bankrupt must complete and lodge a Statement of Affairs with AFSA, and the bankrupt is discharged three years from this date.

The longer the delay in filing the Statement of Affairs, the longer the three-year bankruptcy period is prolonged. If the Statement of Affairs is never filed, the bankruptcy will continue until the death of the bankrupt; however, the estate’s conduct will continue until completed.

Discharge from bankruptcy is an automatic process of law, regardless of whether it ends at the standard three year mark, or at the end of the extended period. Usually a trustee will confirm in writing that the bankrupt has been discharged and ask for information to conduct a final income assessment.

Bankrupt to continue to assist trustee after discharge
Even though the bankruptcy ends, the discharged bankrupt is obligated to assist the trustee under section 152 of the Bankruptcy Act, as the conduct of the bankrupt estate may continue. While the estate is commonly completed within the three-year period, there are exceptions. The estate does not end until the trustee has completed all the necessary tasks. Penalties apply to discharged bankrupts that do not provide all reasonable assistance to the trustee.

Release from debts
Discharge releases a bankrupt from their provable debts. These are debts that were outstanding at the date of bankruptcy—not debts incurred after the bankruptcy commenced—and that can be proved for in the bankrupt estate for a dividend. Debts that are not provable in the estate are not released and some debts are only partially released.

Significantly, a person’s debts are only released up until the point when the bankrupt is discharged from bankruptcy, under section 153 of the Bankruptcy Act.

This allows creditors such as the Australian Taxation Office to offset monies payable to the bankrupt (after bankruptcy) against debts payable by a person before their bankruptcy.

If a bankruptcy is annulled, a person’s debts will still exist and must be satisfied in some other manner. These debts are usually satisfied in the process of getting the annulment, i.e. payment in full, or through a section 73 agreement.

Section 82 of the Bankruptcy Act sets out what debts are provable in the estate and will be released upon discharge. Frequently, all of a bankrupt’s debts fall into this category and are discharged, but there are some significant exceptions including penalties or fines and HECS debts.

Only provable debts are released. Furthermore, some debts are provable in the estate for the amount owing, but by statute are not released in full at discharge (e.g. amounts under a maintenance agreement or order given before the bankruptcy date). An outstanding maintenance agreement amount at the time of the bankruptcy is released, but amounts payable after the bankruptcy commenced are not released at discharge.

Section 82 of the Bankruptcy Act also outlines debts that are not provable and will not be released on discharge. These are confirmed by section 153 of the Bankruptcy Act that provides that non-provable debts are not released upon discharge. These sections include a liability to pay an income contribution to the trustee, debts incurred by way of fraud, and liabilities under maintenance agreements or orders.

A bankrupt should be aware that non-provable debts will survive the bankruptcy process and will need to be paid by other means.

Rights of secured creditors
A debt owed to a secured creditor is not released against the asset secured—only against the bankrupt. Valid securities in place at start of bankruptcy can be enforced against the secured asset at any time, even after the bankrupt is discharged. However, secured assets are generally sold in the three years prior to bankruptcy discharge (although there are some exceptions).

Any shortfall after the secured asset’s sale is released from the bankrupt at discharge. A secured creditor cannot recover any shortfall suffered after selling the asset secured from the discharged bankrupt. Most securities are exercised with the asset sold before the bankrupt’s discharge and any shortfall is proved for in the estate, but not always. Sometimes these assets take longer than three years to realise. In this case, the secured creditor will not recover any shortfall.

If the secured asset has not been sold before discharge, any amount proved for (an estimated shortfall) in the estate is released at discharge. That debt therefore no longer exists and cannot be claimed against the secured asset. This affects creditors that make large shortfall estimates by underestimating the value of the secured asset.

The key point, under section 153(3) of the Bankruptcy Act, is that the secured part of a secured creditor’s debt survives a discharge from bankruptcy and the deficiency is released.

Obligations of business partners, guarantors & joint debt holders
A business partner of a bankrupt is protected, as under section 153(4) of the Bankruptcy Act, a discharged bankrupt is not released from a partnership debt. These debts normally hold a joint liability under the Partnership Act 1892. These provisions also apply to people that entered into contracts or arrangements with the bankrupt, guaranteed a debt of the bankrupt, or simply have joint debts with the bankrupt. These people are liable for such debts, or their part of the debts they are liable for if the bankrupt had not become a bankrupt.

These joint debts are only released against the discharged bankrupt, not the other parties to the debt. Creditors can pursue the other parties to a debt, even after the discharge of the bankrupt, and their subsequent release from the debt from the bankrupt.

Annulment of bankruptcy
An annulment is a reversal of a bankruptcy. However, the bankruptcy will appear indefinitely on the public record (the National Personal Insolvency Index or NPII) and credit reference databases for two years from the annulment date, or five years from the date of bankruptcy, whichever is later. For an annulment to occur, a bankrupt needs to take one of the following three actions:

1. Annulment on payment of debts in full.

2. Section 73 proposal.

3. Annulment by court order.

The first two actions require satisfaction of the bankrupt’s debts, at least in part, and the last one requires an order of the court.

Annulment on payment of debts in full
Under section 153A of the Bankruptcy Act, a bankruptcy is annulled if the estate has sufficient monies to pay all of the debts and the costs of the estate in full. This means that the bankrupt is now solvent and there is no need for the bankrupt estate, or a release from debts. Commonly, a bankruptcy is annulled when a bankrupt receives monies from a third party (usually a relative) or when a bankrupt’s assets are sold or refinanced.

The debts include all those that have been proved for in the bankruptcy, but also any applicable interest accrued after the bankruptcy’s commencement. The administration costs, charges and expenses of the bankrupt estate—including the trustee’s remuneration and expenses and AFSA’s Asset Realisation Charge (ARC, currently 7 percent)—are payable on the amount required to meet all of the debts and costs. If the bankruptcy was commenced by a creditor’s application, the petitioning creditor’s costs also need to be paid.

Bankrupts must understand that the extra estate costs incurred may be significant and must be paid in full to obtain this type of annulment.

Section 73 proposal
A section 73 proposal is made under section 73 of the Bankruptcy Act. Section 73 gives bankrupts an alternative to their continued bankruptcy by allowing them to propose a formal arrangement to their creditors. This process is similar to proposing a Part X agreement to creditors (i.e. instead of bankruptcy); however, a section 73 proposal is initiated during a bankruptcy.

The process requires the creditors to accept the proposal and receive a benefit that was unavailable to them in the bankruptcy, in exchange for agreeing to annul the bankruptcy. Upon acceptance, an annulment occurs and the new agreement takes effect. The debts of the now ex-bankrupt are not released by discharge, but through the agreement terms being satisfied. Non-provable debts are covered in section 75 of the Bankruptcy Act.

Annulment by court order
Under section 153B of the Bankruptcy Act, a bankrupt can apply to the court for an order annulling (i.e. effectively overturning) the bankruptcy. The court will only consider an application if it believes that the bankruptcy should never have commenced in the first place. An application can be made against a sequestration order (i.e. a creditor’s petition) or the acceptance of a debtor’s petition by AFSA.

A bankrupt may apply for an annulment for numerous reasons not detailed here; the emphasis is on the bankrupt’s rights.

Protection of the trustee
Once a bankruptcy is annulled, a trustee gives the appropriate notices to AFSA to update the NPII.

Section 154 of the Bankruptcy Act protects a trustee’s actions while they are trustee of a bankrupt estate. Any transactions or sales entered into during this period are not reversed, or reviewed. The trustee can use assets in the annulled estate to pay any costs and remuneration that remain unpaid at the time of the annulment.

If the assets in the estate are insufficient to meet the trustee’s costs and expenses, a trustee can collect the balance from the annulled bankrupt. This means that it is possible for a trustee to bankrupt the ex-bankrupt for costs incurred before the bankruptcy was annulled. However, this is a rare scenario.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 27.01.2016

What is an objection to discharge?
Normally a person’s bankruptcy automatically ends three years after their Statement of Affairs is filed with the Australian Financial Security Authority (AFSA). The end of a bankruptcy is called a ‘discharge from bankruptcy’. However, a bankruptcy trustee can extend the bankruptcy period by lodging an ‘objection to discharge’ with AFSA.

Why object to a bankrupt’s discharge?
An objection to discharge is used as a penalty for a bankrupt’s actions before or during bankruptcy, or to encourage them to cooperate with their trustee. Often it is in creditors’ interests—or the public interest—that a bankrupt is not discharged at the three-year mark if they have committed an offence under the Bankruptcy Act 1966

When can a trustee object to a bankrupt’s discharge?
An objection can be lodged at any point during the bankruptcy, but before discharge, and must be within the Bankruptcy Act’s statutory grounds.

How does a trustee object to a bankrupt’s discharge?
A trustee lodges the objection notice with AFSA and gives a copy to the bankrupt. Once AFSA records the notice on the National Personal Insolvency Index (NPII)—the statutory register—the objection becomes legal.

How long can a bankruptcy be extended for?
A bankruptcy can be extended for two or five years, making the total bankruptcy period five or eight years. The extension period depends on the type of statutory ground for objection. The usual discharge provisions then apply, with automatic discharge at the end of the extended period.

How is the extension period determined?
The extension period is determined by the statutory ground used for the objection. A ‘non-special ground’ will result in a two-year extension, and a ‘special ground’ will result in a five-year extension.

What are the grounds for objecting?
The objection must address a specific statutory ground. More than one objection can be lodged in a bankruptcy. Under section 149D of the Bankruptcy Act, the grounds for a trustee to object to a bankrupt’s discharge are:

Special grounds (five-year extension)

If the bankrupt:

  1. Fails to provide written information about their property or income.
  2. Fails to disclose particulars of income or expected income.
  3. Fails to pay a contribution amount to the trustee.
  4. Fails to dispose of assets or spend monies within five years before bankruptcy without adequate explanation.
  5. Fails to return to Australia when requested.
  6. Fails to sign a document as required by a trustee under the Bankruptcy Act provisions.
  7. Fails to make assets available to creditors (i.e. void transactions under sections 121, 128B or 128C of the Bankruptcy Act).
  8. Fails to provide true and full information to a trustee (i.e. intentionally providing false or misleading information to a trustee.
  9. Fails to disclose a liability (intentionally) that existed at the time of bankruptcy.
  10. Fails to disclose a beneficial interest in a property.

Other grounds (two-year extension):

If the bankrupt:

  1. Fails to cease managing a corporation in contravention of the Corporations Act 2001 and without leave being granted.
  2. Fails to return to Australia.
  3. Fails to make assets available to creditors (i.e. void transactions under section 120 or 122 of the Bankruptcy Act).
  4. Fails to act honestly in regarding amounts that exceed $3,000 (i.e. the bankrupt’s conduct is misleading involving transactions of $3,000 or more).
  5. Fails to disclose a liability that existed at the time of bankruptcy.
  6. Fails to comply with section 77(1) or section 80 of the Bankruptcy Act.
  7. Fails to attend a creditors’ meeting under certain circumstances, or an interview, or an examination, without reasonable excuse.

What if there is more than one ground?
If more than one ground applies, the extension period is based on the ground with the longest period only, i.e. these periods are not cumulative. If this ground is later removed (i.e. the bankrupt complies with their obligations), the extension period applies to the next longest period attached to any remaining ground. The extension period may not change if two special, or two non-special grounds apply, and only one is lifted.

What is the difference between objection notices for special and non-special grounds?
Special grounds do not require the reasons to be outlined on the notice to object, due to the nature of these grounds. Whereas, a non-special ground requires the reasons to be outlined on the notice to object.

Can an objection be withdrawn?

Yes. A trustee can withdraw an objection at any time. Trustees normally withdraw the objection if the grounds are satisfied. But there is no requirement to withdraw it, especially concerning a special ground. If all grounds have been satisfied, the notice of objection can be completely withdrawn. The objection lodgement and the withdrawal are recorded on the NPII.

Will withdrawing an objection end the bankruptcy?
Sometimes. If the normal three-year bankruptcy passed while the objection was in force, withdrawing the objection will automatically discharge the bankrupt as at the objection withdrawal date—not the original bankruptcy discharge date. If the objection is withdrawn during the normal three-year bankruptcy period, the bankruptcy will end by automatic discharge at the end of that three-year period.

Can the objection be removed by a higher authority?
Yes. The Bankruptcy Act provides a review process. A bankrupt can apply to the Inspector-General in Bankruptcy to review the trustee’s decision to object to a bankrupt’s discharge. The application for review must be made within 60 days of the bankrupt receiving the notice of objection. If the Inspector-General agrees to review the objection, a decision must be made within 60 days of receiving the application.

The Inspector-General must review the objection on the following basis:

  1. Whether the ground exists under the Bankruptcy Act.
  2. Whether sufficient evidence supports that ground.
  3. The bankrupt’s conduct before the objection was lodged.

However, as special grounds do not require reasons to be outlined in a trustee’s notice to object, the Inspector-General cannot consider the evidence, or the bankrupt’s conduct, therefore obtaining a decision to cancel these objections is difficult. Even if the bankrupt subsequently complies with the trustee’s requests, the bankrupt’s conduct will not automatically mean an objection is removed or withdrawn. To get an objection based on a special ground removed, a bankrupt may have to show that the circumstances do not justify the objection in the first instance.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.08.2015

How does a bankrupcy end?
A bankruptcy usually ends with the bankrupt being discharged from bankruptcy, which is the end of the legal process. No action is required of the bankrupt and trustee to obtain a discharge, as it is purely an operation of the Bankruptcy Act 1966 three years after a Statement of Affairs is lodged.

The bankrupt estate may continue after discharge while the trustee finalises the estate, and the discharged bankrupt may have some ongoing obligations, but they will no longer be ‘bankrupt’.

When is a bankrupt discharged?
A bankrupt is automatically discharged three years after their completed Statement of Affairs is filed with the Australian Financial Security Authority (AFSA)—unless a trustee files an ‘objection to the discharge’.

If the bankruptcy commenced via a debtor’s petition (i.e. a voluntary bankruptcy, where a person chooses to bankrupt themselves), the Statement of Affairs must have been filed at the same time, so therefore the bankruptcy ends three years after the debtor’s petition is accepted.

If the bankruptcy commenced via a sequestration order (an order of the court), the Statement of Affairs would not have been filed at that time. The bankrupt must complete and lodge a Statement of Affairs with AFSA. The longer the delay in filing the Statement of Affairs, the longer the three-year bankruptcy period is prolonged. If the Statement of Affairs is never filed, the bankruptcy will continue until the death of the bankrupt; however, the estate’s conduct will continue until completed.

Can a bankrupt get out of bankruptcy before discharge?
Yes. The bankruptcy can be annulled. An annulment reverses the bankruptcy, as if it never happened.

How is a bankruptcy annulled?
There are three ways of annulling a bankruptcy:

  1. The trustee obtains sufficient monies to pay all of the estate’s debts and costs.
  2. A section 73 proposal is accepted by the bankrupt’s creditors.
  3. The bankrupt convinces the court the bankruptcy should never have been commenced.

What are the debts and costs of the estate?
The costs and debts are:

> all provable debts of the estate.
> the Asset Realisation Charge (ARC), which is currently 7 percent and is payable to AFSA.
> the trustee’s expenses and remuneration.
> any other charges or statutory costs of the estate.

For a bankruptcy to be annulled by all debts and costs being paid, the trustee must have sufficient money to satisfy all the pre-bankruptcy debts, the bankruptcy costs and the statutory charges. Generally, this type of annulment happens when the sale of an asset provides enough money to pay these costs, or when a friend or relative provides the funds.

What is a section 73 proposal?
A section 73 proposal is a formal proposal presented to creditors under section 73 of the Bankruptcy Act. It provides a mechanism for bankrupts to put forward a proposal to their creditors as an alternative to the bankruptcy continuing. If creditors accept a section 73 proposal, the bankruptcy is exchanged for an obligation under the section 73 agreement.

Why would the court annul a bankruptcy?
Usually, the court will only annul a bankruptcy when it can be shown that the bankruptcy should never have been commenced. This happens:

> where the proper legal process was not followed in initially bankrupting the person
> if there was no debt outstanding to a petitioning creditor at the time
> if the bankrupt is actually solvent.

A bankrupt who successfully obtains an annulment through the court should be aware that the ex-trustee has the right to use assets in their possession to pay outstanding remuneration and outlays, and if the net value is insufficient, they may seek payment from the ex-bankrupt.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.08.2015

What is a section 73 proposal?
During a bankruptcy, a bankrupt may be in a position to make a proposal to their creditors to satisfy their debts and consequently end their bankruptcy early. Section 73 of the Bankruptcy Act 1966 provides a bankrupt with a mechanism to make that proposal.

If a section 73 proposal is accepted, the creditors would expect to receive a larger distribution than they would receive under the continued bankruptcy.

How does a bankrupt make a proposal?
The bankrupt is required to send a written proposal to their trustee and request that a meeting of creditors be called to consider the proposal. The proposal’s particulars are set out in the written request. The trustee will investigate the benefits of the proposal as necessary, issue a report and call a meeting for the creditors to vote to accept or reject the proposal.

The bankrupt will usually be required to pay the trustee to undertake this process, as there is no requirement for estate funds to be used for this purpose.

If the proposal is accepted, the bankruptcy will be annulled from the acceptance date. If the proposal is not accepted, the bankruptcy will continue as if the proposal had never been put to creditors.

Composition or arrangement?
A section 73 proposal can be structured as either:

> a composition
> a scheme of arrangement.

A composition is an agreement to pay money to the trustee. The composition can be for any amount and can be paid over any period.

A scheme of arrangement can contain almost any lawful provision. It can contain provisions for the payment of monies, the sale of certain assets, and payments from third parties.

Investigating and reporting
Before the meeting of creditors, the trustee will conduct investigations. Once satisfied, the trustee will issue a report to creditors detailing the proposal’s terms. The report will compare the likely returns from the proposal to the bankruptcy’s continuation.

Delays in calling a meeting of creditors
A trustee can decline to call a meeting of creditors if the proposal does not provide for the trustee’s approved fees and expenses or costs to be paid. Prior to the proposal being examined, the trustee may also require the bankrupt to pay an amount (called a surety) to cover the trustee’s costs, and to cover the trustee’s fees to investigate the proposal, and to call and hold the meeting.

How is the proposal accepted?
The proposal is put to a meeting of creditors under the same provisions as bankruptcy meetings. Only the creditors at that meeting vote on the proposal. It must be accepted by a special resolution, which is both a majority in number of the creditors (present and voting), and at least 75 per cent of the dollar value of the creditor’s debts (present and voting). So it is in every creditor’s best interests to attend and vote on a section 73 proposal.

If the proposal is accepted, the bankruptcy is consequently annulled. The now ‘ex-bankrupt’ will be bound by the agreement terms. The agreement binds all creditors, whether or not they attend or vote at the meeting.

Who administers a section 73 proposal?
The proposal must include a provision for a trustee to administer the agreement. Usually, the bankruptcy trustee will administer the agreement; however, a different trustee can be appointed under the agreement. The trustee’s role is to:

> ensure that the ex-bankrupt complies with the agreement’s terms
> enforce the provisions as necessary
> pay dividends.

What about the trustee’s actions during the bankruptcy?
Section 74 of the Bankruptcy Act provides that the actions of the bankruptcy trustee during the bankruptcy period remain valid. Without this provision, the bankrupt or any party to a bankrupt’s transactions would be able to challenge its validity.

Can the trustee pay dividends?
Yes. The trustee of the agreement will make distributions under the agreement terms. If the agreement does not stipulate these provisions, the trustee will make distributions when practical and when the agreement is likely to end.

When does a section 73 agreement end?
The agreement ends when the debtor (the ex-bankrupt) satisfies the agreement terms in full.

What if the debtor defaults?
If the debtor does not satisfy the agreement terms, section 76B of the Bankruptcy Act provides enforcement provisions. All of the powers that are available to a trustee under Part X of the Bankruptcy Act (in the enforcement of personal insolvency agreements) are available to a trustee of a composition or scheme of arrangement. These include terminating the agreement either:

> automatically through the agreement terms
> with creditors’ consent
> by creditor resolution
> by court order.

Any application to the court to terminate the agreement can also include an application to bankrupt the debtor to initiate a new bankruptcy.

Government realisation charge
The administration of section 73 proposals attracts a government charge known as a ‘realisation charge’. From 1 July 2015, the rate is 7 per cent of gross monies received into the estate, less payments to secured creditors and trade-on costs. The realisation charge is payable in priority to any dividend to creditors.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.08.2015

Bankruptcy and the home
How the Bankruptcy Act 1966 applies to a bankrupt’s home is often misunderstood. The loss of the bankrupt’s home is usually felt more intensely than the loss of any other asset.

Understandably, many bankrupts know that the loss of their home will disrupt the family unit, not only affecting the bankrupt but also their children and partners/spouses who may be solvent.

This is why bankruptcy trustees must approach the realisation of a bankrupt’s interest in their home with tact and understanding, while protecting the rights and interests of creditors.

Is the home protected?
No. A home is not a protected asset under the Bankruptcy Act. If there is equity in the property after paying out any proper mortgage and selling costs, the trustee is obliged to realise the property.

What about joint ownership?
The realisation process is relatively straightforward when the bankrupt is the only owner of the home, or all owners are bankrupt. However, often the bankrupt and their non-bankrupt partner/spouse will own the home as ‘joint tenants’. When the bankrupt and a non-bankrupt co-owner jointly own the home, the trustee can still insist on realising the bankrupt’s share of the equity.

What happens to joint tenancies on the bankruptcy of one or more owners?
A joint tenancy is automatically severed upon the bankruptcy of any one of the joint tenants—at least as far as it relates to the bankrupt’s ownership interest.

This occurs due to the ‘involuntary alienation’—or severing of the owner’s fundamental legal rights—that is necessary to create a joint tenancy. This practice is long-established with reference to the 1862 case of Paten v Cribb.

The trigger to this alienation of legal rights is the property vesting in the trustee, which occurs when the bankruptcy commences.

After the joint tenancy is severed, those interests in the property are held as ‘tenants in common’. This is important if a bankrupt dies during the bankruptcy. If the joint tenancy had not been severed, the bankrupt’s share of the property—and the equity attached to that share—would automatically vest in the co-owner upon the bankrupt’s death, and the estate would lose the equity in the property.

How is the equity in a property determined?
The trustee will get the property valued to determine the equity. Secured debts (e.g. mortgages, etc.) are deducted from the property’s value and the bankrupt’s share of the equity is calculated.

What if there is no equity in the property?
When there is no equity in a property and the debts secured against the property are greater than the current property value, the mortgagees may exercise their rights and sell the property.

If mortgagees don’t exercise their rights, the bankrupt—and possibly other parties—can continue to service the loan. It is also reasonable to expect the property’s value to increase. The property vests in the trustee at the time of bankruptcy and remains vested regardless of whether the trustee takes action to sell the property, or when there is no equity in the property. The property remains vested in the trustee when the bankrupt has been discharged from bankruptcy.

The trustee will generally review the property’s equity position periodically. They can realise any equity generated after the date of bankruptcy, even if the equity has been generated by the continued mortgage repayments by the bankrupt or another owner. Mortgage repayments attributed to the bankrupt’s share are deemed to be rental payments to use and occupy the property.

How are properties realised?
Where the trustee is the only owner, they can put the property up for sale. Where there is a co-owner, the trustee will usually take the following approach:

  1. Give the co-owner the opportunity to buy the estate’s interest in the property.
  2. Invite the co-owner to join the trustee on agreed terms to market and sell the property.
  3. If there is no agreement to sell the property, the trustee can ask the court to appoint a ‘statutory trustee for sale’ over the co-owner’s interest to force a sale of the property.

The appointment of a statutory trustee forces the sale of the home, even if the co-owner is solvent and has not contributed to the bankruptcy in any way. While the court will often try to soften the effect of such an order by allowing the co-owner time to relocate, the outcome is that the property will be sold.

What is entering transmission?
‘Entering transmission’ is the legal process to have the trustee’s name placed on the certificate of title in place of the bankrupt’s name. This is necessary for the trustee to execute a sale contract and transfer forms when selling the property.

Usually the trustee will only enter transmission if satisfied that there is equity in the property.  In the interim, the trustee can lodge a caveat over the title to protect the estate’s interests for the short-term, giving the trustee time to determine what to do with the property.

What about mortgagees?
The majority of homes are subject to a mortgage. The mortgage may be enforced during the bankruptcy, even when the mortgage payments are up-to-date, as the bankruptcy itself may constitute a default in the terms of the mortgage. Although mortgagees have the right to sell the bankrupt’s home, in most cases they will leave this task to the trustee.

What if the bankrupt can continue with mortgage repayments?
If the bankrupt has the capacity to continue making mortgage repayments, usually the mortgagee will not insist upon possession of the property—preferring that the loan repayments continue. The trustee and bankrupt may negotiate payment for any equity in the property to the estate.

This type of arrangement benefits everyone concerned: the bankrupt’s creditors benefit from the property’s equity in the estate; the mortgagee retains a performing loan; and the bankrupt’s family avoids losing their home.

However, the trustee can sell the property at any time, even if the mortgage repayments are up-to-date. This means that the estate will benefit from the extra equity generated in the property from additional repayments.

What about getting vacant possession?
Normally, the trustee will need to provide vacant possession when selling a property. A trustee would not usually expect a bankrupt to vacate the property immediately upon bankruptcy; in normal circumstances a few weeks would be allowed for alternative arrangements to be made.

In some cases, the trustee may allow the bankrupt to stay in residence during the selling period provided the bankrupt assists in that process, pays a fair rent, maintains the property, and provided the trustee is satisfied of the bankrupt’s continued cooperation in the bankruptcy process.

How are the proceeds of sale distributed?
If the property is wholly owned by the bankrupt, the estate will receive the entire surplus of the sale after any mortgagee and selling costs are paid. If the property is co-owned, the trustee will share the surplus with the co-owner (non-bankrupt) as per the legal entitlement on the title deed.

Although the title to a property may be held equally, situations arise where unequal contributions have been made towards the property’s acquisition or development. This may lead to one party holding the property for the other party in a constructive or resultant trust, and will potentially alter the sale distribution. The sharing of equity may also be altered under the ‘doctrine of exoneration’ if one owner on title uses loans secured on the property, and not the other.

When does the doctrine of exoneration apply?
The property may be encumbered by a mortgage that secures a loan for the sole benefit of one owner, even though all owners have agreed to the mortgage. The doctrine of exoneration says that the person who received the benefit of the loan should have the first obligation to repay the loan—and the co-owner should only be considered a surety (guarantor) and their share should only be used to meet any shortfall.

A simple example of the doctrine is a home worth $400,000 owned by the bankrupt and a non-bankrupt partner/spouse. Prior to bankruptcy they agreed with the bank taking a mortgage over their property to support an advance of $150,000 to the bankrupt’s business. Upon sale of the property, $250,000 would be available for distribution to the owners (i.e. $400,000 sale price less the $150,000 mortgage). Because each owner had an equal share in the legal title to the property it might be thought that they should each receive $125,000. However, the doctrine of exoneration can require that the amount due under the mortgage should be deducted from the bankrupt’s equity so that the following equitable distribution would apply:

Bankrupt’s share = $200,000

less $150,000 = $50,000

Spouse’s share = $200,000

The trustee must find compelling evidence that the doctrine of exoneration should apply.

Is there a timeframe for the sale of the property?
Section 129AA of the Bankruptcy Act requires trustees to realise property within a period ending six years after the discharge of a bankrupt. This allows nine years to arrange these sales. If the trustee does not sell within the timeframe, the property could potentially revest in the discharged bankrupt.

The six-year rule only applies to property disclosed to the trustee. If the property is not disclosed in the bankrupt’s Statement of Affairs or as after-acquired property, the trustee will have 20 years to deal with the property.

War service homes
A bankrupt or a debtor under Part X of the Bankruptcy Act cannot have a war service home taken from them under the Defence Service Homes Act 1918, except in extraordinary circumstances.

Although the department has the discretion to allow a trustee to sell the bankrupt’s property, in reality this discretion is rarely applied. In our experience, the secretary will not exercise their discretion even when the bankrupt has incurred very substantial business debts.

Undoubtedly, some bankrupts take business risks—which they would otherwise have avoided—in the knowledge that they cannot lose their war service home. This is inequitable as far as creditors are concerned, but it is currently the law.

Summary
A bankrupt’s home can be sold even if the bankrupt only has a part interest in the property.

  1. The trustee will normally offer the property for sale to any co-owner prior to having the property placed on the market.
  2. The trustee will normally sell the interest in the property without undue delay.
  3. The trustee must recover the value for the property, but has a wide discretion regarding how to sell.
  4. The trustee will normally allow the bankrupt a few weeks to arrange alternative accommodation.
  5. The doctrine of exoneration, may adjust the distribution of the sale proceeds.
  6. War service homes are excluded from realisation.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.08.2015

Introduction
The Bankruptcy Act 1966 provides that it is an offence for a bankrupt to travel overseas or prepare for overseas travel (such as purchasing flights) without first obtaining their bankruptcy trustee’s consent.  Section 272 of the Bankruptcy Act imposes a maximum penalty of three years’ imprisonment, upon conviction, for a breach of these provisions.

Does the travel restriction apply to all personal administration types?
No. A debtor who has entered a formal arrangement with creditors under either a Part IX debt agreement or a Part X personal insolvency agreement is not restricted from travelling outside of Australia.

Why do bankrupts have to obtain permission?
It is recognised that a bankrupt may have a legitimate reason for overseas travel, but that this reason will be balanced with the need for the bankrupt estate to be administered in a proper and efficient manner, which may require the bankrupt’s presence in Australia.  The Australian Financial Security Authority (AFSA), being the governing body overseeing personal insolvency administration, outlines that that a trustee may consider the following to decide whether to accept or reject a bankrupt’s consent to travel application:

  • Whether the bankrupt has provided all the information requested by the bankruptcy trustee.
  • Whether there any outstanding matters that require the bankrupt’s presence in Australia for their resolution.
  • Whether the bankrupt’s liability to pay income contributions has been made, and if so, whether the contributions payments are up-to-date.
  • Whether there is any reason to suspect that the bankrupt will fail to return to Australia.

Can travel be approved conditionally?
Yes. Subsection 272(2) of the Bankruptcy Act also provides that trustee can impose conditions on the bankrupt’s consent to travel. Typical conditions may include (but are not limited to):

  • A fixed duration of travel.
  • The prior assistance of the bankrupt with any unresolved matters in the estate.
  • The payment of any outstanding dues (such as any income contributions liability).

What if the travel conditions aren’t met?
If any of the bankruptcy trustee’s conditions are contravened, this is an offence (subsection 272(3) of the Bankruptcy Act) and is punishable, upon conviction, by imprisonment for a maximum period of one year.

On receipt of a travel request, and agreement to any conditions the bankruptcy trustee imposes, consent to travel is granted in all but exceptional circumstances. If travel is refused by a bankruptcy trustee for whatever reason, the bankrupt can appeal the decision through AFSA.

How do bankrupts apply for a consent to travel?
If the bankruptcy trustee is the Official Trustee (AFSA), there is a specific form on their website to submit. If Worrells is the bankruptcy trustee, we just ask for the request to be in writing (email or in hardcopy) including all travel details and we manage the process upon receipt.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Introduction
The principle of the doctrine of exoneration can change respective interests in real property ownership, depending on the conduct of one or more of its owners, or when an interest in an asset is created.

For example, a joint owner of real property who borrows funds and secures them against the real property and uses these funds for their own benefit to the exclusion of another owner.

This Guide outlines how the doctrine of exoneration is applied to real property to adjust each owner’s interests in the property’s equity.

Application of the doctrine
The doctrine applies where a number of parties are registered owners of real property, but where borrowed funds secured against it are used for the benefit of some owners, but not all.

For example, Michael and Samantha own their home, subject to a mortgage. The mortgage is for the benefit of both of them. However, Michael takes out an additional loan for his own benefit, and secures it against the family home. Under the doctrine, Michael’s additional loan is for his benefit alone, and Samantha’s interest in the property’s equity is adjusted to reflect this. (The relationship status of Michael and Samantha is not relevant. The doctrine applies in any such similar instance between co-owners regardless of marriage, de facto relationship, etc.)

The doctrine can have a great impact on a bankruptcy trustee if, for instance, the bankrupt—despite being a registered owner of real property with equity—has no equitable interest in that equity because they had previously borrowed additional funds and secured them against the property.

Example of doctrine
Steve and Robin own their home as joint tenants. The house is worth $400,000. They bought the house with a joint loan secured by a mortgage on the property. They owe $100,000 under the mortgage.

Steve ran a business that Robin had no financial interest in. For the benefit of the business, Steve borrowed $200,000 with a loan secured against their home.

Steve goes bankrupt. The following questions are raised in bankruptcy:

  • What is the impact on the mortgagee?
  • What interest does a bankruptcy trustee have in the real property?
  • What is the impact on the co-owner (Robin)?

The doctrine does not affect the mortgagee’s rights. In a sale, the mortgagee is entitled to the balance of the original loan to purchase the property of $100,000 and the subsequent loan of $200,000. Leaving aside the sale costs, $100,000 remains as the surplus sale proceeds.

In the absence of the doctrine, the surplus funds (of $50,000 each) are split equally between Steve and Robin. However, because the business loan of $200,000 was solely for Steve’s benefit, the doctrine applies and the allocation of the equity is adjusted in Steve’s favour. In this example, the doctrine would apply as follows:

  • The balance of the original mortgage of $100,000 is applied first against the sale proceeds of $400,000, leaving a balance of $300,000.
  • Theoretically, the $300,000 is split equally between Steve and Robin, resulting in a split of $150,000 each.
  • But because the $200,000 business loan was solely for Steve’s benefit, this is applied only against his interest in the property, which means his $150,000 allocation is extinguished.
  • Therefore all of the remaining equity in the real property (the $100,000) is entirely owned by Robin, and Steve in fact owes Robin $50,000, and she can prove in his bankrupt estate for this amount.

In this example, the bankrupt estate would receive nothing from the sale of the real property.

Summary
Whenever dealing with real property interests, trustees are concerned with the re-allocation of equity depending on the nature and use of secured funds to a mortgagee. Owners of real property must ensure they maintain sufficient records to properly record and explain any such borrowings secured against real property, so that they can establish any application of the doctrine to adjust the equity in real property.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 27.01.2016

What is revesting of property?
Vesting of property to a bankruptcy trustee occurs at the commencement of a bankruptcy. Revesting is the transfer of any property that had previously vested in a bankruptcy trustee back to the bankrupt after they have been discharged from bankruptcy. These provisions (under section 129AA of the Bankruptcy Act) are meant to encourage trustees to realize assets as expediently as possible.

Provisions dealing with the revesting of property were added to the Bankruptcy Act in 2003. Until then all property of a bankrupt vested in the trustee and there was no mechanism for that property to revest. Trustees could hold property for 20 years and no one else could deal with that property unless the trustee disclaimed their interest in it. The revesting provisions changed that position.

What estates do the provisions affect?
All bankruptcy estates are subject to the revesting provisions, even if the bankrupt was discharged before the introduction of the provisions in 2003.

What type of property is affected?
Subject to the exemptions below, all non-cash property is able to be revested. Cash held at the time of bankruptcy or cash acquired during the bankruptcy is excluded from the revesting provisions as it does not need to be realized.

What are the other exemptions?

  1. Property that was not disclosed in the bankrupt’s Statement of Affairs; and
  2. Property acquired after bankruptcy (after-acquired property) which was not notified to the trustee within 14 days of the bankrupt’s knowledge of its acquisition.

As this property was not disclosed to the trustee, it is not subject to section 129AA of the Act. As a result section 127 of the Act provides the trustee 20 years from the date of bankruptcy to realise the property.  After that 20 year period the trustee cannot realise that property and it revests in the former bankrupt.

When does an asset revest?
Property will revest to the bankrupt six years after discharge. When that six year period commences will depend upon when the bankrupt estate commences. There are two possibilities for property disclosed in the Statement of Affairs:

  1. for bankrupts who are discharged after 5 May 2003, the revesting date is six years after the date of discharge regardless of whether the bankruptcy commenced before or after 5 May 2003;
  2. for bankrupts who were discharged before 5 May 2003, the revesting date was six years after 5 May 2003. That is, the revesting date was 5 May 2009 unless the revesting date was extended.

The earliest date that any property in any estate could have revested to any bankrupt was 5 May 2009, but in general it will be six years after discharge.

When does “after-acquired property” revest?
The acquisition of after-acquired property must be notified to the Trustee within 14 days of the bankrupt’s knowledge of the acquisition. The revesting date for this property is six years after either the date of discharge or the date of notification, whichever is later.

There are two possibilities:

  1. Where the acquisition and notification occurs before the discharge of the bankrupt, the revesting date is six years after the date of discharge, or if discharge occurred before 5 May 2003, the revesting date of 5 May 2009 applied;
  2. Where the acquisition occurs before the discharge of the bankrupt but notification is given after discharge, the revesting date is six years after the date of the notification, or if notification occurred before 5 May 2003, the revesting date of 5 May 2009 applied. These cases will be fairly limited as the discharge date must fall within 14 day after the acquisition of the property and before notification.

Again, the earliest date that after-acquired property revested to any bankrupt was 5 May 2009.

What happens when an objection to discharge is lodged?
The six year period before revesting starts with the discharge of the bankrupt, which may be up to five years after the normal date for discharge. That is, revesting may not occur until 14 years after the start of a bankruptcy where an objection has extended the bankruptcy period for 5 years.

If the objection is removed and the bankrupt is immediately discharged due to statutory discharge provisions, the six year period commences on the date that the objection is removed (the actual date of discharge), not the date that would have been the date of discharge if there had been no objection.

Can the trustee delay the revesting of property?
The trustee may issue an extension notice to the bankrupt during the unexpired six year period and extend the revesting period for a further three years after the “current” revesting period or three years after some specified event. The Act does not have any limit to the number of extension that the trustee can make. Therefore, in theory, the trustee can keep extending the period indefinitely.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

Can creditors protect their interests before the bankruptcy of a debtor?
The Bankruptcy Act provides two ways for creditors to protect their interests by stopping the debtor’s assets and records from being hidden or the debtor leaving the country.

Both may be done prior to a Sequestration Order being made. Neither is widely used due to the difficulty in convincing the Court that the assets or records are in such danger that the Court needs to take action to protect them.

What are the alternatives?
The two options are set out in the Bankruptcy Act:

1. Section 78 (Arrest of debtor or bankrupt); and
2. Section 50 (Taking control of debtor’s property before sequestration)

What is the difference between these alternatives?
The main difference is the target of the Orders.

Section 78 is used to stop the debtor from fleeing the country before being made bankrupt. It targets the person and can be made before or after the commencement of the bankruptcy. It is primarily used to restrict the movement of the debtor or bankrupt, though there is provision for the Order to also deal with property and financial records.

Section 50 is used to restrict the debtor’s ability to deal with their assets to ensure they will be available to the trustee of the estate. It does this by placing an interim receiver in control of the debtor’s property. The section does not restrict the movements of the debtor physically, and can only be made before the bankruptcy of the debtor. Once the debtor is bankrupted, the property vests in the trustee in bankruptcy and the need for an interim appointment ends.

What is required to get an Order under section 78?
The Federal Court will only issue a warrant for the arrest of a debtor and Orders for the seizure of the debtor’s assets and records in very limited circumstances.

Firstly, a Bankruptcy Notice must have been issued against and served on the debtor. The debtor must have clear knowledge that a bankruptcy is imminent.

Secondly, the Court must be convinced that the debtor is absconding or has the intention of absconding with a view of avoiding paying their debts, or preventing or delaying the proceedings against them. The Courts will usually be reluctant to grant these Orders without sufficient evidence of these matters.

The Court may also grant an Order if the debtor tries to conceal or remove assets or records from the jurisdiction with the same intention.

What orders can the Court give under section 78?
The Court may issue a warrant for the arrest of the debtor and may commit them to goal until the Court believes that the danger of the debtor fleeing or the danger to the assets or records has passed, or a bankruptcy trustee has taken control of the affairs (and passport) of the bankrupt.

In appropriate circumstances the Court will just order that the debtor’s passport be held by the Court until the bankruptcy hearing.

The Court may Order that any property or records of the debtor be seized and placed into the custody of a person until the bankruptcy hearing and the Court gives further Orders.

What is a section 50 receiver?
Prior to the debtor becoming bankrupt the Court may appoint someone to act as an interim receiver of a debtor’s assets to protect and maintain the debtor’s property. This appointment will last until a further order is made. This person will usually be the trustee who has consented to act as the bankruptcy trustee.

When can a Court make this appointment?
Before the Court will appoint a section 50 receiver:

(a) a bankruptcy notice must have been served on the debtor;
(b) the Bankruptcy Notice must have expired, so that there is an act of bankruptcy for noncompliance under that notice;
(c) a creditor must have made an application to the Court for such a Sequestration Order; and
(d) the Court must be satisfied that it is in the interests of the creditors to appoint a receiver due to the danger that the assets or records will be lost before the sequestration order is granted.

The main point and the most difficult to do is satisfying the Court that the debtor’s assets or records are in such danger of being lost and that they will be unavailable to the creditors by the time of the bankruptcy.

When does a section 50 receivership end?
The Court must specify in the Order when control of the property is to end. Usually this will occur when the application for the Sequestration Order has been heard and either a trustee in bankruptcy has been appointed or the application has been dismissed.

What protection does the debtor have?
If the debtor does not become a bankrupt and his assets have been subject to the control of a section 50 receiver, they may have some recourse under Regulation 4.08 of the Bankruptcy Act against the creditor that applied for the appointment for any damage that they suffered because of the appointment.

Within 21 days after the control period ends, the debtor may apply to the Court for an assessment of damages suffered resulting from the appointment and an Order for payment of those damages by the Creditor that requested the appointment.

The application is not against the section 50 receiver, it is against the creditor that applied for the appointment. Creditors will have to keep this potential liability in mind when deciding whether to apply for such an appointment.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

The Bankruptcy Act does not generally impose any restrictions or conditions on employment in any profession, however, various state and national associations / governing bodies do provide certain restrictions. This applies to both bankrupts and a person who has entered into a Personal Insolvency Agreement or Deed Agreements.

The Australian Financial Security Authority – AFSA (formerly known as ITSA) has compiled a schedule to alert people to the potential trades and professional memberships that are affected in these circumstances.

On a general basis state governments administer legislation that governs eligibility rules for trades such as plumbers, builders, second hand dealers etc. While national or state based professional associations / statutory boards govern such professions as accountants, lawyers, barristers and the like.

The schedule is to assist and alert people to which statutory bodies may have such restrictions. It does not mean that employment or operation in those field is voided on the event of bankruptcy, it simply assists in pointing users in the right direction and is not an exhaustive list.

Impact Guide:

Impact on Membership = considered an exclusion by the relevant Act or Rules, however applications for consideration can be made to the governing body to retain membership/licence
Potential Impact = must be disclosed to the governing body but is not specifically considered an exclusion
No Impact = not specifically listed as an exclusion by the relevant Act or Rules
Exclusion = current legislation/regulations advise that bankruptcy/personal insolvency is an automatic exclusion

Legislation and membership rules are subject to change. This table should be used as a guide only. You should contact the relevant source of information directly to confirm any impact prior to lodging the relevant personal insolvency applications.

National Authorities

Profession / TradeImpactAuthority
Accountants - CAImpact on Membership/LicenceChartered Accountants Australia and New Zealand (formerly ICAA)
Accountants - CPAImpact on Membership/LicenceCPA Australia
Accountants - IPAImpact on MembershipInstitute of Public Accountants
BookkeepersImpact on MembershipInstitute of Certified Bookkeepers
Company DirectorAn undischarged bankrupt or a person subject to a Personal Insolvency Agreement cannot be involved in the management of a company unless authorised by a Court. Australian Securities & Investments Commission
CouncillorsImpact on MembershipPlease contact your local government office
Defence ForceNavy and/or RAAF personnel should contact their respective HR departments for information on potential consequences.Department of Defence
Finance Brokers & SecuritiesImpact on Membership/Licence. Note that finance broking in certain States/Territories may also be regulated under respective state legislation.Australian Securities & Investments Commission
Members of ParliamentExclusion from MembershipParliament of Australia
Operating a Business (as a sole trader or partnership)Potential Impact: Debt Agreement and Part X Agreements may not necessarily impact your ability to operate a business. Under Bankruptcy, you may be prevented from running a business because your trustee may sell the assets of your business. Any existing partnership you are part of will dissolve. If you are able to continue running the business by your trustee, you must disclose your bankruptcy to all those who your business deals with and you must include your full name in your business name.Australian Financial Security Authority
Police - FederalImpact on MembershipAustralian Federal Police
Registered Nurse of MidwifePotential Impact (but must be declared on application)Nursing and Midwifery Board
SMSF Trustee or BeneficiaryExclusion from MembershipAustralian Prudential & Regulatory Authority
Tax AgentsImpact on MembershipTax Agent's Board

State/Territory Based Authorities

Profession / Trade ACTNSWNTQLDSATASVICWA
Builders LicenceImpactExclusionExclusionExclusionExclusionExclusionPotential ImpactPotential ImpactPotential Impact
AuthorityACT Environment & Planning Directorate Deparment of Fair TradingNorthern Territory Building Practitioners BoardQueensland Building & Construction CommissionConsumer & Business Services - Licensing Department of JusticeVictorian Building Authority Department of Commerce
Debt Collector/ Process Server/ Repossession AgentImpactPotential ImpactPotential ImpactExclusionExclusionPotential ImpactPotential Impact ExclusionPotential Impact
AuthorityRefer NSWNSW PoliceNorthern Territory LicensingOffice of Fair TradingConsumer & Business Services - LicensingConsumer Affairs & TradingConsumer Affairs VictoriaDepartment of Commerce
ElectricianImpactPotential ImpactPotential ImpactPotential ImpactPotential ImpactPotential ImpactPotential ImpactPotential ImpactPotential Impact
AuthorityACT Environment & Planning Directorate Deparment of Fair TradingNT Electrical Workers and Contractors Licensing BoardElectrical Safety OfficeConsumer & Business Services - Licensing Department of JusticeEnergy Safe VictoriaEnergy Safety – Dept of Commerce
Escort Agencies and/or Brothel ManagersImpactPotential ImpactN/APotential ImpactExclusionN/AN/APotential ImpactN/A
AuthorityOffice of Regulatory ServicesNo AuthorityNorthern Territory LicensingProstitution Licensing AuthorityNo AuthorityNo AuthorityConsumer Affairs VictoriaNo Authority
Gaming Room/ Casino EmployeesImpactPotential ImpactPotential ImpactPotential ImpactPotential ImpactPotential ImpactPotential ImpactPotential ImpactPotential Impact
AuthorityACT Gambling & Racing CommissionNSW Office of Liquor, Gaming & RacingNorthern Territory LicensingThe Office of Liquor, Gaming and Racing (OLGR)Consumer & Business Services - LicensingDepartment of Treasury and FinanceCommission for Gambling & Liquor RegulationDepartment of Racing, Gaming and Liquor
Gas Fitter LicenceImpactPotential ImpactPotential ImpactNo ImpactNo ImpactNo ImpactNo ImpactPotential ImpactNo Impact
AuthorityEnvironment & Planning DirectorateDepartment of Fair TradingNT WorksafeDept of Natural Resources and MinesConsumer & Business Services - LicensingDepartment of JusticeVictorian Building AuthorityEnergy Safety – Dept of Commerce
Justice of the Peace/ Comm. DecImpactImpactExclusionExclusionExclusionExclusionExclusionExclusionExclusion
AuthorityDepartment of Justice and Community SafetyDepartment of JusticeDepartment of JusticeDepartment of Justice & Attorney GeneralAttorney General's DepartmentDepartment of JusticeHonorary Justice OfficeDepartment of the Attorney General
Liquor Licence (Publican)ImpactPotential ImpactPotential Impact ImpactImpactPotential ImpactPotential ImpactImpactImpact
AuthorityOffice of Regulatory Services Office of Liquor Gaming & RacingDirector General of LicensingThe Office of Liquor, Gaming and Racing Consumer & Business ServicesDepartment of Treasury and FinanceCommission for Gambling & Liquor RegulationDepartment of Racing, Gaming and Liquor
Police - StateImpactImpactImpactImpactExclusionImpactImpactImpactImpact
AuthorityAustralia Federal PoliceNSW PoliceNT PoliceQLD PoliceSA PoliceTAS PoliceVIC PoliceWA Police
Plumber LicenceImpactPotential ImpactPotential ImpactPotential ImpactPotential ImpactNo ImpactNo ImpactPotential ImpactPotential Impact
AuthorityEnvironment & Planning DirectorateOffice of Fair TradingNorthern Territory Plumbers & Drainers Licensing BoardQueensland Building & Construction CommissionConsumer & Business ServicesDepartment of JusticeVictoria Building AuthorityPlumbers Licensing Board
Private Investigator LicenceImpactN/APotential ImpactExclusionExclusionPotential ImpactPotential ImpactExclusionPotential Impact
AuthorityN/A - currently no licensing bodyNSW PoliceNorthern Territory LicensingOffice of Fair Trading QldConsumer & Business ServicesConsumer Affairs and Fair TradingVictoria PoliceWA Police
Real Estate LicenceImpactImpactImpactImpactExclusionExclusionExclusionImpactImpact
AuthorityOffice of Regulatory Services Office of Fair TradingNorthern Territory LicensingOffice of Fair TradingConsumer and Business ServicesProperty Agents BoardConsumer Affairs VictoriaDepartment of Commerce
Second Hand Dealers & Pawnbrokers LiencesImpactPotential ImpactImpactImpactImpactImpactPotential ImpactImpactPotential Impact
AuthorityOffice of Regulatory ServicesOffice of Finance and ServicesNorthern Territory LicensingOffice of Fair TradingSA PoliceTAS PoliceConsumer Affairs VictoriaWA Police
Security LicenceImpactPotential ImpactNo ImpactNo ImpactNo ImpactPotential ImpactPotential ImpactPotential ImpactNo Impact
AuthorityOffice of Regulatory ServicesNSW PoliceDirector General of LicensingOffice of Fair TradingConsumer & Business ServicesConsumer Affairs and Fair TradingVIC PoliceWA Police
Solicitors/ Lawyers (Practicing)ImpactImpactImpactImpactImpactImpactImpactImpactImpact
AuthorityACT Supreme CourtLegal Profession Admission BoardNT Supreme CourtLegal Practitioners Admissions BoardBoard of ExaminersTAS Supreme CourtBoard of ExaminersLegal Practice Board
Travel Agents LicenceImpactAll state licencing is being wound downAll state licencing is being wound downAll state licencing is being wound downAll state licencing is being wound downAll state licencing is being wound downAll state licencing is being wound downAll state licencing is being wound downAll state licencing is being wound down
AuthorityOffice of Regulatory ServicesOffice of Fair TradingNorthern Territory LicensingOffice of Fair TradingConsumer & Business ServicesConsumer Affairs and Fair TradingConsumer Affairs VictoriaDepartment of Commerce
Vehicle Dealer LicenceImpactPotential ImpactExclusionExclusionExclusionExclusionExclusionExclusionPotential Impact
AuthorityOffice of Regulatory ServicesOffice of Fair TradingNorthern Territory LicensingOffice of Fair TradingConsumer & Business ServicesConsumer Affairs and Fair TradingConsumer Affairs VictoriaDepartment of Commerce

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 03.02.2015

Worrells

CORPORATE FACTSHEETS

The following outlines the FAQs in Corporate Insolvency administration matters.

What is liquidation?
Liquidation is the process of winding up a company’s financial affairs to dismantle the company’s structure by conducting appropriate investigations and enabling a fair distribution of company’s assets to its creditors. Liquidation occurs either because the company cannot pay all of its debts (i.e. it is insolvent), or its members want to end the company’s existence and have it struck off from the Australian Securities and Investments Commission’s (ASIC) register.

Why choose liquidation?
Liquidation is the only way to fully wind up the affairs of a company and end the existence of the company. An independent party undertakes the process and protects the interests of creditors, directors and members while the company structure is dismantled.

How can an insolvent company be wound up?
An insolvent company can either be wound up by the court, usually by one or more creditors making an application to the courts, or by voluntarily by resolution of the company directors and, if appropriate, the company members at a relevant meeting.

What is a court liquidation?
The applicant must demonstrate to the court that the company is insolvent or can be deemed to be insolvent. The court will then appoint a liquidator, usually one nominated by the applicant (creditor). The court may also wind up a company when there are irreconcilable disputes between shareholders or directors, or for a limited number of other reasons.

What is a voluntary liquidation?
A voluntary liquidation is a process whereby the company voluntarily appoints a liquidator. Creditors have the right to change the appointed liquidator at any time. A voluntary liquidation can occur by a creditors’ voluntary winding up or through voluntary administration.

What is a members’ voluntary winding up?
A member’s voluntary winding up is the process for members who wish to dismantle the company structure. Usually the company will be solvent, and a members’ voluntary winding up is chosen as the company has no useful future.

What is a creditors’ voluntary winding up?
A creditors’ voluntary winding up is a process where the directors determine that the company is insolvent and resolve to place the company into liquidation and they appoint a liquidator. A meeting of creditors is held within 18 days (with an 11-day convening period and a 7-day notice period) of the resolution to wind up the company. At this meeting, the creditors have the opportunity to change the liquidator.

A creditors’ voluntary winding up is commonly used when a company is insolvent and a Deed of Company Arrangement (DOCA) is not possible and the company simply needs to be liquidated. If a wind-up application has been filed with the court, or if the court has ordered that company be wound up, a creditors voluntary winding up is not possible.

Voluntary Administration
A company can also be wound up voluntarily through the voluntary administration process. The directors resolve to appoint voluntary administrators to the company.

A resolution of the members is not required. After the resolution is passed the administrators who consented are then appointed. A meeting of creditors is held within eight days of the appointment of the voluntary administrator. At this meeting, creditors have the opportunity to appoint alternative administrators.

After the first meeting, the voluntary administrators conduct investigations into the company and issue a detailed report pursuant to section 439A of the Corporations Act 2001. This report outlines the investigation’s findings and the available options for creditors regarding the company’s future.

The options available to creditors are:

  • to accept a DOCA, if one is proposed
  • to place the company into liquidation
  • to end administration and hand the company back to the directors.

A second meeting of creditors is held to consider these options. Voluntary administrations are geared towards a company that wishes to put up a DOCA; however, there are circumstances where it may be appropriate to place a company into liquidation, for example:

  • winding-up proceedings are underway and therefore the creditors’ voluntary winding-up process is not an option
  • the business is continuing to trade whereby it is more appropriate or advantageous for a voluntary administrator to manage ongoing trade
  • a DOCA is being considered.

Typically, the voluntary administration process is more expensive due to the increased work involved. In most cases the creditors’ voluntary winding-up process is a more appropriate method of the voluntary appointment of a liquidator.

The liquidation process is almost identical, regardless of how it is started.

How do you prove that a company is insolvent?
A company is insolvent if it cannot pay all of its debts as and when they fall due, even if the company has an asset surplus but no way to liquidate those assets quickly. A company is deemed to be insolvent when it does or fails to do certain things prescribed by law. Most commonly a company is deemed insolvent if it fails to satisfy a creditor’s statutory demand.

Can solvent companies be wound up?
Yes. Solvent companies can be wound up by its members via a members’ voluntary winding up.

Solvent companies can also be wound up by the court by way of an application to the court by its directors or members. Court appointments are common when there is a conflict with the control or conduct of the company and its members are unable to reach a resolution, or cannot agree to appoint a liquidator voluntarily.

What is provisional liquidation?
The court may appoint a liquidator provisionally to exercise interim control over the assets and affairs of a company. The appointment is usually for the period between filing the winding up application, and the court hearing. A provisional liquidator appointment is made when the court believes that assets may be at risk and should be protected in the interest of creditors until the winding up hearing. The appointment is ‘provisional’ as the company may not be wound up at the application hearing, at which time control may pass back to its directors.

Who administers a liquidation?
Liquidations can only be administered by specialist accountants who are registered liquidators with ASIC. They can take all types of corporate insolvency appointments, including those ordered by the courts.

What powers do liquidators have?
The Corporations Act sets out the liquidator’s powers. These powers include all the powers vested in the directors of the company, plus the powers to:

  • investigate and examine the affairs of a company
  • identify transactions that are considered void
  • examine the directors and others under oath (public examination)
  • realise the assets
  • conduct and sell any business of the company
  • admit debts and pay dividends.

What does the liquidator do?
The liquidator will:

  • identify and protect the assets of a company
  • realise those assets
  • conduct investigations into the financial affairs of a company and any suspicious transactions
  • make appropriate recoveries
  • issue reports to ASIC and creditors
  • make a distribution to creditors
  • make a distribution to shareholders (if a surplus exists)
  • apply to ASIC to deregister a company.

What is the effect of liquidation on a company?
When a company is liquidated, its structure survives the appointment of a liquidator, but not the liquidation. Control of assets, conducting business, and other financial affairs are transferred to the liquidator. The directors cease to have any authority. All bank accounts are frozen, any employment can be terminated, but necessary labour may be engaged by the liquidator. At the end of the liquidation, the liquidator applies to ASIC for the company to be deregistered, after which the company will cease to exist.

Can a company trade while in liquidation?
A liquidator may continue trading a company if it is in the creditors’ best interest. A trade-on is considered if there is a prospect to sell the business as a going concern, or to complete and sell any work-in-progress. A liquidator is obligated to end trading and wind up company affairs as quickly but as commercially responsible as practical.

What must the directors do to help the liquidator?
The directors must give all information about the company’s financial affairs and provide a Report as to Affairs (detailing the assets and liabilities of the company as at the date of appointment of the liquidator) and assist the liquidator when reasonably asked. The directors must also deliver all company books and records and cooperate with the liquidator throughout the liquidation process. The Corporations Act contains various offence provisions that apply to directors who do not cooperate with liquidators.

What investigations are undertaken by the liquidator?
The liquidator must investigate:

  • why company is insolvent
  • when a company became insolvent
  • a potential insolvent trading claim against the directors
  • any recoverable preferential payments to creditors
  • any possible offences committed by the company officers
  • if any void transactions can be overturned
  • if any other recoveries may be made.

These powers include holding public examinations, seizing books and records and gaining access to property. The liquidator must also identify any offences committed by the directors and report these to ASIC.

Can the liquidator recover property sold before the liquidation?
The liquidator will look at any sales, or transfers of property within the years before liquidation. If property transactions appear improper, un-commercial or undertaken to defraud creditors, that property or its value may be recoverable. The liquidator can recover money from creditors who received payments that gave them ‘preferential’ treatment in the six months before the liquidation.

What is insolvent trading?
Directors have a duty to ensure that their company does not continue to incur debts when it is insolvent. If the director breaches that duty, the liquidator can bring an action against them for recovery of the amount of the debts incurred during the period that the company was insolvent. The insolvent trading claim is made against the directors personally, making them personally liable to compensate the company for the unpaid debts.

Can a liquidator attack a director’s personal assets?
No. A liquidator can only take possession of a company’s assets. However, if a liquidator can prove that the directors have taken company assets, the liquidator may then recover those assets. If a company has loaned money to the directors, the liquidator will seek to recover the money, and if necessary may instigate legal proceedings to recover these funds.

If a liquidator can establish an insolvent trading claim, they may take recovery action against any directors and, if necessary, commence bankruptcy proceedings against that director. This allows a bankruptcy trustee to access the director’s assets to satisfy the liquidator’s claim.

How do personal guarantees become part of the liquidation?
When directors, or other parties, execute a personal guarantee, it becomes a personal arrangement between creditor and guarantor, and therefore not affected by liquidation.

What effect does the liquidation have on secured creditors?
Secured creditor’s rights are not affected by liquidation. Commonly, secured creditors allow liquidators to sell the assets while recognising the secured creditor’s rights. A secured creditor can prove for any shortfall in the liquidation after their security is realised.

What is the effect of the liquidation on unsecured creditors?
Unsecured creditors lose their right to recover money from the company, but gain a right to prove for dividends in the liquidation.

Can a liquidator pay dividends?
Yes. The ultimate role of the liquidator is to realise the company’s assets and take all possible steps to recover sufficient funds to distribute the proceeds among creditors.

Are the dividends paid under certain priorities?
Yes. The liquidator must pay dividends in the order of priorities set out in section 556 of the Corporations Act. These priorities include:

  1. costs and expenses of the liquidation
  2. costs of the applicant creditor (if the company was wound up by the court)
  3. employee entitlements
  4. other unsecured creditors.

How long does the liquidation last?
There is no set time limit for a liquidation. The liquidation lasts for as long as necessary to complete all the required tasks of liquidation; however, a liquidator will usually try to finalise the liquidation as soon as possible.

How does the liquidation end?
The liquidation ends when:

  • the company is dissolved by a court order on the application of the liquidator, or
  • the company is struck off the register of companies by ASIC at the request of the liquidator, or
  • the winding up is set aside or stayed by the court.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.02.2017

What is voluntary liquidation?
Liquidation is the process of winding up a company’s financial affairs in order to provide for an orderly dismantling of the company’s structure, the undertaking of appropriate investigations and the fair distribution of the company’s assets to its creditors. This occurs either because the company can’t pay all of its debts (i.e. it is insolvent), or its members want to end the company’s existence.

A voluntary liquidation is a liquidation commenced by a resolution of its members. That is, the liquidation is not forced upon the company by the court, it is started by a voluntary act of the members.

Why choose voluntary liquidation?
Liquidation is the only way to fully wind up the affairs of a company and end its existence – as opposed to just selling the company’s assets and paying its debts which leaves the company structure in existence. Having an independent party act as liquidator to undertake the process protects creditors’, directors’ and members’ interests while the company structure is dismantled.

How can an insolvent company be wound up?
In a voluntary liquidation, the company is wound up by resolution of its members. This may occur at a meeting of members or by the members executing a notice of resolution and bypasses the need for a formal meeting. If it is wound up by its members, they will choose the liquidator—though creditors have the right to change the liquidator at the first meeting of creditors.

A voluntary liquidation may also begin through the voluntary administration provisions of the Corporations Act 2001, where the members resolve to place the company into administration and the creditors resolve to place it into liquidation. This is the ‘Voluntary Administration’ factsheet.

A company may also be wound up by the court usually on the application of one or more creditors—who usually must prove to the court that the company is insolvent—or by its members if there are irreconcilable disputes between shareholders or directors, or for a limited number of other reasons.

How do you prove that a company is insolvent?
In most cases a company is wound up voluntarily because it is insolvent. A company is insolvent if it can’t pay all of its debts as and when they fall due, even though the company may have an asset surplus but no ability to liquidate those assets quickly. The directors will usually decide that the company is insolvent when they can no longer pay all of the company’s debts when are they due to be paid.

Can solvent companies be wound up?
Yes. Solvent companies can be wound up by its members as a Members Voluntary Winding Up. Solvent companies can also be wound up by the Court on an application by its directors or members. This usually occurs when there is a conflict in the leadership of the company and the parties are unable to resolve that conflict or cannot agree to appoint a liquidator voluntarily.

Who conducts a voluntary liquidation of a company?
Liquidations are administered by specialist accountants who are registered liquidators with ASIC. They can take all types of corporate insolvency appointments, including those ordered by the courts.

What does the liquidator do?
The liquidator will:

  • find and protect the assets of the company;
  • realize those assets;
  • conduct investigations into the financial affairs of the company and any suspicious transactions;
  • make appropriate recoveries;
  • issue reports to ASIC and creditors;
  • hold the meetings of creditors required by the Corporations Act;
  • make a distribution to creditors (if there are assets available);
  • make a distribution to shareholders (if a surplus exists) and
  • apply to deregister the company.

What effect does the liquidation have on the company?
The company structure itself survives the appointment of a liquidator, but not the liquidation. The control of all assets, the conduct of any business and other financial affairs are transferred to the liquidator. The directors cease to have any authority. All bank accounts are frozen, all employment can be terminated, but necessary labor may be rehired by the liquidator.

At the end of the liquidation the liquidator will apply to ASIC to have the company deregistered, after which the company will cease to exist.

Can a company trade during the liquidation?
The liquidator will continue trading a business if they believe that it will be in the interest of creditors to do so. This is usually done when it may be possible for the business to be sold as a going concern, or in order to complete and sell work-in-progress. The liquidator has the obligation to end trading and wind up the affairs of the company as quickly, but as commercially, as practical. His role is to eventually cease the trading.

What must the directors do to help the liquidator?
The directors must provide information about the company’s affairs and provide a Report as to Affairs (detailing the assets and liabilities of the company) and a Director’s Questionnaire. The directors must also hand over all of the company’s books and records and cooperate with the liquidator throughout the liquidation. There are various offense provisions that relate to directors who do not cooperate with liquidators.

What investigations are done?
Where possible, the liquidator must establish the following:

1. Why the company is insolvent and when it became insolvent;
2. Whether there is a potential insolvent trading claim against the directors;
3. Whether there are any preferential payments to creditors that may be recovered;
4. Whether there are any offenses that may have been committed by the officers of the company;
5. Whether any void transactions can be overturned; and
6. Whether any other recoveries may be made.

These powers include holding public examinations of the directors and other parties, seizing books and records, gaining access to property and detaining persons relevant to the investigation. Also, the liquidator must identify any offenses committed by the directors and report these to ASIC.

What meetings must the liquidator hold?
The liquidator must call three types of meetings.

(a) they must hold an initial meeting of creditors within 18 days of being appointed;

(b) they must hold annual meetings within 3 months after each anniversary of the appointment, though lodging a report with ASIC may be substituted for these meetings;

(c) they must call a final meeting of creditors to end of the liquidation.

Can the liquidator recover property sold before the liquidation commenced?
Sometimes. The liquidator will look at any sales or transfers of property that have occurred within the years before the liquidation. If a transaction appears improper, uncommercial or to have been undertaken to defraud creditors, that property or its value may be recovered from the recipient. The liquidator may also recover money from creditors who have received payments that gave them ‘preferential’ treatment in the six months before the liquidation.

What is insolvent trading?
This is a claim for compensation made against a director who allows a company to incur debts when he or she is, or should be, aware that the company cannot pay them. Directors have a positive duty to ensure that their company does not continue to incur debts at a time when it is insolvent. If the company is wound up and some of that debt remains outstanding, the directors may be made personally liable to compensate the company for that amount.

Can a liquidator attack the director’s personal assets?
No. The liquidator can only take possession of the company’s assets. However, if the liquidator can prove that company assets have been taken by the directors, the liquidator may recover those particular assets or their value. If the company has loaned money to the directors, the liquidator will seek to recover the monies.

If the liquidator can prove a claim against a director, he may take recovery action against that director liable to compensate the company and if necessary bankrupt them. This will allow a trustee in bankruptcy access to the director’s assets to satisfy the claim of the liquidator.

What is the effect of the liquidation on personal guarantees?
Personal guarantees executed by directors and other parties are not affected by liquidation, as a guarantee is an arrangement between the creditor and the guarantor personally.

What is the effect of the liquidation on secured creditors?
The rights of secured creditors are usually not affected by the liquidation. It is common for secured creditors to allow the liquidator to sell the assets whilst he or she recognizes the rights of the secured creditor. The secured creditor may prove in the liquidation for any shortfall after their security has been realized.

However, in some circumstances, the security itself may not be enforceable against the liquidator.

What is the effect of the liquidation on unsecured creditors?
Creditors lose their right to recover money from the company, but gain a right to prove for dividends in the liquidation. The ultimate role of the liquidator is to sell the company’s assets and distribute the net proceeds amongst creditors. The liquidator must pay dividends in the order of priorities set out in section 556 of the Corporations Act. These include:

(a) the costs and expenses of the liquidation;
(b) the costs of the creditor who applied for the winding up (if any);
(c) employee entitlements; and
(d) other unsecured creditors.

How long does the voluntary liquidation last?
There is no set time limit. The liquidation lasts for as long as is necessary to complete all of the tasks, but the liquidator will usually try to finalize the liquidation as soon as possible. The liquidation ends when a final meeting of creditors has been called and ASIC deregisters the company.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.02.2017

What is voluntary administration?
The voluntary administration process is designed to assist insolvent companies satisfy their debts, by ensuring that they can either:

  1. come to a formal arrangement with their creditors to pay those debts through a Deed of Company Arrangement (DOCA), or
  2. be placed into liquidation, quickly and inexpensively.

The voluntary administration process maximises the chances of a company continuing to exist by giving it the opportunity to propose a DOCA to its creditors.

Why choose voluntary administration?
A voluntary administration offers a collaborative approach to satisfying the company’s debts. It restrains creditors from enforcing their claims, and can assist a company to trade out of short-term difficulties caused by cash-flow restrictions or one-off financial problems. When appropriate, it can also provide a way to restructure a business or the company itself to revive it to a healthier financial position.

How does a voluntary administration begin?
A voluntary administration begins when an appointment document is executed by either:

  • the directors of a company after they have resolved that the company is, or is about to, become insolvent
  • a liquidator if a proposed DOCA will provide a better return to creditors than the continued liquidation
  • a secured creditor after the terms of their finance agreement has been breached and the administrator consents to the appointment.

What is the voluntary administration process?
A voluntary administrator is appointed to control a company’s affairs. The administrator convenes two meetings of creditors. The first meeting is held within eight business days of the appointment. The second meeting is usually held within 20 to 30 business days after the appointment. At the second meeting, creditors will choose the option they believe will best serve their interests.

The two most common outcomes of a voluntary administration are the execution of a DOCA or the liquidation of the company.

What is the effect on secured creditors?
Secured creditors have 13 business days from the appointment date to exercise their security. If they do not do so within that time, they are bound by a moratorium for the duration of the voluntary administration period. This decision period gives the secured creditor time to decide whether to exercise their charge, and the administrator some certainty during the administration.

What is the effect on unsecured creditors?
A moratorium is imposed on unsecured creditor actions—they cannot enforce their claims or apply to wind up a company.

A provisional liquidator cannot be appointed to a company without the leave of the court, and all proceedings or enforcement action against a company’s property is placed on hold.

What are the administrator’s powers?
The administrator assumes control of a company’s business, property and financial affairs. The administrator assumes sole responsibility to perform all functions and exercise any and all director powers that could be exercised if the company was not under administration, including continuing to trade or dispose of all or any part of a business or property. The directors and other officers lose all these powers.

What does the administrator do?
The voluntary administrator will:

  • take control of the company’s assets
  • investigate the company’s affairs
  • report any offences to Australian Securities and Investments Commission (ASIC)
  • assist the directors to formulate a DOCA proposal
  • report to creditors on the course of action that gives for the best outcome for creditors
  • call the required meetings of creditors to decide the future of the company.

Does the administrator look at preferences?
The administrator is required to investigate potential voidable transactions, but only to carry out sufficient investigations to justify any recommendations made in the report to creditors. The administrator has no power to commence any recovery proceedings.

Personal Property Securities Act 2009 and Voluntary Administrators
In the event of the appointment of a voluntary administrator to the company under Part 5.3A, section 440B of the Corporations Act 2001 imposes restrictions on:

  • an owner of property used by the company from taking possession of or recovering the property
  • a lessor from levying distress rent, taking possession, or otherwise recovering the property
  • a secured party with possessory security from selling the property or otherwise enforcing the security interest.

The voluntary administrator may still sell or dispose of assets:

  • with the consent of the secured party
  • with the consent of the court
  • in the ordinary course of business.

Any disposal made by the voluntary administrator requires the sale proceeds from the secured property to be distributed to those holding relevant security interests.

How does the voluntary administration affect a landlord?
A landlord is bound by the same moratorium applying to all creditors, providing the landlord did not commence enforcement proceedings prior to the appointment.

The administrator can occupy the company’s leased premises for up to seven calendar days without paying rent, but must pay rent for the remainder of the voluntary administration period.

The administrator’s liability to the landlord ends at the conclusion of the voluntary administration or when the premises are vacated. The administrator will not be liable for rent if they do not have possession of the property. However, the company will continue to incur liability for the rent.

How does a voluntary administration affect guarantees?
Creditors holding third-party guarantees from directors are bound by the moratorium during the period of the administration. After the voluntary administration ends, guarantees can then be enforced.

Can a voluntary administrator pay dividends?
No. A voluntary administrator does not have the authority to pay dividends.

What happens at the first meeting of creditors?
The first meeting of creditors is held within eight business days after the appointment of the voluntary administrator. The Corporations Act requires two matters to be considered at this meeting:

  1. if creditors wish to replace the administrator with another administrator
  2. if creditors wish to elect a number of representatives to form a committee that will advise and assist the administrator.

What happens at the second meeting of creditors?
A second meeting of creditors is normally held between 20 to 30 business days after the appointment. Creditors will decide the future of the company at this meeting. Before this meeting the administrator will issue a report detailing the results of investigations, offences (if applicable) and the viability and suitability of each options available to creditors.

The report must include sufficient information for creditors to make an informed decision in respect of the future of the company, and provide a recommendation to creditors.

What options are available to creditors?
The creditors can pass a resolution to:

  1. accept a proposal for a DOCA (if one is proposed)
  2. end the voluntary administration and pass control of the company back to the directors
  3. liquidate the company.

How complete must a draft deed of company arrangement be?
Commonly a draft DOCA is submitted to the administrator in summary form. A full draft DOCA is preferred to be tabled at the meeting of creditors, as the final DOCA will include many technical provisions.

Creditors should insist on the full draft, or at least as close to the final draft as practicable, so they are fully aware of all of the terms. The meeting can be adjourned to allow time to produce a more detailed draft.

Voting at meetings
A vote can be determined ‘on the voices’ if there is a clear majority of those present at a meeting. Each person (whether a creditor or a proxy) only has one vote.

If the vote is inconclusive, or if requested by creditors, the vote can be put to a poll. A poll works on a majority in both numbers and values. In the event of a stalemate (i.e. majority of numbers voting one way and the majority of value voting another), the administrator will generally exercise a casting vote and make the final decision. Otherwise the resolution will fail.

Do creditors need to decide on a course of action at the second meeting?
No. The second meeting may be adjourned for up to 45 business days for further investigations to be carried out, or for a proposed DOCA to be amended. The court has the power to extend this period if there is a genuine reason for an extension.

What does a voluntary administration cost?
Each administration is different and will therefore have a different cost depending on the work required. There are two types of work on insolvency files, statutory and non-statutory, but both are necessary.

Statutory work is required on every file regardless of size, complexity or other unique factors. Statutory work includes:

  • notifying ASIC
  • issuing notices to creditors
  • issuing notices to utilities and statutory authorities, such as the Australian Taxation Office
  • conducting the first meeting of creditors
  • dealing with creditors’ enquiries
  • conducting preliminary investigations into preferential payments, insolvent trading and other voidable transactions
  • preparing and issuing a detailed report to creditors
  • conducting the second meeting of creditors
  • notifying creditors and ASIC of the outcome of second meeting of creditors.

Non-statutory but still necessary work may include the following tasks:

  • trading on the business
  • dealing with secured creditors
  • dealing with finance companies
  • collecting and selling some or all of a company’s assets or the business of a company
  • more detailed investigations into potential recoveries, assets ownership and the viability of any proposal for a DOCA.

When does a voluntary administration end?
The voluntary administration ends when:

  • a DOCA is fully executed
  • the creditors resolve to wind up a company
  • the creditors resolve that the voluntary administration should end
  • the court orders that the administration is to end
  • the approved DOCA is not signed within 15 business days of the second meeting
  • the period for calling the second meeting ends without the meeting being called
  • the court appoints a liquidator to the company.

How should a company under voluntary administration be referred to?
While in voluntary administration, a company must advertise its status. For example, ABC Pty Ltd should be described as ABC Pty Ltd (administrator appointed) on all public documents.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 08.04.2015

What is a Deed of Company Arrangement?
A Deed of Company Arrangement (DOCA) is a formal agreement between a company and its creditors and any other relevant third parties to satisfy company debts. A DOCA sets out terms and conditions, warranties and indemnities, the extent and nature of obligations, and the relationships between those who are a party to it.

A DOCA binds all creditors, both unsecured and secured, to the extent of any shortfalls on their securities and releases the company from its debts, at least to the extent provided for within the DOCA’s terms and conditions.

Why choose a DOCA?
A DOCA aims to maximise the chances for a company to continue to exist, or to continue one aspect of its business. Alternatively, a DOCA will provide a better return for creditors than an immediate winding up of a company.

Who can propose a DOCA?
A DOCA proposal is usually put forward by company directors. However, it is not limited to only directors; any third party may propose a DOCA.

What happens if the DOCA is not executed?
When creditors vote for a DOCA, the company must sign the DOCA within 15 business days of the creditors’ meeting, unless the court allows a longer time. If this deadline is not met, the company will automatically go into liquidation, and the voluntary administrator becomes the liquidator.

How long does a DOCA last?
A DOCA lasts for as long as is provided for in its terms, and until all deed obligations are satisfied. The DOCA must state its term and its moratorium period. If the DOCA does not specify an end date, or ending conditions, it is invalid.

Are secured creditors bound by the DOCA?
A secured creditor is only bound by a DOCA if they are a party to the deed, or agree to be bound by it. The court can order to limit the rights of a secured creditor, but this situation is not common. If a secured creditor suffers a shortfall, that debt then falls within the provision of the DOCA.

How does a DOCA affect directors’ guarantees?
Creditors holding guarantees from directors or other parties are bound by the moratorium during the voluntary administration period. Guarantees are enforceable once a DOCA is signed, or the company is wound up. The release of the company’s debt under the terms of the DOCA does not discharge a guarantor’s liability for any shortfall.

Can creditors vary the DOCA after it has been executed?
Yes. Creditors can vary or terminate a DOCA by resolution at a creditors meeting. The administrator must convene the meeting at the request of at least 10 percent of the value of all creditors. Alternatively, the administrator may convene a creditors’ meeting if it is deemed beneficial. Any amendment to the DOCA terms must have the company’s consent. Creditors can apply to the court for the DOCA to be varied or terminated.

What happens to tax losses?
A company proposing a DOCA is likely to have tax losses. These losses are usually preserved; however, they may be lost or reduced if a company fails to pay its creditors 100 cents in the dollar. Directors should seek tax advice before proposing a DOCA to contemplate tax losses being available at the end of the DOCA.

Can a deed administrator pay dividends?
Yes. A deed administrator’s role is to pay a dividend to creditors.

When does a DOCA end?
The DOCA ends when its terms are satisfied, or when a creditor applies to the court to terminate, and is subsequently granted.

What happens if the company does not comply with the DOCA?
If the DOCA terms are not satisfied, it is considered to be in default. Usually, a default notice will be issued by the deed administrator. If the default is not rectified within the period set out in the notice, the agreement will be breached. The DOCA may contain enforcement provisions or the deed administrator may have access to guarantees given in support of the DOCA. The DOCA may also be terminated by:

  • the provisions of the agreement, automatically terminating the DOCA
  • passing a resolution at a creditors’ meeting
  • an application to court and the subsequent granting of an order.

A DOCA termination usually results in the company being placed into liquidation.

How should a company under a DOCA be referred to?
While subject to a DOCA, a company must advertise this status. For example, ABC Pty Ltd should be described as ABC Pty Ltd (Subject to Deed of Company Arrangement) on all public documents.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.01.2016

What is provisional liquidation?
A provisional liquidation is the court appointment of a liquidator to a company for the period between the application being filed to wind up the company and the court hearing.

The appointment is ‘provisional’ because the company may not be wound up at the hearing of the application, or a different liquidator may be appointed at that time. The appointment is a caretaker role as the provisional liquidator is generally only required to maintain the status quo as far as possible.

Why apply for a provisional liquidation?
The Court will appoint a provisional liquidator when it is convinced that the assets of the company are in danger of being dissipated or otherwise lost before the winding up application is heard. The appointment is usually made to protect the company’s assets or business. Other reasons may be that:

(a) there is some form of stalemate or dispute internally with the company leadership and an independent party needs to take control, or
(b) the company is insolvent and needs an external administrator appointed immediately for other reason.

How is a provisional liquidator appointed?
A court appoints a provisional liquidator. The method is the same as applying for the winding up of the company, with both applications usually filed at the same time. The hearing for the provisional appointment is heard shortly after the application is filed and the winding up application heard about four weeks later—depending on when the court can hear the applications.

The main difference between getting a liquidator appointed provisionally, is the applicant must convince the court that the assets etc. are in such danger that they must be protected. Whereas, a creditor only needs to prove that a company is insolvent to have a liquidator appointed.

Who may make the application?
Three parties may apply for an appointment of a provisional liquidator.

1. Creditors making a winding up application may apply if they believe that the assets of the company are at risk of being lost or made otherwise unavailable during the period before the winding up application is heard.

2. Members (shareholders) of a company may apply where they believe that the directors of the company are acting improperly, recklessly or in their own interests. These applications do not need to show that the company is insolvent, only that it is just and equitable that the company be wound up and that an independent person should take immediate control of the company. These applications are usually made by minority shareholders who do not have the voting powers to remove and appoint directors.

3. The company (through its directors) may apply. This may arise due to a dispute between directors and other officers, or because the company is insolvent and the directors do not want to risk insolvent trading claims in the period before a liquidator is appointed.

What are provisional liquidators’ powers?
The main role of the provisional liquidator is a caretaker to the assets and business of the company. While his or her powers may be extensive and absolute, the provisional liquidator will generally try to have as little impact on the company as possible.

Provisional liquidators are granted powers by the Corporations Act and the court order under which they are appointed. The order may limit or extend the powers granted under the Act, depending upon the individual circumstances.

The provisional liquidator has the power to operate the business of the company or to close the business and sell off the assets. They have the power to call for proofs of debt, determine the priority of creditors and conduct investigations. But they do not have the power to recover void transaction or pay dividends.

What is the effect of the appointment on the company?
The effect is very similar to the appointment of a registered liquidator. The company structure itself survives the provisional appointment. The control of all assets, the conduct of any business and other affairs are transferred to the provisional liquidator and the directors cease to have any authority.

But at the end of the provisional liquidation, control of the company will either pass back to the directors, or to a ‘standard’ liquidation appointment – depending on the outcome of the winding up application. In most cases the provisional liquidator will be appointed as liquidator if the company is wound up.

What is the effect of the appointment on creditors?
The effect is identical to that of any other liquidation, except they cannot receive a dividend during the provisional liquidation.

When does a provisional liquidation end?
Usually this will be at the hearing of the application to wind up the company. The application will generally either be:

(a) dismissed, ending the appointment, or
(b) granted, turning the appointment into a court liquidation.

The court may also order that the appointment ends, either on an appeal to the original appointment, or where the court is convinced that it is proper to end the appointment.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.02.2017

What is a members’ voluntary winding up?
A members’ voluntary winding up is the process for a solvent company when its members no longer wish to retain the company’s structure because the company has reached the end of its useful life.

Why choose a members’ voluntary winding up?
A members’ voluntary winding up is the only way to fully wind up the affairs of a solvent company. All outstanding creditors are paid in full, and any surplus assets are distributed to its members. A members’ voluntary winding up also protects the members’ interests while the company structure is dismantled.

When is a company solvent?
Usually a company is only considered solvent if it can pay all of its debts as and when they fall due.

However, this strict definition does not apply to members’ voluntary winding up as the appointment lasts for 12 months. If a liquidator forms the view that all creditors will not be paid in full within the 12-month period, the members’ voluntary winding up must convert to a creditors’ voluntary winding up administration.

How is the members’ voluntary winding up process started?
The directors resolve to call a meeting of members to wind up the company. Directors must complete a ‘declaration of solvency’ that states the company is solvent and can pay all its debts within 12 months. The declaration is lodged with the Australian Securities and Investments Commission (ASIC) before the members’ meeting. The solvent company is then wound up on the resolution of its members at the meeting.

What is the effect on the company?
The company structure itself survives the appointment of a liquidator. The control of all assets, conducting any business, and financial affairs are transferred to the liquidator. The directors cease to have any authority. All bank accounts are frozen, any employment can be terminated and the liquidator may engage necessary labour. At the end of the liquidation, the liquidator applies to ASIC to deregister the company, after which the company ceases to exist.

Can a company trade while in liquidation?
A liquidator may continue trading a company if it is in the creditors’ best interest. A trade-on is considered if there is a prospect to sell the business as a going concern, or to complete and sell any work-in-progress. A liquidator is obligated to end trading and wind up company affairs as quickly but as commercially responsible as practical.

What must the directors do to help the liquidator?
Directors must supply the liquidator with all information about the company’s financial affairs and provide a Report as to Affairs (detailing the assets and liabilities of the company as at the date of appointment of the liquidator) and a director’s questionnaire. Directors must deliver all company books and records, and cooperate with the liquidator throughout the liquidation. Various offence provisions relate to directors that do not cooperate with liquidators.

The investigation process
Many of the investigations normally conducted under a creditors voluntary or court liquidation are not required under a members’ voluntary winding up. As the company is solvent and creditors should be paid in full, there is no need for any recovery actions to be initiated. Preferential payments and insolvent trading are recovery actions that require the company to be insolvent at the time of the transaction, or if there is a loss to creditors.

Liquidators may have to verify what assets are available to them. Commonly, some assets are loans made to shareholders and are sometimes either in dispute or insufficiently recorded. In these cases, the liquidator has to reconstruct the loan accounts to determine the amounts and extent of the debts.

A liquidator must ensure a proper distribution is made to members through the capital accounts of the company. This distribution requires some investigation into a company’s balance sheet, particularly capital reserve accounts and franking accounts. Generally, the company’s external accountant can provide a current and detailed balance sheet showing all equity accounts. The liquidator then pays the distribution to members in the most tax-advantageous way.

How long does the members’ voluntary liquidation process last?
The members’ voluntary liquidation lasts for as long as necessary. Selling assets and paying creditors usually happens within the first few months. Completing the company’s financial statements and final tax returns could potentially delay the distribution to members, particularly if there is a dispute between members. Clearance from the Australian Taxation Office (ATO) is essential before a members’ voluntary liquidation can be finalised.

Can a liquidator pay dividends?
Yes. The role of the liquidator is to sell the company’s assets and distribute them among:

  1. company creditors as a dividend, and then
  2. company shareholders as a distribution.

Are the dividends paid under certain priorities?
Yes. The liquidator must pay dividends under a set of priorities. These priorities include:

  1. the costs and expenses of the liquidation
  2. employee entitlements
  3. non-priority creditors
  4. members.

While the liquidator follows these priorities, all creditors should be paid in full within the first 12 months.

How does the process end?
The members’ voluntary liquidation process ends when the liquidator calls a final meeting of the company’s members. The meeting will only be called after all creditors’ claims are satisfied, all other issues are resolved, and any surplus is distributed to the members. This meeting is a statutory process and attendance by members is optional.

The company is automatically deregistered by ASIC three months after the final meeting is held.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 08.04.2015

Introduction
It is often necessary to call meetings of creditors when companies are under external administration. Depending on the type of external administration, meetings may be called at a variety of times and for a variety of reasons. Some will be called because the Act states that they must be called, others because the external administrator believes it will benefit the estate. Same are called simply for the external administrator to obtain fee approval.

The first meeting in a voluntary administration has a very short notice period, as the Act requires it to be held within eight business days of the appointment. The second meeting in a voluntary administration has to be held between 15 and 25 business days after the appointment. Meetings in liquidations require longer notice and there is no time period in which to hold them. The initial meeting in the Creditors’ Voluntary Winding Up process also have a short notice and must be held within a statutory time period.

Notices of meetings issued to creditors will normally be accompanied by a report from the external administrator that will contain details of any resolutions to be proposed. The agenda for meetings under the Corporations Act is not generally prescribed by the statute, as is the case for meetings under the Bankruptcy Act, nevertheless an amount of formality attaches to these meetings – particularly concerning the required notice, the chairman, quorums, motions and rights to vote.

From time to time creditors will consider that it is impractical to hold regular meetings with all of the creditors of the company, even though there are matters that will need to be resolved. In such cases, a smaller group of creditors called a Committee of Creditors or a Committee of Inspection might be appointed to work with the liquidator or administrator.

By necessity, this paper is general in detail. The Act contains a number of Regulations that govern these provisions and these should be read to obtain more than a summary understanding of the provisions.

This paper contains links to legislation. These will open in a separate window. Most of the legislation shown in this paper is only a summary or extract of the entire section. The links go to the entire section.

Reasons for Calling Meetings
Each type of corporate insolvency appointment has its own requirements and timings for calling and holding meetings of creditors. But there is a significant amount of crossover, especially when dealing with admittance of proofs of debt and proxies etc. These are explained in greater detail later in this paper. Some meetings of creditors are required by statute, while some can be held at any time the external administrator wishes.

Controllerships and provisional liquidations do not require meetings of creditors. The types of external administrations detailed below do require meetings.

Voluntary Administrations
Administrators must hold a first meeting of the creditors within eight business days of their appointment. The only prescribed business for that meeting is to:

(a) determine if the creditors wish to replace the current administrator with a new administrator (they cannot end the administration at this meeting); and
(b) determine whether they wish a committee of creditors to be appointed.

Although the agenda is limited, administrators will usually provide all the information that they have to hand, an outline of the future of the administration, and the prospects for a proposal for a deed of company arrangement. As the administration will only be eight business days old, with effectively only six full days of examination, administrators will not be able to provide creditors will results of any detailed investigations.

The second meeting of creditors is called to decide the future of the company. Usually one of three options is available;

(a) to approve a deed of company arrangement, if one has been proposed;
(b) to liquidate the company; or
(c) hand the company back to the directors and end the administration.

When calling the meeting, the administrator must issue a report to creditors detailing the options available, along with all relevant information so that creditors may make an informed decision on how to vote on the future of the company. That information will include the expected recoveries in a liquidation, a comparison of that return to any proposed deed, and the likelihood of creditors being paid if the administration ends. This meeting will also include consideration of the administrator’s remuneration.

Deeds of Company Arrangement
An administrator of a deed of company arrangement has the power to call meetings of creditors to consider any variations to the deed or the termination of the deed as required. The deed administrator will also call meetings when necessary to obtain further fee approval.

The deed will usually contain provisions to allow the creditors to ask the deed administrator to call a meeting to consider various resolutions. In that case, the deed administrator may have to call the meeting, but the creditors requesting the meeting usually will usually have to pay the costs of calling the meeting. The deed should set out all such provisions.

Creditors Voluntary Liquidations
Apart from the initial creditor’s meeting, the Act provides that two types of meetings must be called in a voluntary liquidation that are not required in a court liquidation. These are Annual Meetings (they are discretionary) and a Final Meeting (this is mandatory). Other meetings may also be held if the liquidator thinks them necessary – usually for fee approval – and will be called under the same general provisions as used in a court winding up.

When called annual Meetings must be held within 3 months after the anniversary of the commencement of the winding up. These are called to keep the creditors updated on the conduct of the liquidation, but these are not generally well attended. Generally the liquidator will keep creditors informed through written reports.

The liquidator may decide not to call an annual meeting of creditors. Liquidators of voluntary liquidations commenced after 1 January 2008 have the option of lodging a report on the conduct of the liquidation with ASIC. This report is then made available to creditors through ASIC.

Final Meetings are held to formally end a voluntary winding up. The company is automatically de-registered three months after notifying ASIC of the final meeting being held. Final meetings are never well attended as no resolutions are proposed. The purpose of the meeting is simply to detail what the liquidator has done through the process of liquidation, but full details have usually been provided to creditors throughout the liquidation. A final meeting is not required in a court appointed winding up.

Court Liquidation
A liquidator may call a meeting of creditors to pass whatever resolutions may be necessary for the conduct of the liquidation. There are various reasons why a liquidator may call a meeting, but one of the most common is approval of their remuneration. Although this is usually the most common reason to call a meeting, the meeting will usually contain a full report of the liquidation and discussion of future investigations etc.

Procedures at Meetings of Creditors
The procedures for calling and holding meetings of creditors are set out in the Act and Regulations. The main ones are detailed below. A meeting will not necessarily be invalid if the procedures are not fully followed, but any variance should not be material.

Meetings must be called by the external administrator giving notice to all parties believed to be creditors at their last known address. Each type of meeting has a minimum notice period that varies depending on the type of administration and the type of meeting in that administration.

That document calling the meeting is in the form of a formal notice of meeting that sets out any resolutions that are to be considered at the meeting. The notice should be accompanied by a report from the external administrator that provides all of the necessary information for creditors to make informed decisions about any resolutions proposed. It will usually also contain an update of the administration.

The basic factors for any meeting are:

1. The agenda
2. A quorum
3. The chairperson
4. Lodgment of proofs of debt
5. Lodgment of proxies
6. Minutes of meetings
7. Voting at meetings
8. Adjournment of meetings

1. The agenda
The Act regulates the conduct of meetings in a number of ways, but one of the least regulated parts is setting an agenda. The agenda sets out the steps that should be taken throughout the meeting and the order in which they should be taken, and notice of any resolutions that are to be considered.

The agenda is formed by the external administrator and is sent to the creditors as part of the notice calling the meeting. In effect, the external administrator will draft a tailored agenda covering all of the statutory requirements and any resolutions that will or must be proposed. Sometimes different meetings will have greatly varied agenda items, but all still must comply with the Act.

A chairperson may allow the proceedings to depart slightly from the strict agenda if he or she thinks it is in the interests of creditors, and provided that the overall integrity of the meeting is not compromised. But strictly the chairperson may not listen to any business that is not listed in the agenda.

2. A Quorum
A meeting cannot be held without a quorum. That quorum must be obtained within 30 minutes after the time set for the meeting, or the meeting is automatically adjourned. If there is only one creditor in the estate, that creditor will constitute the quorum. If there is more than one creditor, a quorum is constituted by at least two creditors in person or represented by proxy.

Creditors can attend meetings in person or by proxy, and any person, including the chairman, holding two or more proxies constitutes a quorum. Quorums are important as resolutions cannot be passed at meetings that do not have proper quorums.

If no quorum is present within 30 minutes after the time set for the meeting, the meeting will stand adjourned to be recalled within the next 7 to 21 days. If the adjourned meeting does not have a quorum within the allocated time, the meeting will lapse without any business being conducted.

3. The Chairperson
The chairperson is set by the regulations to be the liquidator or the administrator or their representatives in all but one case. Receivers do not generally call meetings of creditors and, if they do, the meeting is not called under the provisions of the Corporations Act. The only exception to the liquidator or representative rule is the initial creditors’ meeting under the creditor’s voluntary winding up provisions. In that case the creditors may choose the chairman from the creditors present, or may have the liquidator chair the meeting.

This is different to meetings under the Bankruptcy Act, where a president of any meeting is decided by a vote of the creditors. In company matters, the creditors will generally be stuck with the liquidator or administrator, or his deputy.

4. Lodgment of Proofs of Debt
A person must be a creditor of the company to vote on resolutions at a meeting of creditors. The liquidator or administrator will usually require that the creditor lodge a claim or a proof of debt with them before or at the meeting.

A proof of debt is a statutory document and the proper form to show the existence of a debt owed by the company. All supporting documentation should be attached to ensure that the proof of debt is admitted for voting purposes. If there is insufficient evidence of the debt, the chairperson will not be able to admit it. The onus is on the creditor to prove that the debt exists.

Proofs of debt can be lodged with the liquidator or administrator before the meeting or with the chairperson at the meeting. Once a proof of debt is lodged, the creditor does not need to lodge another one for further meetings or for dividends purposes. This is different to proxy forms (see below) that expire at the end of each meeting.

Proofs of debt that are not admitted for voting at a meeting will not be formally rejected, as they may be for dividend purposes. The chairperson will declare that the proof is or is not admitted for voting for a certain amount. The liquidator may also object to a proof of debt, but must still allow the proof of debt for voting purposes. The liquidator or administrator is bound by certain rules on admitting proofs of debt. That proof of debt may be reexamined for dividend purposes.

If the liquidator or administrator cannot determine whether a proof of debt should be admitted for vote purposes or not based on the evidence attached, the regulations prescribe that they mark that proof of debt as ‘objected to’ and allow it to vote for its face value. At other times the liquidator or administrator will be able to admit or reject based on the evidence. The Regulations have provided this mechanism as a number of proofs of debt may be received at the start of the meeting and there is little time to adjudicate on them.

5. Lodgment of Proxies
Any creditor can appoint a proxy to represent them at any meeting. The liquidator, chairperson, another creditor or any other real person may act as a proxy. The form of the proxy is very specific but only has a life of one particular meeting, including any adjournments. A new proxy will have to be completed for each separate meeting of creditors.

The form of the proxy is set out in Regulation 5.6.29 to be a particular statutory form. The Act now allows for the lodgment of proxies that are not in hard copy written form. Proxies may be lodged online in an electronic format, subject to some requirements.

Voting by proxy is possible in two ways:

(a) a general proxy; or
(b) a specific proxy.

A creditor may give their proxy a general instruction to represent them at a meeting of creditors and to vote in any manner and on any resolution that the holder of the proxy thinks fit. Alternately, the creditor may give the proxy special instructions on the manner to vote on specific resolutions. These will be general or special proxies respectively. A proxy that is not a special proxy is a general proxy.

6. Minutes of Meetings
Minutes are the official recording of the meeting and its resolutions. The Act requires that minutes of all meeting of creditors be lodged with ASIC within 1 month after a meeting in a liquidation and 14 days after a meeting in a voluntary administration.

These minutes will be available from ASIC for inspection, but the liquidator or administrator must also make the minutes available for inspection by creditors or contributors upon request. (Worrells usually posts minutes of meetings to its web page shortly after the meeting).

7. Voting at Meetings
There are two ways that a vote may be taken at a meeting.

Initially voting on resolutions is usually conducted ‘on the voices’, which is decided upon a simple majority in number of those creditors present and voting. A resolution will be decided on the voices unless someone (the Chairperson, two or more creditors, or a creditor holding at least 10% of the value) demands a poll to be taken.

On the voices literally means creditors stating ‘Yes’ or ‘No’ to a resolution. It is common for chairpersons to also require the creditor to raise a hand whilst voting, as it is easier to determine the vote. In this case, the simple majority in number wins the vote.

A poll is a written vote decided upon a double majority. For a resolution to be carried in a poll, a majority in number of the creditors present and voting must vote for the resolution, and they must hold more than one half of the value of the debt represented and voting at the meeting.

If there is a stalemate (one majority voting ‘for’ the resolution and the other majority voting ‘against’ the resolution) the liquidator or administrator will use a casting vote to decide the vote. The courts have determined that liquidators’ or administrators’ have a duty to try to resolve resolutions at meetings and, unless there is a good reason not to do so, use their casting vote for that purpose. They must also include their reasons for using their casting vote in that manner in the minutes of meeting.

Usually the chairperson will call for someone to move a resolution before a vote takes place. Sometimes these formalities are shortened by the chairman, using a proxy in their name, moving the resolution. This is acceptable if the rights of the creditors are not constrained.

After the vote the chairperson will make a declaration of whether the motion is carried or not and record that declaration in the minutes.

8. Adjournment of Meetings
Meetings can be adjourned in certain circumstances. The first is when there is no quorum within 30 minutes after the time set for the meeting. In this case, the meeting is automatically adjourned by process of law for between 7 and 21 days. This is discussed above.

Regulation 5.6.18 allows the chairperson to adjourn a meeting if they are directed to do so by the creditors (sometimes after a vote on the matter) or where the chairperson gets the consent of the meeting to adjourn the meeting. The liquidator has no absolute power to adjourn meetings. They must at least have creditor approval.

The adjourned meeting usually must be held at the same place of the original meeting, but if that is inconvenient, the meeting may be held at another location.

The liquidator or administrator will issue a new notice of meeting for the adjourned meeting. That notice will be issued to all creditors, not just the creditors that attended the first part of the meeting. Any creditor that did not attend the first meeting may attend and vote at the adjourned part of the meeting, but only on resolutions that have not been moved before the end of the first part of the meeting.

Committee of Creditors/Inspection
A committee is a smaller group of creditors that can act on behalf of the general body of creditors. The advantage is that the practitioner can meet with the smaller group more regularly and cost effectively than continually calling large meetings of creditors. The group may also contain members that may have some technical expertise that the practitioner may find useful in conducting the estate.

Committees are appointed by resolution at a meeting. They are not appointed by the practitioner. Whilst the committee may offer suggestions and advice to the practitioner, they cannot direct then to do, or not do, certain tasks.

Liquidations
Committees of inspection in a liquidation are formed under Section 548 by a system of two meetings – a meeting of creditors and a meeting of contributories – each specifically called to consider the appointment of a committee. They cannot be formed at a general meeting of creditors.

The one exception to the strict rules in appointing committees is the initial meeting of creditors in a Creditors’ Voluntary Winding Up called under section 497. That section waives the need for calling two meetings of creditors and allows the creditors at that meeting to form a committee and chose its members.

There are no similar provisions that deal with second meetings of creditors in a voluntary administration or at meetings called to terminate deeds of company arrangement.

Voluntary Administrations
Committees of creditors can be formed at a first meeting of creditors under section 436E and governed by sections 436F and 436G, but the committee only last for the duration of the administration.

If the company is wound up at the second meeting, the procedures for forming committees in a liquidation will have to be followed.

If the company goes under a deed of company arrangement, that deed may allow for the formation of a committee, but the committee will not be able to be formed until the deed is executed by all parties and this will be after the second meeting. The only way of having a committee proposed and voted upon at the second meeting of creditors is to have its formation and members nominated and included as part of the proposed deed. In that case the committee will be formed when the deed is fully executed.

Generally on Committees
Meetings of committees can be held as frequently as required, due to the smaller number of people involved. The process of calling, conducting and preparing minutes of a meeting is almost identical as the process for a general body of creditors. It is also common for committees to meet informally to discuss certain issues that do not require a formal resolution. Sometimes some items may have to be kept confidential while certain tasks are completed.

The committee may include a member representing the employees of the company, the management of the company, any bankers and a few representing the general trade creditors. Committees usually number 3 to 7 creditors or their representatives, with more than 7 becoming too large for convenience.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

What is it?
The Personal Property Securities Act 2009 (PPSA) replaced commonwealth, state and territory based legislation with respect to parties’ rights over personal property. The PPSA also established the Personal Property Securities Register (PPSR), again replacing existing registers, to be a single notice board of all registered interests in personal property. The PPSA commenced on 30 January 2012. The Australian Financial Security Authority (AFSA) administers the PPSR.

What is personal property?
The term ‘personal property’ covers most examples of property dealt with in the normal course of a person’s or company’s business. Examples include: motor vehicles, boats, caravans and trailers, artwork, crops, inventory (stock), livestock, plant and machinery, shares, investment instruments, and intellectual property.

What assets are not covered by the PPSA?
Real property (including water rights and fixtures to real property) are not covered by the PPSA, and remain subject to existing state and territory based registrations.

How do I obtain security?
The most important element is there must be a signed security agreement between the parties. This must happen before the supply of any finance, or goods. Once a security agreement is signed, a registration should be made on the PPSR.

What are the types of registrations?
The two common types of registrations are identified as All Present and After-Acquired Property (ALLPAAP) and Purchase Money Security Interests (PMSI).

An ALLPAAP is a registration over all present and future property. Financiers for company finance, generally make an ALLPAAP registration when there is no specific purpose, e.g. an overdraft, loan, etc.

A PMSI is a specific registration for an interest in a specific item for all or part of its purchase price. A PMSI holder has a super priority, even over and above a security registered as an ALLPAP. A PMSI is commonly registered by suppliers or financiers of; stock, motor vehicles, and items of plant and equipment.

When does a security interest have to be registered?
A security interest must be registered within six months of execution, and 20 business days after the security interest came into force. If these periods are not met, there is a risk the security interest will not be enforceable against an external administrator or bankruptcy trustee.

A PMSI must be registered before the supply of the goods, if they are inventory (stock). For goods other than inventory (stock), the PMSI must be registered within 15 days after delivery of the item.

What happens if you don’t register your security interest?
When an external administrator (liquidator or voluntary administrator) or a bankruptcy trustee is appointed, and where the security interest has not been properly registered or in time, the property will not be available to the creditor, but instead will be an asset of the entity who granted the security interest.

Therefore it is critical that suppliers and financiers properly register their security interests, and in time, to ensure they retain their rights to the assets in the event of default, or the appointment of an external administrator or bankruptcy trustee.

PPSA & voluntary administrations
Section 440B of the Corporations Act 2001 imposes restrictions when a voluntary administrator is appointed to the company under Part 5.3A:

  • An owner of property used by the company from taking possession of, or recovering, the property.
  • A lessor from levying distress rent, taking possession, or otherwise recovering the property.
  • A secured party with possessory security from selling the property or otherwise enforcing the security interest.

The voluntary administrator may still sell or dispose of assets:

  • with the consent of the secured party
  • with the consent of the court
  • in the ordinary course of business.

Any asset disposal requires the voluntary administrator to distribute the sale proceeds from the secured property to those holding relevant security interests.

PPSA & Deeds of Company Arrangement
A Deed of Company Arrangement (DOCA) cannot bind a secured party from enforcing or otherwise dealing with their security unless the DOCA makes specific provision for their debt and they vote in favour of the DOCA.

PPSA & liquidation
The stay of claims by creditors against the company and its property contained under sections 471B and 500 of the Corporations Act do not affect creditors with an enforceable security interest over assets of the company.

The property of any unperfected security interest vests with the company in liquidation. A security interest will also vest in the company if the security interest is not registered by the secured party:

  • Six months before the commencement of the relevant external administration or insolvency (the critical time); or
  • 20 business days after the security agreement came into force, or the critical time, whichever time is earlier.

New terminology
The PPSA introduced a range of new terms. These include:

Grantor—the party providing the security.

Secured Party—the party receiving the security.

Collateral—the secured asset.

Attachment—the creation of security over the collateral for value.

Perfection—is a technical term particular to the PPSA. the security interest being enforceable against third parties and ‘is stronger than the mere attachment of their security interest’.

Circulating Asset—previously described as floating assets, being assets used or transferred in the ordinary course of business.

Non Circulating Asset—previously described as a fixed asset, and prohibited from dealing with without the consent of the secured party.

Purchase Money Security Interest (PMSI)—a security interest taken in collateral to the extent that it secures all or part of the purchase price. A PMSI provides a ‘super priority’ over other forms of security and is typically used in the supply of stock or other non circulating assets.

How do I find out more or register an interest?
To find out more, or to register a security interest, go to www.ppsr.gov.au

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 08.04.2015

What are preferences?
Preferences are payments or transfers of assets that give a creditor an advantage over other creditors. Any payments or transfers made to a creditor before to liquidation may be recovered by liquidators in certain circumstances. Preferences are usually payments of money, although a variety of transactions could be deemed ‘preferential’.

Who may recover preferential payments?
Liquidators can recover preferential payments; however, recovery may require a court order to perfect the entitlement to recovery. Recovering preferences is not available to provisional liquidators, voluntary or deed administrators, or receivers and managers.

Why do liquidators void preferential payments?
The liquidator’s main role is to distribute a company’s assets between its creditors on an equal basis (pari passu). Liquidators must determine whether any creditor received treatment, prior to liquidation that was not equitable compared to the distribution to other creditors in the liquidation. Liquidators can void transfers that involve one creditor to make a more equitable distribution to all creditors, including the creditor who received the preference.

What are the elements of a preferential payment?
When considering whether a payment is preferential, a court must be satisfied that:

  1. a transaction was entered into (this is usually a payment of monies)
  2. was between the company and a creditor of the company
  3. happened when the company was insolvent
  4. happened within the statutory period before the liquidation started
  5. the transaction gave the creditor an advantage over other creditors
  6. the creditor suspected, or had reason to suspect, that the company was insolvent.

When is a company insolvent?
The definition of solvency is being able to pay one’s debts as and when they fall due. Conversely, if a company is not solvent, it is therefore insolvent. In the context of preferences, the company must have either been insolvent at the time of the transaction or became insolvent because the transaction was made. The reasoning is that a solvent company has the capacity to pay all of its debts (whether they actually did or not) and therefore no creditor could have been advantaged over others.

Who has to prove insolvency?
The onus of proving insolvency lies with the liquidator.

The main elements of a preference

1.   There must be a debtor–creditor relationship
The transfer of property must have involved or been done at a creditor’s direction, and must satisfy a debt that would be a provable debt if the transfer had not been made. A cash-on-delivery (COD) payment for goods is not a payment to a creditor, so is never deemed preferential.

However, suppliers often supply goods on COD with a requirement for further payment towards satisfying an existing debt. This additional payment is deemed preferential and is therefore recoverable by a liquidator.

An advance payment for future works, or the future supply of goods, cannot be preferential, but would be required to be repaid to the liquidator if the services/products have not been used by the company

2.   There must be a transaction
There must be a transaction between the company and creditor. Commonly, a transfer is a payment from a company’s bank account, although any asset passing from a company to a creditor is sufficient to establish a transaction.

For example, the return of stock that is not subject to the Personal Property Securities Act 2009 (PPSA), or assignment of a debt, would be a transaction for the purposes of the preference provisions.

3.   The relevant time period
The transaction must have occurred during a specific period before the ‘relation back-day’. The actual period depends on whether the recipient is related to the company, and on the company directors’ intention. The periods are:

  • six months for non-related parties
  • four years for related parties
  • ten years for any evidence of “attempt to defeat, delay or interfere” with the rights of creditors.

The relation-back day is the date that the liquidation is deemed to have started. For the various types of liquidations, the relevant days are:

  • for a liquidation that follows a voluntary administration or Deed of Company Arrangement (DOCA), it is the day that the voluntary administrators were first appointed
  • for other voluntary liquidations, it is the date of the members’ meeting that the liquidators were appointed
  • for a court appointment it is the day that the application was filed in the court.

4.   The debt must be unsecured
A preference does not apply to a creditor holding a valid and subsisting security over company assets pursuant to the PPSA, where the value of the assets secured is greater than the payment amount. But, if the security is not properly created or registered, or the value of the security is less than the payment amount, the liquidator may render it void and the debt may be deemed unsecured.

Other provisions also apply to securities provided to related entities and created within six months of the start of the liquidation. The creation of a security itself within the six months can also be a preference.

5.   Continuing business relationship
The continuing business relationship provision is similar to what was previously known as a ‘running account’. The business relationship provision is used to determine the amount of any preference received by a particular creditor; it takes into account all transactions between relevant dates. It shows whether the owed debt increased or decreased to the creditor during that period.

If the balance owing decreased, this amount is the potential preference amount, with all other factors being considered. If the balance owing increased, there is no preference as the creditor is actually disadvantaged by the transactions.

The liquidator determines the start date and concludes on the date the winding up commenced.

6.   The creditor must obtain a preference
The creditor must have received more than they would have received if they refunded the monies and proved for that amount in the liquidation process. If the creditor did not receive more by way of the payment than they would have received from a dividend, there is no advantage or preferential treatment.

What defences are available to creditors?
Section 588FG of the Corporations Act 2001 provides defences that may be available to creditors who received preferential payments. To rely on a defence, a creditor must be able to satisfy all three conditions of the defence. The onus of proving the defences is on the creditor, it is not for the liquidator to disprove them.

The three conditions of the statutory defence are:

  1. the creditor gave valuable consideration for the payment
  2. the creditor received the payment in good faith
  3. the creditor had no reason to suspect the insolvency of the company.

Each of these conditions is outlined as follows:

1.   What is valuable consideration?
Usually, the easiest condition to prove is the creditor gave valuable consideration. For trade creditors, the initial supply of goods or services provides the valuable consideration. A loan creditor can rely on the initial loan to the company. The creditor will only have to show that they have given something of value in consideration for receiving the payment.

2.   What is good faith?
The creditor must not have acted in any manner that would indicate they were not acting in good faith or under normal trading conditions. Actions that may repute good faith are: commencing proceedings or issuing statutory notices; ceasing supply; or changing to a COD basis. They must not have forced the payment by any form of threat or action.

3.   What is needed to suspect insolvency?
The creditor must not have received or have known of any information or circumstance that would lead them (or a reasonable person in their position) to suspect that the company was insolvent. It is not necessary that the creditor knew, or believed, or even expected that the company was insolvent to lose the benefit of this defence. The mere suspicion of a reasonable person is enough.

Actions such as receiving post-dated cheques, dishonouring cheques, entering into repayment agreements, knowing of other creditors that are unpaid and pressing for payment can reasonably lead to this suspicion. Whether or not a person should have suspected insolvency is often difficult to determine particularly as the courts recognise a distinction between a short-term cash flow problem and insolvency.

What should creditors do if a liquidator claims a preferential payment?
Creditors should ensure that:

  1. the transaction was entered into within the relevant period
  2. they are not a secured creditor
  3. they are (or were) a creditor when the transaction was made, and that it was not a cash on delivery payment
  4. the liquidator demonstrates they received an advantage over other creditors by virtue of the payment.

These basic points are usually easy to demonstrate. The following points are more difficult
to determine:

  1. whether the creditor gave extra credit to the company after the payment or transfer was received, whether it is possible that the claim may be reduced or eliminated by the amount of extra credit granted, that is, to determine whether the creditor had a continuing business relationship with the company
  2. that the liquidator can show insolvency at the time of, or before the payment was received
  3. whether the creditor has a realistic chance of convincing the liquidator that the statutory defences apply.

What can creditors do if required to refund money to a liquidator?
Creditors refunding preferences may lodge a proof of debt with the liquidator for the amount refunded. They may also have some rights under any guarantees.

How long does the liquidator have to make a claim?
Claims must be commenced within three years after the relation-back day. A liquidator must issue proceedings within three years­­—not just make a formal demand. A time extension may be granted by the court, but the application must be made within the three-year period after the relation-back day, and the liquidator must demonstrate a reasonable cause for the delay in initiating the claim.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.02.2017

What is insolvent trading?
Insolvent trading is when directors allow their company to incur debts when the company was insolvent. The liquidator can make a compensation claim against a director if those debts are unpaid when the liquidation commences. A director may be held personally liable to compensate creditors for the amount of the unpaid debts incurred from the time the company became insolvent to the start of the liquidation.

Why do liquidators make these claims?
Liquidators are obliged under the provisions of the Corporations Act 2001 to investigate the existence of any insolvent trading claim, and if so, take appropriate action. Further, directors have a duty to stop a company from incurring debts it is unable to pay. Under the Corporations Act, failing to stop a company from incurring debts it is unable to pay is a breach of the directors’ duty. Directors may have to pay compensation to the company for losses creditors have incurred under that breach of duty.

Who makes insolvent trading claims?
Liquidators have the first opportunity to make insolvent trading claims. If they decide not to make a claim, creditors may start their own actions, but creditors’ claims are limited to the amount of their individual debt.

Can creditors take insolvent trading action?
Yes. If a liquidator does not pursue an insolvent trading claim, the creditors of the company (individually or in a group) can make a claim. Creditors may start an action either with a liquidators consent or if the liquidator fails to provide their consent, the creditors can seek leave of the court in certain circumstances.

Creditors can only take action against directors for their own debts. Whereas a liquidator can pursue an insolvent trading claim on behalf of all creditors’ unpaid claims.

A creditor cannot commence action when a liquidator has already begun proceedings or has intervened in an application for a civil penalty order. That is, claims are restricted when the liquidator has started their own action.

What are the factors in an insolvent trading claim?
Aside from the company being in liquidation, the factors in an insolvent trading claim are:

  1. The company must have been insolvent when the debts were incurred.
  2. The debts must remain unpaid at the time of the liquidation.
  3. The claims must be made against people who were company directors at the time debts were incurred.
  4. There were reasonable grounds for the director to suspect the company was insolvent.

Who are directors?
The status of ‘director’ of a company is not exclusive to those who are appointed as directors, recorded in the company register, or those notified to the Australian Securities and Investments Commission (ASIC). People who act as a director, even if not formally appointed, may be defined as a director. Shadow or de facto directors, or other parties that controlled the company at the time the company became insolvent can be exposed to an insolvent trading claim.

The Corporations Act defines a ‘director’ as:

‘(a) a person who:

(i) is appointed to the position of a director; or

(ii) is appointed to the position of an alternate director and is acting in that capacity; regardless of the title of their position; and

(b) unless the contrary intention appears, a person who is not validly appointed as a director if:

(i) they act in the position of a director; or

(ii) the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes.’

The definition excludes people who give advice as part of their normal professional role. For example, accountants, solicitors and other paid consultants.

When is a company insolvent?
A company is insolvent when it cannot pay its debts as and when they become due and payable. The Corporations Act defines solvency and insolvency as:

Section 95A — Solvency and Insolvency

(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. A person is defined to include a corporation.

What about accrued debts?
For an insolvent trading claim, the debt must be incurred, not just accrued, when the company is insolvent. Incurring a debt is the legal creation of a debt that did not previously exist. Accrued debts usually relate to ongoing contractual agreements.

Contractual agreements are incurred at the time of the original agreement and only become payable (or accrue) at a later date. If the original agreement was made while the company was solvent, and the later amounts only accrue because of that original contract, those debts will not form part of an insolvent trading claim. For example, reoccurring lease payments are under a contract that was entered into prior to the company’s insolvency.

How do directors become liable for insolvent trading claims?
Section 588G of the Corporations Act sets out the director’s duty to prevent insolvent trading and sets the parameters by which a liquidator can initiate the process for making a claim against a director. Directors contravene this section by allowing the company to incur a debt when they are aware of grounds to suspect the company was insolvent.

When directors breach their duty, the provisions of section 588M allow compensation to be recovered from that director. A claim is possible where the creditors suffered loss or damage because of the company’s insolvency and the debt was wholly or partly unsecured.

What defences are available to directors?
The Corporations Act provides statutory defences for directors. The burden of proving these defences is on directors. The statutory defences can be summarised as:

  1. the director had reasonable grounds to expect (not just suspect) the company was solvent
  2. a reasonable, competent person produced information that would reasonably lead to a belief that the company was solvent
  3. the director had a good reason for not taking part in the company management at the relevant time
  4. the director took all reasonable steps to stop the company incurring the debt, including attempting to appoint a voluntary administrator to the company.

The courts have made it clear that the position of director carries certain responsibilities, which cannot be avoided, including the duty to keep informed about the company’s solvency.

Is insolvent trading an offence?
Yes. Insolvent trading is an offence and can be referred to ASIC for further investigation and possible criminal prosecution. Directors should seek legal advice. Section 588G (Director’s duty to prevent insolvent trading by company) stipulates:

(3) A person commits an offence if:

(a) the person is a director of the company when it incurs a debt; and

(b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and

(c) the person suspected at the time when the company incurred the debt that the company was insolvent or would become insolvent as a result of incurring that debt or other debts (as in paragraph (1)(b); and

(d) the person’s failure to prevent the company incurring the debt was dishonest.

How long do liquidators have to take action for insolvent trading?
Liquidators have six years from the beginning of the liquidation to commence an action for insolvent trading. Proceedings must be commenced by way of the filing of an application with the court within that six-year period. It is not sufficient to just issue a letter of demand.

What should directors do if a liquidator makes an insolvent trading claim?
A liquidator should be asked to demonstrate:

  1. that the company was insolvent during the appropriate period
  2. that the debts were incurred after that time
  3. proof of director status at that time, whether formally appointed or not.

In settling claims with the liquidator, the settlement must be sanctioned by the court, usually by way of a consent order. This consent order protects directors from any future claims made by creditors of the company.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 08.04.2015

What is an unreasonable director-related transaction?
A transaction that has little or no benefit to the company that is made by a director or close associate (as defined by the Corporations Act 2001) of the company is called an ‘unreasonable director-related transaction’. Under the Corporations Act, the other party to the transaction is required to return the asset or make a payment to the liquidator.

Who recovers an unreasonable director-related transaction?
Only liquidators may recover unreasonable director-related transactions. Unreasonable director-related transactions cannot be recovered by provisional liquidators, voluntary administrators, deed administrators or controllers.

What is the basis of the claim?
The liquidator must prove that:

  1. a transaction was entered into
  2. a director or close associate of the director was involved in the transaction
  3. either there was no benefit to, or there was a detriment to the company.

Why recover an unreasonable director-related transaction?
A liquidator will examine whether the company entered into any transactions that reduced the amount of assets available for distribution in the liquidation.

A liquidator will seek recovery of money or assets transferred to make a more equitable distribution to creditors.

How much can be recovered from an unreasonable director-related transaction?
The liquidator will recover the difference between the value that was given by the company and the value received by the company. Only the excess between the two values is recoverable.

What are the main elements of unreasonable director-related transactions?
There are two main elements to an unreasonable director-related transaction: the transaction and the party involved.

1.   The transaction
The transaction must involve the company. The transaction can be a payment; a transfer or disposition of property; a security, or incurring an obligation or commitment to make a payment, disposition or issue. Section 588FDA is designed to cover money or assets actually leaving the company, or commitments (like security interests) being made over money or assets.

2.   A director or close associate must have been involved
The transaction must involve one of the following:

  1. a director of the company
  2. a close associate of a director of the company
  3. a ‘nominee’ acting on behalf of, or for the benefit of, a director or their close associate.

Nominees are people who are trying to disguise their involvement by including another person to the transaction, but where the related party still receives the benefit.

Who is a director?
A director is defined under section 9 of the Corporations Act as:

(a) a person who:

(i)   is appointed to the position of a director; or

(ii) is appointed to the position of an alternate director and is acting in that capacity; regardless of the name that is given to their position; and

(b) unless the contrary intention appears, a person who is not validly appointed as a director if:

(i) they act in the position of a director; or

(ii) the directors of the company or body are accustomed to act in accordance with the person’s instructions or wishes.

Who is a close associate?
A close associate is:

  • a relative or de facto spouse of a director, or
  • a relative of a spouse or of a de facto spouse, of the director. A relative is a spouse, parent or remoter lineal ancestor, son, daughter or remoter issue, or brother or sister of the person.

How is a transaction considered to be unreasonable?
The company must benefit from the transaction for it to be considered ‘reasonable’. Therefore, if the benefits of the transaction are outweighed by the detriment of the transaction to the company, it is deemed unreasonable. The liquidator will look for a reduction in the net position of company assets caused by the transaction to determine whether it is reasonable or not.

What is a reasonable person test?
The court will look at the transaction from the view of a ‘reasonable person’ in the company’s circumstances. This is someone that has knowledge of the company’s financial position, who is not trying to gain a personal benefit, or give a benefit to anyone else, or cause a loss to the company. It is assumed that a reasonable person would not enter into a company transaction that would cause detriment to the company or reduce its assets.

What time period is involved?
The transaction must have been entered into within four years before the ‘relation-back day’, or between the relation-back day and the appointment date. The relation-back day is the day that the liquidation legally commences. There are three possible dates for the relation-back day in corporate administrations:

  1. For a liquidation following a voluntary administration, the relation-back day is when the administrators were first appointed to the company, even if a Deed of Company Arrangement (DOCA) was in effect in the intervening period.
  2. For a court appointment, the relation-back day is the day the application was filed.
  3. For a creditor’s voluntary winding up, the relation-back day is the date of the members’ meeting that resolved to wind up the company.

Does the company need to be insolvent?
No. The company does not need to have been insolvent at the time of the transaction or because of the transaction. This means the statutory defences available in other recovery actions—such as the good faith defence and no reasonable grounds to suspect insolvency do not apply.

What relief is available to the liquidator?
Recovery applications are limited to a relief available under section 588FF of the Corporations Act. The most common relief sought by liquidators is the return of the monies or assets received by the other party. However, recovery is limited to the excess or the unreasonable benefit of the transaction. The whole transaction is not voided, unless there was no ‘reasonable’ part to it. Therefore a recovery is generally the payment of money.

How long does the liquidator have to make a claim?
A claim application for an unreasonable director-related transaction must be made within three years after the relation-back day. It is insufficient for the liquidator to only have issued a demand within that period, legal proceedings must be commenced within the three years.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.02.2017

Introduction
Section 588FH is one of the recovery provisions in the Corporations Act available to liquidators. The section allows liquidators to recover monies from entities related to the company.

The liquidator will be able to claim the unfair preference from the creditor, and claim the amount of the payment (or more correctly the amount of the reduction in the obligation) from the related entity. The maximum amount that the liquidator can recover from both parties combined is the amount of the payment – they cannot recover the full amount twice.

The reasoning behind this section of the Act, is that the creditor was likely to have been preferred (received the preferential payment) in Order that the related party (usually a family member of the director or the director them self) is released from a financial obligation. The creditor received preferential treatment by receiving the payment, but the related party also receives preferential treatment by having their obligation reduced or eliminated.

Proving the claim
The liquidator will need to prove two separate things to be able to make a claim against the related party. They are:

1. that the creditor received an unfair preference or was party to a transaction void under section 588FE; and
2. the related party had an obligation released.

The liquidator will not be able to take the claim against the related party if they cannot prove both of these components. The job is made slightly easier as the liquidator only needs to prove that the unfair preference to the creditor is “voidable under section 588FE”, not that the statutory defences available to the creditor can be defeated.

This could lead to a position where the creditor received a preferential payment and can rely on the defences, but the related party is still liable under the section.

To prove the positive factors of an unfair preference, the liquidator will need to show the transaction:
(i) gave the creditor a preference or advantage over other creditors;
(ii) was an insolvent transaction (it was done while the company was insolvent); and
(iii) was entered into within the relevant time period (usually 6 months before the relation-back day);
These factors are summarised below.

Preference to a third party
The transaction must be preferential to the creditor, but it does not have to be collectable from the creditor if the defences apply. To be preferential, the creditor must be an unsecured creditor and have received more from the transaction than they would have if they had proved for their debt in the liquidation and received a dividend. This is generally a simple mathematical calculation. Practically these positive factors are relatively easy to prove.

Insolvent Transactions
To be preferential, the transaction to the creditor must be an insolvent transaction as defined by the Act. A transaction is an insolvent transaction if it is:

1. an unfair preference or an uncommercial transaction, and
2. it was entered into at a time when the company was insolvent, or the company became insolvent because of the transaction.

If the company was not insolvent at the time of the transaction or did not become insolvent because of the transaction, there will be no unfair preference and no section 588FA or section 588FH claim.

The time period
To be a preferential payment, the insolvent transaction must be a voidable transaction under section 588FE. To be voidable, the transaction must have occurred within the relevant time periods as set out in section 588FE.

An unfair preference that is attached to the reduction of an obligation to that creditor is usually made to a non-related creditor who holds a guarantee from a related party. Therefore the most common time period considered under section 588FE starts six months before the start of the winding up (called the relation-back day). If the unfair preference was made to a related party a four year period will apply.

The relation-back day is variable depending on how the company was originally wound up. The three common ways for a company to be wound up and therefore three possible relation-back day calculations:

1. the date of the filing of the winding up application (Court appointment);
2. the date of the appointment of a voluntary administrator – if a liquidation results from that appointment; or
3. the date of the member’s resolution appointing a voluntary liquidator – if the company was wound up voluntarily. “relation-back day” , in relation to a winding up of a company or Part 5.7 body, means:
(a) if, because of Division 1A of Part 5.6, the winding up is taken to have begun on the day when an Order that the company or body be wound up was made-the day on which the application for the Order was filed; or
(b) otherwise-the day on which the winding up is taken because of Division 1A of Part 5.6 to have begun.

Once these three factors have been proved, the liquidator will determine whether the positive factors of an unfair preference apply and a prima facie claim can be made against the creditor, and whether or not a claim can be made against the related entity.

The related entity

What is related entity?
A creditor must have received the unfair preference, but the obligation that was released must have been given to that creditor by an entity related to the company as defined in the Corporations Act. The 588FH claim is brought about because the related party received a benefit from the fact that the creditor received an advantage from the original unfair preference.

The related entity is usually a director or member of the company; a beneficiary under a trust of which the company is the trustee; or a close relative of any of these entities.

The liquidator must show that the party that had the obligation released (not the creditor that received the payment) falls into one of these categories.

Release from an obligation
The provisions allow recovery of compensation from a related entity when a transaction was entered into that:

(a) disadvantaged the body of creditors by reducing the available assets (the unfair preference), and

(b) advantaged the related entity by releasing a obligation that they had granted.

The amount of the compensation claim is the amount of the advantage received by the related party, which is the amount of the obligation released because of the payment. That advantage may not be the same amount of the payment – but it usually is.

For example: A creditor is owed $1,000 and the related party had guaranteed that debt to a limit of $800. An unfair preference is paid to the creditor of $1,000 leading to a 588FA claim against the creditor for $1,000. But because the obligation released was only for $800, the 588FH claim against the related party is limited to $800.

Also: If the creditor was owed $2,000 and was fully guaranteed by the related party (to the amount of $2,000), but only received an unfair preference of $1,000 – the creditor would be subject to a $1,000 claim and the related party would be subject to a $1,000 claim as their obligation had been reduced by that amount. But only one of these amounts (or a combined total of $1,000) maybe collected.

That obligation released is commonly a guarantee given by the related entity, but it can be any obligation and under any other form of security or document (e.g. a registered security or mortgage over the related party’s property). The liquidator just needs to show that this commercial obligation existed and was at least partially released.

Limitation of claim
The Act limits the amount that may be claimed from the creditor to the amount of the unfair preference less what has already been collected from the related party, if anything. The claim against the related party may be limited to the amount of the reduction in the obligation less any amount already recovered from the creditor, if anything. The Court will look at what amounts have already been recovered and adjust the amount of any later claims accordingly.

The unfair preference recovery – a claim under 588FA – is sought under section 588FF of the Act. That section provides relief for all claims that are void under section 588FE. Claims under section 588FH are not void under section 588FE, they are void under 588FH. The 588FH claim against the related party is sought under subsection (2).

But the amount of any recovery under section 588FF for the unfair preference, the Court must take into account any recovery made against the related party.

There is no particular Order in which the liquidator has to take these two actions. They are likely to take the easiest claim first, and due to the fact that the statutory defences are not available to the related entity, the easiest claim is likely to be against the related entity.

Once a recovery action is taken against the related party, that party will then gain the same rights that they would have received if they had discharged the obligation to the extent of the payment. For example the related party made a payment to the creditor under the guarantee. These rights would generally arise from a right to indemnities or subrogation into the creditor’s position.

Defences and Timeframe

Statutory Defences – Not Available
The Act provides statutory defences for creditors against claims by liquidators for recovery of unfair preferences. These defences are set out in section 588FG of the Act.

Importantly, these defences are only available to the creditor that received the preference, and not to the related entity that had the obligation released. That is, they are not technically available when considering whether the creditor received a preference or not for the purposes of this section. In Order to make a claim against the related party, the liquidator only needs to show that the transaction (the preference) is a voidable transaction under section 588FE, not that it is actually recoverable from the creditor when the defences are taken into account.

The reasoning is that the defences apply to the actions and knowledge of a party that has had dealings with the company, usually at arm’s-length. The related party has not had those types of dealings in relation to the obligation released and is not at arm’s-length.

Because the defences are available to the creditor, it is possible that recovery may be possible against the related party, but not against the creditor.

Timeframe for claims
A liquidator does not have an endless time period to investigate and commence claims against creditors for unfair preferences. The Act provides that these claims must be made within three years after the relation back day, that is, an application to Court must be made within that three year period. It is insufficient for the liquidator to only have made a demand within that period.

An extension may be granted by the Court, but the application for the extension must be made within the three year period, and the liquidator will need a good reason for the delay.

Section 588FH does not require an Order under section 588FF and the section does not set any time limit for the claims to be made against the related entity.

Corporations Act – Sect 588FF
Courts may make Orders about voidable transactions pursuant to Section 588F(1) of the Corporations Act, if a Court is satisfied, on the application of a company’s liquidator, that a transaction of the company is voidable because of section 588FE.

The claim against the related party can be made even though no claim has been made against the creditor within the time period. Using the same logic as is the case with the statutory defences, the preference only needs to be void under section 588FE. The time limit applies to claims made against the creditor under section 588FF, which does not apply in relation to claims made against the related party.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

What is a corporate dividend?
This is a dividend paid by a company to its shareholders from time to time as a way of distributing the company’s profits. This paper does not deal with dividends paid by external administrators to creditors – they are dealt with in another Fact Sheet. The dividends explained in this Fact Sheet are paid to shareholders before the liquidation.

Who declares and pays the dividend?
The directors declare a dividend, calculate the amount to be paid and decide when it is to be paid. This process is governed by the Constitution or Articles of the company and the Corporations Act, all of which give the necessary powers and guidelines on the process and on shareholder’s entitlements.

Can directors get into trouble paying a dividend?
In two circumstances directors may become personally liable to compensate the company for the amount of the dividend paid.

It is an offence under section 254T to pay a dividend except out of surplus assets. The claim arises when dividends are paid and the company has not earned sufficient profits to support the dividend.

The second is where dividends are paid while the company is insolvent and the company is later wound up. This could result in an insolvent trading claim being made against the directors.

SECTION 254T

Dividends out of profits
Dividends to shareholders must be paid out of the surplus assets of the company. Directors have a duty to maintain the company’s share capital. A company should not pay a dividend to shareholders if it has not earned the (income or capital) profits to do so.

Distributions that are not from profits are seen as a disguised return of paid up capital and require a different legal procedure. When considering this question, the New Zealand Courts have stated that:

“The payment of a dividend out of paid up capital will occur if the payment has the effect of reducing the company’s net assets below the amount of its paid up capital” [Hilton International Ltd v Hilton & Anor (1989)]

What are profits?
Most profits will be paid from profits, not excess capital (which is usually ‘returned’ to shareholders in a more tax effective manner). The Courts have applied some rules to the calculation of profits.

(a) Profits can be trading or revenue profits. The Courts do not set any strict rules as to what is trading profit and generally leave that question to accountants and businesspeople. The Court may sometimes rule that some items must be included in, or excluded from, the calculation of profits.

(b) Profits can be capital profits accrued from the increase in value of capital assets. These capital profits may be from a revaluation of capital assets or from the realization of capital assets.

(c) Dividends can be paid from one year’s revenue profits without needing to make back past revenue losses – but only if the company remains solvent.

(d) The company must have earned profits in order to declare and pay a dividend, but it does not need to have collected them. A company can borrow the money to physically pay the dividend, as long as the profits have been earned and are collectable. The principle is designed to set the upper limit on the source of the dividend to profits earned, not on the capacity to pay the dividend. But, the company must be solvent at the time and remain solvent after the dividend.

What happens if this section is breached?
A breach of the section can lead to an action against the directors for compensation in the amount of the dividend. That is, directors may become personally liable to the company for the amount of a dividend, whether or not they received any part of that dividend themselves. Compensation is sought to bring the company back into the position that it held before paying the dividend.

Who can take the action?
If the company is in liquidation, the liquidator will take the action. But any shareholder or director can commence the action.

Does the company need to be insolvent when the dividend is declared?
There is no requirement for the company to be insolvent at the time of the payment of the dividend or in liquidation when the claim is made. Commonly the action is taken because the payment of the dividend made the company insolvent and ended up with it being wound up. In these cases the liquidator will take the action.

Insolvent Trading

What is insolvent trading?
Insolvent trading occurs when a director allows a company to incur a debt when the company is insolvent. The Corporations Act places directors under a duty to prevent a company from incurring a debt when the company is insolvent.

If a dividend is paid whilst the company is insolvent, the directors may be liable for insolvent trading. The possibility of incurring a debt by declaring a dividend is also set out in section 254V of the Act.

Does the company need to be insolvent at the time?
Yes. The company must have been insolvent at the time of, or become insolvent because of, the payment or declaration of the dividend. Without insolvency at the relevant time, there is no insolvent trading claim.

What can a liquidator do?
A liquidator can seek compensation from a director in an amount equal to the amount of the dividend. This claim can be made whether the director was a shareholder or not, or received any benefit from the dividend or not. This section does not allow the liquidator to commence proceedings against the shareholders that received the dividend.

Who else can take an insolvent trading action?
If a liquidator does not take an action, the creditors of the company may commence one as they can with any claim for insolvent trading.

Summary
The New Zealand Courts in Hilton International Ltd v Hilton & Anor set out 9 points that state the general position. These points can be summarized as follows:

1. Dividends including capital dividends can only be paid out of profits and not from a reduction of paid up capital.

2. The payment of a dividend out of paid up capital will occur if the payment has the effect of reducing the company’s net assets below the amount of its paid up capital.

3. Whether there are profits and how much should be paid out as divided is a matter of commercial judgment, but made with the following points in mind.

4. No dividend may be paid, whether out of capital or income profits, if the company is in a state of trading insolvency.

5. No dividend may be paid, whether out of capital or income profits, if the company is in a state of balance sheet insolvency, or will enter that state as a result of the payment.

6. No dividend may be paid, whether out of capital or income profits, if the company is in a state of doubtful trading or balance sheet solvency, unless the directors can demonstrate a good faith belief on reasonable grounds that the payment would not jeopardize the company’s ability to pay creditors.

7. No dividend should be paid, even if the company is solvent, if the directors ought to have appreciated that the payment was likely to jeopardize the company’s balance sheet or trading solvency.

8. The directors of the company owe a duty to the creditors of the company.

9. Directors who act in breach of these principles are liable to compensate the company for its loss arising as a result of the breach.

 Disclaimer

The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

Introduction
Dividends are the conclusion to most external administrations. Winding up a company cannot be finalised until dividends are distributed in accordance with statutory time limits and investigations to admit or reject proofs of debt are completed.

The Corporations Act 2001 sets the minimum period to pay a dividend. If there are no complications, a corporate insolvency dividend will take about one month to distribute.

If there is a complexity in relation to the admissibility of proofs of debt, the payment of the dividend can be delayed, particularly if a creditor applies to the court for a review of the liquidator’s decision to reject their proof of debt.

Dividends in detail
When there are funds to distribute, the payment of a dividend is often the only tangible output from a winding up.

A liquidator withholds sufficient monies to complete the winding up. They also determine the most appropriate time to pay dividends when considering any further anticipated realisations and the costs related to paying a dividend.

Dividends must be declared in accordance with the requirements of the Corporations Act, and be paid to creditors in order of their priority.

Steps in paying dividends
The four basic steps required to pay dividends are:

  1. call for proofs of debt—every known creditor must have the opportunity to lodge a proof of debt and participate in the dividend
  2. admit proofs of debt—verify that the debt is proper and has been ‘proved’ to the liquidator’s satisfaction
  3. reject proofs of debt—to ensure only legitimate creditors participate in the dividend
  4. pay the dividend—the liquidator distributes the cheques.

1. Call for proofs of debt
All creditors must be given the opportunity to lodge their claim in the form of a proof of debt. A proof of debt is a formal document used to prove that a debt exists and it sets out the amount of the debt. Without sufficient proof that the debt exists, it will not be admitted for the stated amount or possibly it may not be admitted at all.

Proofs of debt are a prescribed form under the Corporations Act. A liquidator may not admit claims that are insufficiently detailed on the correct form, which may result in a creditor being excluded from a dividend.

Creditors can lodge proofs of debt at any stage in an administration. They do not need to wait until a dividend is called, and only need to submit one. Creditors should ensure that their claim has been lodged and appears in any list of proofs of debt received. If creditors are in any doubt that their claim has been lodged, they should contact the liquidator’s office.

Periods for calling for proofs of debt
The liquidator must formally notify all known, or potential, creditors of the intended dividend and request that proofs of debt be lodged by a certain time.

The Corporations Act states that creditors must be given at least 21 days to lodge proofs of debt.

Definite periods to lodge proofs of debt are important to expedite dividend payments or to ensure dividends are not challenged while cheques are being drawn. The cut-off date for proofs of debt is final and the provisions of the Corporations Act set out the creditors’ and liquidator’s rights if a proof of debt is not lodged in time.

Notices to be issued for calling for proofs of debt
To notify creditors in accordance with the Corporations Act, two notices must be issued:

  1. an advertisement on ASIC’s website to notify the public
  2. a Corporations Form 547 or 548 must be posted to creditors that have not lodged a proof of debt.

Dates for payment of dividends
Dividends cannot be paid until the proofs of debt cut-off date has passed and all proofs of debt have been admitted or rejected. That is, cheques will not be drawn within that period.

The notice period from the initial notice calling for proofs of debt to the intended payment date must not be longer than two months. However, payment may be made after the intended payment date due to complications in the dividend process, typically due to the admittance and rejection process.

If the dividend date is postponed, the liquidator may need to re-advertise the notice with a new intended date.

Non-lodgement of proof of debt
Creditors that miss the proof of debt cut-off date can lodge a proof of debt for the next dividend distribution, and they will be paid the first dividend they missed out on (a catch-up dividend), as well as the upcoming dividend. If there are insufficient funds to pay a second dividend (a second dividend is never declared), creditors will not receive a dividend at all. Therefore, it is imperative that creditors lodge their proofs of debt before the cut-off date.

2. Admitting proofs of debt
Creditors have the burden to prove the existence and amount of their debt. The liquidator does not need to disprove a debt.

The liquidator assesses the creditors’ supporting evidence and determines the validity and amount of the debt. If the liquidator believes that all or part of the debt is not sufficient, they will seek further clarification and material from the creditor. Without further information, the liquidator may reject the proof of debt in full or in part. The liquidator is not required to locate sufficient information.

Creditors should attach copies (not originals) of all appropriate documents to their proof of debt.

Liquidators must review proofs of debt within 14 days of the lodgement date and decide to admit or reject the claim or seek further information. The Australian Securities and Investments Commission (ASIC) can grant an extension to the review period.

3. Rejecting proofs of debt
If a proof of debt is rejected because a creditor does not provide sufficient evidence, a liquidator will provide a notice outlining the reasons for rejecting the proof of debt and will set a deadline for appeal.

Appeals against decisions
Creditors’ rights are set out in regulation 5.6.54 of the Corporations Regulation. Creditors can have the court review the liquidator’s decision to reject their proof of debt, but have a limited time to apply for adjudication. A liquidator can amend their decision to reject a proof of debt when sufficient information is given if it is still within the required timeframe.

The court may allow an application for adjudication after the time limited period expires, but creditors should not rely on it being granted.

Creditors have the burden to prove to the court that the claim should be admitted in the liquidation. Creditors must show that the decision to reject the proof of debt was incorrect based on the information provided to the liquidator.

Revoking a decision to admit or reject
A liquidator can reverse their admittance or rejection of a proof of debt.

When a liquidator reverses their initial decision to reject a proof of debt, they must give the affected creditor notice of the new decision and, if appropriate, adjust the dividend to be paid or, if necessary pay a catch-up dividend.

4. Pay the dividends
Dividends are paid after the proof of debt lodgement date expires, after all the proofs of debt have all been admitted or rejected, and after any appeals on rejections have been heard in court. The liquidator will forward a cheque to the creditor.

If dividend cheques are not banked within a reasonable period, or if creditors cannot be located, the liquidator will hold monies for six months following payment, and then forwarded these monies to ASIC. The creditor must then request the money from ASIC.

Priorities in the payment of dividends
Subject to specific priorities, all creditors will rank equally in a winding up and will be paid ‘pro-rata’ dividends.

The Corporations Act gives the greatest priority to employees. Entitlements due to employees must be paid in full before payments to non-priority creditors.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 08.04.2015

How can a company get out of liquidation?
A liquidation usually ends with a company being deregistered. However, there are two other ways a liquidation could end:

  1. the liquidator appoints a voluntary administrator to a company, which leads to a Deed of Company Arrangement (DOCA)
  2. the court orders the stay or termination of a winding up.

When will a liquidator appoint a voluntary administrator?
Liquidators appoint a voluntary administrator to a company when they believe creditors will receive a greater return under a proposed DOCA, than under a liquidation. The liquidator must be convinced that the DOCA proposed is worthwhile and is likely to be accepted. When the DOCA is accepted and signed, the liquidator applies to the court to end the liquidation.

When does the court end a liquidation?
Generally, an application to court for an order staying or terminating the winding up of a company happens shortly after the initial winding up was ordered, but is not essential. Technically, an application can be made at any time, but it becomes less viable the longer the liquidation continues.

Which court can make a stay order?
The power to wind up companies resides with the Federal Court of Australia, the Supreme Court in each state and the Family Court of Australia. These courts have jurisdiction to order the stay or termination of a winding up. In most cases, a stay application is made in the court that ordered the original winding up. However, a stay application can be made to any of these courts, and they can subsequently transfer applications between the courts.

Who can apply for stay orders?
Under section 471A of the Corporations Act 2001, director’s powers are removed while the company is in liquidation. The residual powers of the directors only allow them to resist or appeal against the original winding-up application or order.

Usually, the liquidator will make a stay application after a DOCA is signed, or a contributory or company member can make an application to stay or terminate the winding up.

Why would the court make an order to end a liquidation?
A court can make an order to end a liquidation for many reasons, including:

  • The winding-up application and other supplementary material was not served on the company in the proper way or in a way that did not allow the company to suitably defend it. That is, the process of winding up the company was deficient.
  • The company is solvent and should not have been wound up.
  • The liquidator has appointed a voluntary administrator and this appointment resulted in the company entering into a DOCA. The liquidation is no longer  necessary.
  • It is just and equitable to do so for any other reason.

What factors are considered by the court to end a liquidation?
A New South Wales Supreme Court decision in 2002 provides some insight into what the courts may look for when considering an application to end a liquidation. In this case, the judge listed eight criteria:

  1. The granting of a stay is a discretionary matter, and there is a clear onus on the applicant to make out a positive case for a stay.
  2. There must be service of a notice of the application for a stay on all creditors and contributories, and proof of this.
  3. The nature and extent of the creditors must be shown, and whether or not all debts have been or will be discharged.
  4. The attitude of creditors, contributories and the liquidator is a relevant consideration.
  5. The current trading position and general solvency of the company should be demonstrated. Solvency is of significance when a stay of proceedings in the winding up is sought.
  6. If there has been non-compliance by directors with their statutory duties as to the giving of information or furnishing a report as to affairs, a full explanation of the reasons and circumstances should be given.
  7. The general background and circumstances which led to the winding up order should be explained.
  8. The nature of the business carried on by the company should be demonstrated, and whether or not the conduct of the company was in any way contrary to ‘commercial morality’ or the ‘public interest’.

What happens to the company after the winding up is stayed?
The company directors usually take control of company affairs as soon as the order is given to stay the winding up. Some circumstances make this inappropriate, particularly if the company was wound up due to disputes between directors and shareholders. Where there is some disagreement between the directors and shareholders, the court may make directions on the matter.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.02.2017

Can directors be liable for company debts?
Yes, including when directors have taken remedial action to try to solve a company’s financial problems.

The areas of potential liability are:

  1. insolvent trading compensation claims
  2. unreasonable director-related transactions
  3. loss of employee entitlement claims
  4. PAYG taxation debts and superannuation contributions
  5. personal guarantees.

What are the differences between these liabilities?
The three main differences between these areas of liability are:

  1. who has the right to make a claim
  2. whether or not a company must be in liquidation
  3. how the liability arises.

In summary:

In liquidation, under the Corporations Act 2001:

  • Insolvent trading claims can be made by liquidators, or creditors (section 588M and 588R respectively).
  • Unreasonable director-related transactions by liquidators, under section 588FDA.
  • Employee entitlement claims by liquidators, or creditors (section 596AC and 596AF respectively).

Not in external administration:

  • PAYG taxation debts and superannuation claims are made by the Australian Taxation Office, under the provisions of the Income Taxation Assessment Act 1997 (ITAA) through the directors penalty notice (DPN) regime.
  • Personal guarantees can be exercised by creditors holding guarantees, under their agreement document.

Who is a director?
Under section 9 of the Corporations Act directors can be appointed directors, de facto directors, shadow directors, and those acting as directors. Therefore, a person does not have to be formally appointed as a company director to be liable for claims in liquidations.

Insolvent trading

When is a director liable for insolvent trading?
Insolvent trading occurs when a company incurs a debt that it cannot and does not pay, at a time when a director knew, or should have known, that the company was insolvent. Under section 588G of the Corporations Act directors have a duty to prevent insolvent trading. The Corporations Act makes a director liable to pay an amount of compensation equal to the amount of the debt.

How much can be recovered?
A claim can be made for compensation for losses resulting from insolvent trading. The amount claimable is equal to that of the debt incurred when the company was insolvent, as long as the debt remained unpaid at the time of liquidation.

How is a director made liable?
A liquidator can make a demand upon a director to compensate the liquidator for the amount of the insolvent trading claim; however, in reality, the liquidator must prove the elements of the claim. The liability will not be enforceable until such time as the court makes an order against the director.

What are the defences available to directors?
Section 588H of the Corporations Act sets out the available defences. Directors will not be liable if they can establish one of the following:

  • They had reasonable grounds to expect that the company was solvent.
  • They did not participate in management of the company, due to illness or some other good reason.
  • They took all reasonable steps to prevent the company from incurring the debt.

What are ‘all reasonable steps’?
A court may consider the following matters when deciding whether a director took ‘all reasonable steps’:

  1. ‘any action the person took with a view to appoint an administrator of the company; and
  2. when that action was taken; and
  3. the result of that action.’

The appointment of a voluntary administrator or a liquidator will mitigate a director’s exposure to an insolvent trading claim; but, it may not eliminate a claim for debts incurred prior to the appointment.

How long do liquidators have to take an insolvent trading action?
Liquidators have six years from the beginning of the liquidation to commence an action for insolvent trading. Proceedings must be initiated by way of an application to the court within that six-year period, merely issuing a demand for payment is not sufficient.

Unreasonable director-related transactions

What is a director-related transaction?
A director-related transaction includes:

  • payments of money made by a company
  • conveyances, transfers, or other dispositions of company property
  • securities issued by the company
  • incurred obligations to make such transactions.

To be ‘director-related’, a transaction must involve either:

  • a company director
  • a close associate of a company director
  • a ‘nominee’ acting on behalf of, or for the benefit of, a director or their close associate.

When is a director liable?
Directors will be liable to compensate a company for loss if they cause the company to enter into a director-related transaction that would have resulted in an ‘unreasonable’ benefit.

Who is a close associate?
Under section 9 of the Corporations Act a close associate is a relative or de facto spouse of a director, or a relative of a spouse, or de facto spouse, of a director.

What makes a transaction unreasonable?
A transaction is unreasonable if a reasonable person in the same circumstances as the company would not have entered into the transaction after considering:

  • any benefits that the company may have obtained
  • any detriment the company may have suffered
  • any benefits that other parties to the transaction may have obtained
  • any other relevant matters.

If a reasonable person who would not personally benefit from the transaction would not have entered into that transaction, the transaction is likely to be ‘unreasonable’.

How a director is made liable?
A liquidator can make a demand upon a director to compensate the liquidator for the amount of the unreasonable transaction; however, in reality, the liquidator must prove the elements of the claim. The liability will not be enforceable until such time as the court makes an order against the director. The Corporations Act outlines the relief available, but the type of compensation is dependent on the transaction.

What is the effect when a court orders the transaction?
If a court ordered the transaction, and it meets the criteria for an unreasonable director-related transaction, the director will be liable under section 588FDA of the Corporations Act, which states:

‘(3) A transaction may be an unreasonable director-related transaction under subsection (1):

(a) whether or not a creditor of the company is a party to the transaction; and

(b) even if the transaction is given effect to, or is required to be given effect to, because of an order of an Australian court or a direction by an agency.’

How much can be recovered?
A liquidator may claim the amount of loss suffered by the company as a result of the director entering into the transaction.

A director or close associate may be liable for more than the mere loss if any extra consideration is deemed reasonable when compared with the benefit received from the transaction. That is, if an asset was sold for undervalue to a director, the director would have to pay the extra consideration deemed reasonable for that asset.

What is the applicable timeframe?
The transaction must also have occurred, or action was taken for the purposes of giving effect to the transaction, during the four years before the winding up commenced.

Loss of employee entitlement claims

When is a director liable?
Liquidators and employees have a right to claim against a director if a company entered into a transaction that reduced the amount of assets available to pay priority employee entitlements in a liquidation. These transactions are known as agreements or transactions to avoid employee entitlements.

What amounts to a contravention of the Corporations Act?
Section 596AB of the Corporations Act states that:

‘A person must not enter into a relevant agreement or a transaction with the intention of, or with intentions that include the intention of:

(a) preventing the recovery of the entitlements of employees of a company; or

(b) significantly reducing the amount of the entitlements of employees of a company that can be recovered.’

Directors contravene the Corporations Act if they intentionally cause a company to enter into one of these agreements or transactions. A contravention of section 596AB activates section 596AC and gives the liquidator the right to make a recovery claim.

How does a director become liable for the claim?
Directors become liable to either a liquidator or, in some circumstances, an employee, if:

  1. the director contravenes section 596AB of the Corporations Act
  2. the company is being wound up
  3. company employees suffer loss or damage because of:

(a) the contravention
(b) action taken to give effect to an agreement or transaction involved in the contravention.

How much can be recovered?
An amount equal to the loss caused by entering the transaction may be claimed. The loss is limited to the total of the priority employees’ entitlements that cannot be paid due to the reduced available assets caused by the transaction, or agreement.

How are recovered monies distributed?
Under the Corporations Act employees and other parties who would have been entitled to priority claims under section 560 are given priority.

Taxation debts

Can directors be liable for a company’s tax debts?
Yes. Directors are personally liable if a company fails to remit PAYG withholding tax or superannuation contributions by their due dates; however, personal liability can be avoided in certain circumstances. Directors may also be liable if the ATO needs to refund monies to a liquidator under the unfair preference provisions in section 588FGA of the Corporations Act.

How does liability operate when preferences are recovered from the ATO?
Under section 588FGA of the Corporations Act directors are liable to the ATO for payments originally made by a company to the ATO, then set aside as preferential and refunded to the liquidator. That is, if a liquidator forces the ATO to return money, directors become liable to the ATO for that amount, as well as any costs the ATO is ordered to pay to the liquidator.

Liability extends anyone who was a director at the time of the original payment to the ATO, not simply at the time the company was wound up.

What are directors’ responsibilities?
Please see the ‘Director Penalty Notices’ factsheet.

Personal guarantees

Does an insolvency administration disrupt a personal guarantee agreement?
No. A personal guarantee is a separate third party agreement between a director (the guarantor) and a creditor, where the guarantor agrees to pay company debts, usually in full, when they have not been paid. The validity of personal guarantees is not disrupted by the actions of liquidators or administrators. Generally, a creditor does not need to take any specific action to make a guarantor liable. However, a personal guarantee cannot be exercised while a company is under voluntary administration. Once that period ends, the guarantee can be exercised immediately.

What are the implications if a guarantor pays a creditor?
If a guarantor pays a creditor in full, the guarantor has the right to ‘stand in the shoes of the creditor’ under a right of subrogation. This replaces the creditor with the guarantor and means the guarantor has the same rights against the company as the creditor. The creditor must have been paid in full for any right of subrogation to exist, as this right does not exist partially.

When do directors usually enter into personal guarantees?
Commonly, directors sign personal guarantees, with suppliers when they enter into a credit agreements, with guarantees found in the terms and conditions. Sometimes, guarantees are found in a separate document. Guarantees usually form part of any finance facilities with banks and other financial institutions.

Does a company have to be in liquidation for a claim to be made?
No. Because a personal guarantee is a separate agreement between a director and a creditor, the company does not need to be in liquidation, or even insolvent, for the guarantee to be exercised.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 08.04.2015

Overview
Under the pay as you go (PAYG) withholding system, the Income Tax Assessment Act 1997 (ITAA) requires companies to withhold money from wages to meet employees’ tax liabilities to the Australian Taxation Office (ATO). Companies are also required to pay a superannuation guarantee charge (SGC) under the Superannuation Guarantee (Administration) Act 1992 (SGA Act). Company directors are legally responsible for ensuring that their company meets its PAYG withholding and SGC obligations. If a company fails to comply with their obligations under the PAYG withholding system or the SGC provisions, company directors are held personally liable for the amount the company should have paid.

The laws governing the director penalty notice regime were strengthened significantly in June 2012. The net result is that it is now easier for directors to be pursued for these debts.

Under certain circumstances, the ATO can force directors of a company that is unwilling or unable to meet these obligations, to personally pay those debts. This is achieved with the issuance of a director penalty notice, for an amount equal to these amounts.

A director becomes liable to a penalty at the end of the day the company is due to meet its obligation. At this time, the penalty is created automatically. The ATO does not need to issue any notices or take any action to create the penalty, The Commissioner, however, must not commence proceedings to recover a director penalty until 21 days after a DPN is issued to a director.

There are two types of DPNs; non-lockdown penalty notice, and lockdown penalty notice.

Non-lockdown Director Penalty Notices
The first type is the ‘non-lockdown’ directors penalty notice. Non-lockdown notices are issued to company directors that have lodged its business activity statements, instalment activity statements and/or superannuation guarantee statements within three months of the due date for lodgment, but the PAYG withholding and/or SGC debts remain unpaid. The notice gives directors 21 days to take certain actions, which results in the penalty being ‘remitted’ i.e. cancelled.

Lockdown Director Penalty Notices
The second type is “lockdown” DPN (also referred to as the three-month lockdown provision). Lockdown notices are issued to company directors where a company has failed to lodge its business activity statements, instalment activity statements and/or superannuation guarantee statements within three months of their due lodgement date. In this case, the penalty permanently locks down on the director and there is no ability to remit (i.e. cancel) the penalty, other than by paying the debt in full.

PAYG withholding non-compliance tax
PAYG withholding non-compliance tax (NCT) is imposed on directors and associates of directors under the Pay As You Go Withholding Non Compliance Tax Act 2012 (PAYG withholding NCT). The NCT is a ‘tool of last resort’ option for the Commissioner to pursue individual directors and their associates for an amount related to a company’s unpaid PAYG withholding liabilities.

Payment by directors
Directors are liable to pay the NCT if they:

  • were a director when the company failed to pay the withheld amounts on the date they were due
  • became a director after the date the payment was due and they are still a director 30 days after the amount was due, but is still unpaid.

The amount of tax payable by the director is the lesser of:

  • the total amount withheld from payments made to the individuals by the company in the year
  • the company’s PAYG withholding liability for payments made during the year.

The same defences for director penalties can also be used for NCT.

Payment by associates
An individual who is an associate of a company director can also be liable to pay PAYG withholding NCT if the company has not paid the outstanding amount by the last day for remitting.

An associate is defined in section 995-1 of the ITTA as having the same meaning as defined by section 318 of the Income Tax Assessment Act 1936, which defines associates as including relatives, partners, a spouse, or children of a ‘natural person’. However, the Commissioner must determine that the associate knew, or could reasonably be expected to have known, that the company failed to pay the withheld amounts. The Commissioner must also be satisfied that the associate:

  • did not take reasonable steps to influence the director to make the company notify the Commissioner about the amount withheld
  • did not take reasonable steps to influence the director to make the company pay the withheld amounts to the Commissioner
  • did not take reasonable steps to influence the director to appoint an administrator, or have the company wound up
  • did not report that the company had not paid the amount withheld to the Commissioner or other relevant authority.

Recovering withheld amounts
The Commissioner must not give an NCT notice to a director who has a director penalty liability. A director must also have an entitlement to a PAYG withholding credit for an extent to an amount withheld by the company from payments made by the company to the director (such as directors fees).

The PAYG withholding NCT tax applies to amounts withheld during 2011-12 and later.

A director or an associate can object to any decision the Commissioner makes.

Superannuation
SGC obligations are due to be paid:

  • when a company lodges its quarterly superannuation guarantee statement, or
  • when the ATO quantifies an unreported SGC shortfall.

SGC obligations are payable on the same day a company lodges its quarterly superannuation guarantee statement with the ATO, generally 1 month and 28 days after the end of a quarter. However, the Commissioner can agree to a later payment date under section 33 of the SGA Act.

Directors may receive a director penalty at the end of the lodgment day (or the agreed lodgment date) if the company has not lodged its superannuation guarantee statement and paid the corresponding SGC by the end of that day.

Estimates and director penalty notices
Where the company has failed to meet its reporting requirements for PAYG withholding and SGC, the ATO may issue a DPN based upon the ATO’s estimate. Directors can submit a statutory declaration or an affidavit to verify the amount of the estimated liability, which may reduce or revoke the liability.

Recovering director penalties
Director penalties are automatically imposed by the ATO. However, the Commissioner must follow a specific procedure before starting proceedings to recover that debt, as set out in the note to 269-20(2) of the Taxation Administration Act 1953. If the Commissioner determines it is ‘fair and reasonable’ for a director to pay the outstanding tax, they will issue a DPN. The Commissioner will not start proceedings to recover the debt until 21 days after the DPN is issued.

DPNs must be issued to an individual director. Directors are jointly and severally liable for the debt and will each owe the same amount of money under the DPN. The ATO considers that a DPN notice is issued on the day it is posted to the director’s address listed in the company records maintained by the Australian Securities and Investments Commission (ASIC). If a DPN is delivered to an old address, it is still considered to be validly issued. The ATO may also send a copy of the DPN to the director’s registered tax agent as an additional way of bringing the penalty to the director’s attention; however, if the tax agent does not bring the notice to the director’s attention, the notice is also still considered to be validly issued.

The ATO can also collect the tax in other ways, for example by withholding a tax refund or issuing a garnishee notice. The ATO has the power under section 260-5 TAA to issue a garnishee notice to any third party that owes or holds (e.g. the company’s bank) any money on behalf of the company. A garnishee notice requires the third party to pay money directly to the ATO.

A garnishee notice can require payment of a percentage of the debt, or funds held, or may seek payment of a lump sum amount i.e. the full amount up to the ATO’s debt. For individuals, this means that the ATO can issue a garnishee notice to an employer or contractor. For businesses, the ATO can issue a garnishee notice to a financial institution, or any trade debtor.

Remitting director penalties
Director penalties will be remitted if the company pays the outstanding tax at any time. Director penalties will also be remitted if, at any time on or before 21 days after a DPN is issued:

  • The company reported its PAYG withholding or SGC liabilities to the ATO within three months of the due dates (i.e. it is a non-lockdown DPN); and
  • The company goes into voluntary administration or liquidation.

However, if the company fails to report its PAYG withholding or SGC liabilities within three months of the due dates, the director penalties cannot be remitted even if an administrator or a liquidator is appointed. The DPN regime imposes a lockdown on a director for liabilities that are unpaid and unreported three months after the due date.

The strengthened director penalty regime commenced on 30 June 2012, and these remittance provisions apply to:

  • PAYG withholding liabilities incurred after 30 June 2012.
  • Un-extinguished PAYG withholding liabilities incurred before 30 June 2012.
  • SGC liabilities incurred after 30 June 2012.

Defences for director penalties
A director is not liable for a director penalty if they can establish that one of the defences under the legislation is available to them.

A defence can be that due to illness or another acceptable reason, a director was not managing the company at the time the liability was incurred. This defence can be used if it is ‘unreasonable to expect (the director) to take part due to illness (theirs or someone else’s) or some other good reason’.

A director is also not liable for a director penalty if they can establish that they took all reasonable steps to:

  • make the company to meet its obligation to pay
  • appoint an administrator
  • wind the company up.

However, this defence is only acceptable if no reasonable steps were available. Unacceptable defences would include:

  • the company had insufficient funds to pay the tax
  • a consensus to appoint an administrator could not be reached.

For the SGC, a director may not be liable for a director penalty if they can establish that the company took reasonable care in trying to apply the SGA Act. This provision recognises that there can be some uncertainty about SGC liabilities, especially relating to employee entitlements. However, there is no corresponding defence for PAYG withholding obligations.

Directors cannot use a defence that a DPN was sent to the wrong address. The ATO use the address listed on the public record of the company with ASIC. The ATO considers directors are responsible to keep this information current.

Previous Directors
The ATO is able to issue a DPN to a director who has resigned before issuance of any notices.

Recently Appointed Directors
The ATO is also able to issue a DPN to a director who has recently joined the board, provided they have held office for more than 30 days at the date of issuance. This means that a newly appointed director is liable to pay all outstanding PAYG and SGC liabilities incurred by the company after 30 June 2012, as long as they have held office for more than 30 days. This includes shadow and de-facto directors.

Where the company has failed to report its PAYG withholding or SGC liabilities within three months of the due dates, that personal liability permanently locks down on the newly appointed director three months after they commence as a director.

Right of indemnity and contribution
The legislation outlines the rights of a director who pays a company liability as against the other directors who were also liable to pay the penalties. To deal with the potential unfairness associated with recovering different amounts from company directors, a right of indemnity and contribution allows directors to recover amounts they have paid on the company’s behalf against the company or its other directors.

Associates who have been levied with a PAYG withholding non-compliance tax also have right of indemnity and contribution, to claim back tax they have paid. However, no individual may recover their contribution from an associate.

The right of indemnity and contribution seeks to ensure that any one individual, particularly an associate, is not solely responsible for the financial burden caused by the company’s failure to comply with its obligations.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 07.03.2016

Worrells

COMMON CONSIDERATIONS FACTSHEETS

The following outlines the FAQs that apply to both Personal (individual) and Corporate (company) Insolvency administration matters.

Landlords and insolvency practitioners have different rights when a tenant becomes insolvent. The type of insolvency administration will determine the immediate rights between the parties, and the terms of the tenancy will determine what claims the landlord has against the insolvent tenant.

The end result of most administrations will either be that:

(a) the tenant will vacate the premises and the landlord will lodge a claim in the insolvent estate; or
(b) the tenant’s financial affairs will be rectified through some formal arrangement and the tenancy will continue.

Either way, it is likely that some of the outstanding rental will remain unpaid.

What are the common issues between the landlords and insolvency practitioners?
The most common issues are:

(i) who is liable for the rent during the period
(ii) the landlord’s right to re-enter the premises
(iii) what will be included in the landlord’s provable debt
(iv) the insolvency practitioner disclaiming the lease
(v) any liabilities of the practitioner (as opposed to the insolvent tenant)

What happens to a lease when a tenant enters an insolvency administration?
A lease is a contract that generally survives the initial appointment of an insolvency practitioner. Regardless of whether the tenant is a company or an individual, the tenant will be liable under that contract and the estate of the tenant will deal with the liability for unpaid rent as a provable debt.

The terms of the contract may also include some provision for dealing with insolvency, usually an automatic breach upon liquidation, bankruptcy etc. If not, the rights of the landlord are firstly based in a breach of the contract for unpaid rent.

Will an insolvency practitioner be liable to pay rent?
Sometimes. The lease contract is with the insolvent tenant, not the insolvency practitioner, so an insolvency practitioner will only be liable in limited circumstances.

An insolvent tenant will remain liable for rent after the appointment of a practitioner, at least until the tenant vacates the premises but usually for the remainder of the rental period. Any liability to pay the rent during this period rests with the insolvent tenant albeit that it will probably not be paid. The landlord can prove in the estate for post appointment rent (as well as unpaid current rent) as a claim based on the original contract.

The practitioner is not a party to the lease and, in the normal course, does not become personally liable for rent accrued during the period that the tenant continues to occupy the property. But the relevant insolvency Act may specifically provide for that liability.

What types of insolvency practitioners may be liable to pay rent?
1. A voluntary administrator under section 443B; or
2. A receiver under section 419A.

These practitioners will be liable for the rent accrued where the insolvent tenant “uses, occupies or is in possession” of the leased premises. This liability starts seven days after the appointment and ends when the practitioner:

(a) gives notice that the tenant is vacating the premises;
(b) vacates the premises – whether notice is given or not; or
(c) ceases to be the voluntary administrator or receiver – whether the tenant continues to occupy the premises thereafter or not.

Sometimes the insolvent tenant (through the practitioner) will vacate the premises but another party will remain, usually negotiating new arrangements with the landlord. The liability of the practitioner ends when the tenant vacates the premises. Notice will usually be served on the landlord at that time and the landlord can deal with the other party as it sees fit.

Why are administrators and receivers liable for rent?
The Corporations Act specifically makes voluntary administrators and receivers personally liable for rental after the seven day period to force the practitioner to decide whether they need to occupy the premises, or can hand it back to the landlord. The seven day rent-free period gives the practitioners the time to make that decision and, if needed, to vacate of the premises.

In both cases the company is not being wound up. The administration is a control period to allow the company to form and propose a deed of company arrangement to creditors, and the administration of the company may end. The receivership is purely an appointment to benefit a secured creditor and the landlord should not have to contribute to that process.

Without these provisions practitioners would not be personally liable for rental and could continue to occupy the premises indefinitely. This would be unfair to landlords.

Are practitioners liable for any breach of the lease?
No. The appointment of a practitioner usually breeches the terms of a lease, and by this time the lease has usually been breached for nonpayment of rent. The practitioner will not be liable for these or any other breech of the lease, including any costs for removal of rubbish or making good a fit-out etc. The contractual arrangement is between the landlord and the tenant, not the practitioner.

Can a practitioner remain in the premises?
The insolvent entity remains the tenant and the practitioner (acting through the entity) can remain in possession of the premises as long as the normal steps of eviction have not occurred.

The Corporations Act provides that voluntary administrators can retain possession of the premises during the period of the administration (section 440C), but the administrator will become liable for the rent for that period (section 443B). Receivers do not have the power to remain in possession if the landlord wants them out. However, legally the landlord will have to follow the normal eviction process. They usually cannot demand the immediate removal of the tenant.

Even though the tenant is insolvent, and subject to the above, the landlord can still rely on the terms of the lease to evict the tenant.

What do landlords have to do to get possession?
In most cases the landlord will have to take the steps set out under the lease to evict a tenant. These will be of no effect if a voluntary administrator invokes the powers under section 440C. The landlord should consult a solicitor about the preparation and service of appropriate notices. The notice should be directed to the practitioner, but be in the name of the tenant.

Usually the practitioner will be able to advise the landlord of when they expect to vacate the premises.

What if the landlord needs to go to Court to get possession?
When a corporate tenant is placed into administration or liquidation, all proceedings against the company are stayed and no new ones can be commenced. A landlord will have to seek leave of the Court in order to obtain the necessary Order evicting the tenant. In normal circumstances, the court will grant leave for this purpose but it is an extra step in the process. In most cases, the practitioner will deal fairly with the landlord and will try to vacate as soon as possible.

Nothing stops the landlord from commencing eviction proceedings or suing the tenant for rent owed when a receiver is privately appointed. A receiver is not protected by any special legislation limiting the rights of the landlord. In the case of a court appointed Receiver, a landlord must apply to the court to exercise its rights.

What if the practitioner does not comply with the notices?
If an insolvency practitioner does not provide possession of the premises to the landlord after all relevant notices have been issued, that practitioner may be held liable for damages and trespass. Once the appropriate notices have been issued, a practitioner must vacate the premises. It is rare that a practitioner will ignore a properly delivered eviction notice and risk personal liability.

When can a landlord lodge a proof of debt?
The landlord can lodge a proof in any liquidation, administration, deed of company arrangement, agreement under Part X or bankruptcy of a tenant.

What can landlords prove for?
A landlord is entitled to prove for any rent outstanding at the time of the appointment and for any rent that becomes due for payment after the appointment and that cannot be collected from the practitioner.

Future rental that would have been paid under the lease is a provable debt; however, the amount may have to be discounted at a rate which is prescribed by the various Regulations. The landlord can also prove for any other amounts that are owing under the provisions of or breach of the lease.

What about mitigation of the loss?
A landlord must attempt to mitigate their loss by taking reasonable steps to find a new tenant – and will generally be anxious to do so. The claim will have to be adjusted for the amount paid by any subsequent lessee. At times, these amounts will have to be estimated as the landlord will not be able to determine the exact debt when they will need to lodge a proof.

Can the landlord commence legal action for his debt?
No. Where the landlord has a right to prove for a debt, there is no need to commence any legal action to recover rent. Actions against the insolvent entity will be stayed. Practitioners will process any claims made by landlords and will adjudicate on them under the relevant provisions of the Act. These rental claims will then rank alongside the other non-priority creditors for dividend purposes.

What is disclaiming a lease?
Disclaiming a lease is different from the notices given by administrators and receivers when they vacate any premises.

Disclaiming a lease terminates the lease. This allows the landlord to re-enter possession (if they have not already done so) and re-tenant the premises. It also removes the registration of the lease from the title of the property.

Liquidators (section 568) and Trustees in Bankruptcy (section 133) have powers to disclaim lease contracts. This does not affect the rights of the landlord to prove for any amount is the estate, but allows the landlord to deal freely with the property.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

Fair Entitlements Guarantee Act 2012
On 5 December 2012, the Fair Entitlements Guarantee Act 2012 (FEG) commenced, as a legislative scheme to replace the General Employee Entitlements and Redundancy Scheme (GEERS). FEG assists employees who have lost their job because their employer entered into liquidation or bankruptcy. FEG operates in relation to claims for unpaid employee entitlements for employer liquidations and bankruptcies that occur on, or after 5 December 2012. GEERS continues to operate for claims that occurred before 5 December 2012.

Introduction
Employees are usually the most affected creditor when their employer becomes insolvent. Their jobs are at risk and their outstanding entitlements may not be recovered, or that receiving payment (even under FEG) will take a long time. Unlike other creditors that largely have income from other sources, and may have a security or personal guarantee to support their debts. The Corporations Act 2001 provides employees certain priorities in consideration of these conflicting positions. The FEG provisions, in some circumstances, also provide payments to employees.

Often the priorities are of no consequence as there are no assets to cover employee entitlements, so the Federal Government assists employees under FEG/GEERS when there is insufficient money to satisfy their entitlements.

FEG
FEG was set up to ensure that employees of insolvent employers are paid at least some of their entitlements.

The scheme is designed to cover the payment of outstanding wages, leave and redundancy payments on the insolvency of the employer. FEG specifically excludes payment of outstanding superannuation. It also excludes the entitlements of directors, or relatives of directors, and individuals defined as ‘excluded employees’ under section 556 of the Corporations Act.

The scheme provides assistance with the following employee entitlements:

1.   Wages—up to 13 weeks of unpaid wages.

2.   Accrued annual leave.

3.   All long service leave.

4.   Payment in lieu of notice (up to 5 weeks).

5.   A limited amount of redundancy (where a legal entitlement exists)—up to 4 weeks per full year of service.

The employee must have been terminated because of the insolvency of the employer (liquidation or bankruptcy). Any employee terminated for other reasons, even if owed money at the time of an insolvency practitioner appointment, is not eligible to claim under FEG.

FEG decide whether an employee has a claim, and decide on the payment amount. Employees must show they are an employee, and not a contractor. FEG requires documents to support their claim such as, an employment contract or agreement and pay-slips detailing start dates and normal wages.

FEG’s strict review process requires the insolvency practitioner to verify the employee’s entitlement and relevant contracts or awards. FEG then verifies the claims and can result in sometimes significant adjustments (as records may differ) to employees’ claims. Once FEG and the insolvency practitioner agree, the funds are released to the insolvency practitioner to distribute to employees.

FEG has its own ‘excluded employee’ classification, which is, in essence the same as the Corporations Act’s classification. FEG does not pay excluded employees (relatives of a director under the Corporations Act), regardless of the limits set for excluded employees under the Corporations Act. An employee may have a claim against the company (subject to the limits) but if the company does not have the funds to pay these, FEG will not pay those entitlements.

Who is an ‘employee’?
It is important to determine exactly who is an employee. The relevant definition of employee in section 556 of the Corporations Act is:

Employee, in relation to a company, means a person:

(a) who has been or is an employee of the company, whether remunerated by salary, wages, commission or otherwise; and

(b) whose employment by the company commenced before the relevant date.

The Bankruptcy Act 1966 does not define ‘employee’, but are in effect are described in the same terms with a priority to: “amounts payable by way of allowance or reimbursement under a contract of employment or under an award or agreement regulating conditions of employment”.

Usually it is easy to determine if a person is an employee or a contractor. As a general rule, services supplied by a company, partnership and trust are not regarded as been supplied by an employee. It is clear when the service is supplied under an ABN.

Which act applies?
Whether the Bankruptcy Act or the Corporations Act applies depends upon the legal form of the employer—a company or an individual or partnership etc.

>    If the employer is a company—the Corporations Act applies.

>    If the employer is a natural personor a business owned and run by a natural personthe Bankruptcy Act will apply.

These two Acts deal with employee entitlements differently, with different priorities to different amounts. To make a claim, employees must be certain of their employer’s legal form. The insolvency practitioner should provide the appropriate proof of debt to employees to complete.

The Corporations Act

Priorities
Employees are generally owed entitlements when a liquidator is appointed. Some entitlements will be outstanding wages that are owing immediately, but some may be leave payments that are not, in the usual course, payable. The Corporations Act deems all employee entitlements are payable when a liquidator is appointed, giving employees the right to claim for outstanding leave (annual/long service). These amounts then form part of the payments to employees. Section 556 of the Corporations Act gives priorities for dividends to company employees. Employees are entitled to be paid their full entitlements, before other unsecured creditors. For a comprehensive understanding of the priority provisions, section 556 should be read in full.

In summary priorities are in the order of:

  1. Wages, superannuation contributions, and any superannuation guarantee charge.
  2. Leave entitlements.
  3. Retrenchment payments.

One of the differences between the two Acts are the Corporations Act requires employee entitlements to be paid in full before any other creditor is paid (subject to any circulating creditor claims under section 561). The Bankruptcy Act sets limits on the amount of priority given to employees.

Each separate employee entitlement is a separate class and forms a separate priority to be paid in that particular order. Each class of entitlement must be paid in full before the next class of entitlement may be paid (i.e. wages must be paid in full before any leave entitlements are paid). All priority employee entitlements must be paid in full before unsecured creditors receive a dividend.

Excluded employees
The Corporations Act defines excluded employees as officers of the company, and their relatives. Although they are employees and have access to the priorities, for some entitlements, they have a statutory limit on the priority amount. For the entitlements not covered by the Corporations Act, these amounts become non-priority debt that are claimed alongside other unsecured creditors.

Currently, excluded employees can claim $2,000 for wages/superannuation and $1,500 for leave entitlements. Also, they can claim a retrenchment entitlement, but only for the amount attributed to when they were not excluded employees. In practice, this means that relatives of directors are unable to claim retrenchment compensation, unless their status changed during their employment.

The Bankruptcy Act does not have similar provisions, for employees related to the bankrupt.

Carrying forward of employee entitlements
The liquidator may continue to trade the business and therefore retain the employees. A trade-on can be for days, or for months. Holiday, long service, and retrenchment entitlements are based on the length of employment. These entitlements are factored into the administration costs, and not as a distribution and is a cost payable under section 556(1)(a) of the Corporations Act.

The liquidator will determine what amount of the entitlement relates to the period of employment and pay that amount before declaring a dividend.

Payments to employees by third parties
Section 560 of the Corporations Act identifies that when a third party advances funds to a company to pay its wages and other employee entitlements they can ‘stand in the shoes’ of the employees. Thereby receiving the same priority that employees would receive if those payments were not made, but only to the amount they advanced.

Secured creditors
When secured creditors exercise their securities, they can generally bypass the insolvency process. However, the Corporations Act allows priority to employees, over assets subject to securities in either a liquidation or receivership scenario.

These provisions relate only to recoveries made from the realisation of circulating assets of a PPSA security (debtors and stock-in-trade etc). Recoveries from non-circulating assets will not be affected by this section. They will be available in full to the secured creditor.

Assets secured by a circulating security may be affected. Section 560 grants a priority to employees over those floating assets to the amount sufficient to pay wages and superannuation, leave entitlements, and redundancy entitlements to employees—or to a third party that received priority.

Section 560 gives the liquidator power to use floating assets to satisfy employees’ claims. Secured creditors will not be paid from circulating assets until the liquidator has retained sufficient funds to pay these entitlements.

Receivers and managers are also bound by the same type of priorities in part 5.2 of the Corporations Act. There are occasions when a receiver is acting but no liquidator has been appointed. If a controller is appointed before a liquidator, the Act obligates the controller to pay these entitlements.

The controller’s priorities and limits are different to a liquidator’s. The controller provisions do not include section 558 that activates all leave entitlements. Controllers only pay leave entitlements that are approved and due for payment at the time of their appointment. If the leave amounts are not approved by the company for payment before the appointment, they are not under the controller’s priority.

The result of these two sections is that some employee entitlements will have priority over the secured creditor regardless of which insolvency practitioner is appointed. The balance of entitlements can be paid by a liquidator from any assets not subject to a security, or any surplus.

The Bankruptcy Act does not have any provisions granting priority over secured creditors claims to assets.

The Bankruptcy Act

Priorities
The Bankruptcy Act deals with employee claims differently to the Corporations Act, although they still provide employees with priorities over unsecured creditors.

In summary, the Bankruptcy Act sets the following priorities:

  1. Wages, some superannuation or other amounts due with some exceptions—to a limited of $4,300. This amount is linked to CPI and current indexed amounts released by the Australian Financial Security Authority.
  2. Injury compensation and has no limitation.
  3. All types of leave entitlements with no limitation.

Any amount not covered by the limited priority provisions can be claimed as a non-priority claim alongside other non-priority unsecured creditors.

The Bankruptcy Act does not have an ‘excluded employee’ classification, so employees related to the bankrupt are treated the same as other employees. There are no special provisions for an employee entitlement to have priority over secured creditor claims on assets. A secured creditor is not concerned with employee entitlements.

Payments to employees by third parties
When a third party advances funds to a company to pay its wages and other employee entitlements, they have the right to be repaid. This third party can ‘stand in the shoes’ of the employees and thereby receive the same priority that employees would receive if those payments were not made, but only to the amount they advanced.

The third party can claim for any shortfall from the priority amount as a non-priority creditor—their rights are also limited to the statutory limit on wages. Importantly, the advancement must be made prior to bankruptcy, for the intended purpose.

Carrying forward of employee entitlements
The trustee may continue to trade the business and therefore retain the employees. A trade-on can be for days, or for months. Holiday, long service, and retrenchment entitlements are based on the length of employment. These entitlements are factored into the administration costs, and not as a distribution and is a cost payable under section 109(1)(a) of the Bankruptcy Act.

The trustee will determine what amount of the entitlement relates to the period of employment and pay that amount before declaring a dividend.

Superannuation claims
Employers must remit employer superannuation contributions to relevant funds within 28 days after the end of each quarter. If an employer fails to remit, they must lodge a Superannuation Guarantee Statement (SGS) with the Australian Taxation Office (ATO). The ATO can make a default assessment if this statement is not lodged.

If the employer is subject to an insolvency administration, the ATO may lodge a proof of debt with the insolvency practitioner for the Superannuation Guarantee Shortfall (assessment, default or otherwise). The SGS, which makes up the Superannuation Guarantee Charge (SGC), can be made up of three components:

  1. the superannuation amount unremitted
  2. a penalty
  3. interest.

Who can prove for unpaid superannuation?
The employer must deduct an amount for superannuation and pay to the employee’s superannuation fund. The statutory superannuation amount is not technically a debt to the employee, and is not provable by the employee if it falls under a claim made by the ATO under the Superannuation Guarantee provisions (see below). Also, technically it is not a debt due to the superannuation fund trustee.

Section 553AB of The Corporations Act provides priority to the ATO’s proof of debt over an employee’s or superannuation fund trustee’s proof of debt.

An employee can lodge a proof of debt for superannuation in the limited cases following:

  1. Where the employer contributions are payable under a contract of employment, rather than an award or pursuant to the Superannuation Guarantee Levy.
  2. Where the claim is for unremitted employee contributions (as opposed to employer contributions) under a salary sacrifice arrangement.
  3. Where the outstanding superannuation contribution, for whatever reason (catch-all for other possible scenarios) does not form part of a SGC lodged by the ATO.

The Corporations Act, states that only the ATO can lodge a proof of debt for unpaid superannuation if it falls under the Superannuation Guarantee Charge—whether a claim has been made, or not. When the ATO has the right to make a claim for the SGS, no one else can make that claim.

Superannuation guarantee shortfall
The rules differ slightly under the Corporations Act and the Bankruptcy Act when it comes to the priority of the Superannuation Guarantee debt, or any claim that may be made by the employee or their superannuation fund trustee.

Under the Corporations Act any superannuation not remitted (contributions or superannuation guarantee charge) has a priority under section 556(1)(e), with superannuation specifically noted as a priority entitlement.

The superannuation amount is subject to the limit for excluded employees under section 556 (1A) of the Corporations Act. Previously it was determined that superannuation claimed is a claim payable to the ATO, not as an employee entitlement (payable to the employee), and not subject to the limitation—therefore claims related to excluded employees could be paid in full. This position changed on 1 January 2008 with a change in the wording of the legislation in section 556(1E) of the Corporations Act.

The Bankruptcy Act gives priority for amounts due to the bankrupt’s employees. Section 109(1C) includes any outstanding SGC (which includes interest and penalties) as part of that priority amount.

Therefore, any superannuation amount claimed and proved for by the ATO is subject to the upper priority limit imposed by the Bankruptcy Act. The balance of superannuation guarantee charge would then be a non-priority debt along with the balance of the wages amount.

Claims by employees for excess contributions or contract contributions have the section 109 priority, as they are due in respect of an employee and for services rendered, but are also subject to that limited priority.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 18.11.2015

What is a subcontractors’ charge?
A subcontractor’s charge is a statutory security granted to certain parties in the building industry under the subcontractors’ Charges Act. The charge secures payment of monies owed to subcontractors. Only Queensland Act and South Australia have these Acts. This Fact Sheet is explained in terms of the Queensland Act.

What parties are involved?
There are generally 3 parties involved in a subcontractor’s charge:

The developer (the employer) owes money to the builder under the building contract. The Act defines an employer as: “a person who contracts with another person for the performance of work by that other person, or at whose request or on whose credit or behalf, with the person’s privity and consent, work is done..”

The builder or contractor was engaged by the developer to complete a building project. The Act defines a contractor as: “regards an employer, means a person who contracts directly with the employer to perform work and, as regards a subcontractor, means a person with whom the subcontractor contracts to perform work”.

The subcontractor is engaged by the builder to conduct part of the work under the main building contract. The subcontractor is owed money by the builder for work performed under this subcontract. The Act defines a subcontractor as “a person who contracts with a contractor or with another subcontractor for the performance of work.”

What is the purpose of the charge?
The charge provides the subcontractor with some protection from an insolvent builder by securing the monies owed by the developer to that builder and directing some of those monies to the subcontractor. This bypasses a potentially insolvent builder.

Who can lodge a charge?
Any subcontractor of a builder as defined by the Act is entitled to charge monies payable to a builder or a superior contractor. The monies must be owed to the subcontractor for “Relevant Work”. Monies owed for work that falls outside relevant work cannot be the subject of a charge.

What is relevant work?
Relevant work is:

“work” includes work or labour, whether skilled or unskilled, done or commenced upon the land where the contract or subcontract is being performed by a person of any occupation in connection with–

(a) the construction, decoration, alteration or repair of a building or other structure upon land; or
(b) the development or working of a mine, quarry, sandpit, drain, embankment or other excavation in or upon land; or
(c) the placement, fixation or erection of materials, plant or machinery used or intended to be used for a purpose specified in paragraph (a) or (b); or
(d) the alteration or improvement of a chattel;

and includes also the supply of materials used or brought on premises to be used by a subcontractor in connection with other work the subject of a contract or subcontract but does not include–

(e) the mere delivery of goods sold by a vendor under a contract for the sale of goods, to at or upon land; or (f) work or labour done or commenced by a person–

(i) under a contract of service; or
(ii) in connection with the testing of materials or the taking of measurements or quantities; or

(g) the supply under a contract of hire of materials, plant or machinery not intended to be incorporated in the work.

Section 3AA of the Act extends this definition. If in doubt, seek legal advice.

What can be secured under the charge?
Money. The subcontractor can lodge a charge only on money owed to a contractor under that building contract. This includes retention monies and any security monies held by the developer. But the developer must still have the money and still owe a debt to the builder. Money cannot be charged after it has been paid to the builder, or if the entire debt to the builder has been paid by the developer.

How is a charge lodged?
A notice of the subcontractor’s charge must be given to both the builder and developer. The notice must specifying the amount and particulars of the claim in relation to the relevant work. It must be certified by a “prescribed person” and supported by a statutory declaration from the subcontractor.

Subcontractors will usually engaged solicitors to prepare the charge notice as charges may be overturned if not completed properly, if not on the prescribed form and not within the relevant time periods.

What are the time periods?
A notice of charge can be given at any stage during the subcontract period, but the following time restrictions apply after the completion of the subcontract:

1. for contract monies – Within (3) three months after the completion of works.
2. for retention monies – Within (3) three months of the expiration of the maintenance period.
3. for monies held under a security – Within (3) three months of the expiration of the release period.

Consequences of a notice of charge
Within fourteen days after the notice of charge is received by the builder and the developer, the builder must give a “contractor’s notice” to the developer, stating that the builder:

(a) Accepts liability to pay the claimed amount;
(b) Disputes the claim; or
(c) Accepts liability to the amount stated in the “contractor’s notice”, but otherwise disputes the claim.

When a builder provides a notice accepting the liability the developer will pay the amount to the subcontractor. If the builder does not accept the liability, the subcontractor’s must take the next steps to enforce the charge, essentially proving the debt. But at least the money wil be secured as the developer should not pay any monies to the builder or risk also having to the debt to the subcontractor.

What if more than one charge is lodged?
Where the money payable under a contract is insufficient to meet the claims of two or more subcontractors, any deficiency shall be borne by subcontractors in proportion to the amounts of each claim (pro rata). Each subcontractor will share equally in the charged monies. The developer will usually pay the monies into court and have the court determine the disbursement of the funds.

What should the developer do if they receive a charge?
The lodgment of a charge secures the monies owed to the builder for the subcontractor to the amount of the claim.

Usually charges are lodged when a builder is insolvent, and many times when that occurs the builder will not be able to complete the contract. The developer may be able to withhold all monies that have been charged and that are owing to the builder and use them to complete the project (using another builder). The developer may not be obliged to pay out any of the monies under a charge until after the project has been completed and these costs have been paid. Then only the surplus after the costs of completion will have to be paid.

The developer will not have to pay any more money than they would have had to pay under the original contract. The charge does not create an extra obligation on the developer, it just directs payment of the monies due under the contract.

It is not uncommon for the developer to pay surplus monies (monies due under the contract after it has been completed) into Court. This removes the obligation of disbursing the monies from the developer and places it on the Court.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

Overview
Proving the date that a company or a person became insolvent is usually one of the most difficult and time consuming tasks in any insolvent estate. It can, therefore, be one of the most expensive tasks to complete.

But it can be one of the most necessary, as most void transactions recovered by external administrators had to have happened when the company or person was insolvent. This is why insolvency practitioners will spend significant time looking into the solvency question and ask creditors and banks to assist by providing information.

In its most simplistic form the task is mathematical. It is primarily a comparison of what resources were available to the company or person and the debts that were due and payable at a particular time. In reality the task is not that easy. The greatest hurdle is gathering sufficient evidence to prove the necessary values at the relevant time in order to make the comparison because, many times, the records do not provide a clear picture.

It is also important to distinguish between insolvency and a temporary lack of liquidity or cash-flow problem. A lack of liquidity is a simple lack of available cash for a short period, but where the situation will naturally rectify itself. This is not insolvency. Insolvency is a lack of resources, not just the liquidity of resources for a time.

This paper gives an idea of the process, though variations to this process occur from file to file by necessity. The full detailed insolvency investigation process is too long and has too many variables to be explained in such a short paper, so we have summarized the major processes. We have concluded with the deeming provisions of the Corporations Act.

Definitions of Insolvency
The definitions of solvency and insolvency are identical in the two Acts so this paper can explain the process without compensating for differences in the legislation. This also means that the process necessary to prove insolvency is the same.

An investigation into insolvency is centered upon when the company or person (the entity) ceased being able to pay its debts as they needed to be paid. It is the inability to pay the debts that is significant. Just because an entity was not paying its debts does not mean that is was unable to do so and was insolvent. They may have decided not to pay for some other reason. The entity must have been unable to pay the debts from a lack of resources to do so.

The Determination of Solvency

Terminology Used in the Examination
This paper uses a number of terms that may not be familiar. Two of these terms are not defined under accounting principles or in the Acts. They are descriptive terms that we as a firm use. Other practitioners will use different terms to describe these items.

1. Assets
The definition of asset is the same as under accounting principles. It is anything of value owned by or available to the entity, whether current or non-current, tangible or intangible or in any form. Assets are a starting point in determining “Resources”.

2. Resources
Resources are the subset of assets that can be used to satisfy debts, either immediately or within a reasonable time thereafter. Some resources are immediately available, like cash. Some resources may not be available for a short period, like accounts receivable that have to be collected, or stock that has to be sold.

If the asset cannot be used to pay debt (e.g. a piece of equipment) it will not be a resource. It is possible for an asset rich entity to be insolvent, if its assets cannot be used to pay debt or realised within a reasonable period.

3. Liabilities
The definition of liability is the same as under accounting principles. It is any obligation that has a commercial (money value) basis, whether current or non-current, contingent or otherwise. If the entity is financially obligated, it has a liability. Liabilities are the starting point for determining “Due and Payable Debts”.

4. Due and Payable Debts
Due and Payable Debts are the subset of liabilities that are due to be paid at a particular time. Debts that are not due at that time (e.g. long term liabilities) or debts that have not reached the end of their credit term (current trade creditors) will not be due and payable. Most liabilities will eventually become due and payable, but timing is important in this examination. It is possible for an entity to have more liabilities than assets but not be insolvent, if its debts are not due for payment.

Step One – Classes of assets and liabilities
Step one is to list all of the classes of assets and liabilities the entity had over the period of examination. This step does not examine any amounts or dates, just the different types of assets and liabilities. This information is obtained from the financial statements, the business records, searches and any other source available. The task is then to classify which of these classes are resources and relevant to the solvency question.

Assets vs. Resources
The next step is to distinguish between assets that can be used for debt repayment (resources) and those that cannot. This is generally a three part process. Once we have determined which classes of assets are not resources, they will be excluded from the calculation of solvency.

The first part is to determine whether a particular class of asset will never be a resource as they are not liquid or realising them will disrupt the business. These are usually the sort of assets listed below:

(i) Plant and Machinery
(ii) Motor Vehicles
(iii) Goodwill
(iv) Intangible Assets
(v) Land and Buildings

Part two is determining classes of assets that can be easily classified as resources for their entire value. These are the liquid assets and include:

(i) Cash at bank
(ii) Available balance of a Bank Overdraft
(iii) Cash Investments
(iv) Shares in Listed Companies

Part three are the assets that as a class would be resources, but where the total value of that asset may not be immediately available. Some of that value should become available within a reasonable time as these assets are realized or liquidated in the normal course of business. Only that part that may be realized or liquidated in that reasonable time may be classified as a resource at a particular time. This group includes assets like:

(i) Trade Debtors – what can be collected in a reasonable period?
(ii) Stock on Hand – what can be sold for cash in a reasonable period?

This information usually has to come from historic trends – what was collected last month, the same month last year, on average over a period, etc?.

Liabilities vs. Due and Payable Debts
The difference between liabilities and due and payable debts is whether or not they are due for payment at a particular time. This involves two decisions;

1. whether the debt is due and payable as a class, and
2. what amounts are due at any particular time.

The first decision is which liabilities will not be due and payable without a particular event occurring, usually a formal demand for payment or a breach or expiry of an agreement. These will not form part of the calculation, unless that event has occurred. These liabilities include:

(i) Bank Overdrafts
(ii) Loans from third parties
(iii) Lease and finance arrangements
(iv) Provisions for payment of liabilities

The rest of the liabilities should become due and payable at some time. The question is how much is payable at different points in time. The major class, and usually the largest class of debts of a trading entity, is trade creditors.

Step Two – Determining Values
Step two is to allocate values to the resources and due and payable debts at the various times covered in the examination. This may be easy or difficult depending on the information available. Obtaining values for some of these items can be the most time consuming part of the examination. Each class of resource and due and payable debt must be shown in isolation and at each relevant point in time.

A. Resources
The highly liquid assets can usually be valued easily, due to their liquidity. Cash at bank can easily be identified from the bank statements. Shares in pubic companies etc can usually be valued very easily from ‘market’ figures. The difficulty lies with the classes that are only partly resources due to the need to be realized or collected. The result of this examination will be a valuation of the resources that may be used now, or in the near future, to satisfy due and payable debt.

(i) Trade Debtors

Trade Debtors are usually collectable after some short credit period. After the invoice has been prepared and issued, it may usually be expected that the debt will be collected in one month. Even though credit terms vary between businesses, and there are some significant exceptions to the rule, these terms are the most common.

This leads to some questions:

(a) What if they are not collected at that stage?
(b) What if they have not been collected after 3 months or are disputed?
(c) What if there are extended credit terms and they do not become collectable for some time?

We must determine two matters:

1. Which trade debtors are not collectable yet due to the fact that the credit terms have not expired; and
2. Which trade debtors are not collectable now or in the immediate future, or may never be collectable, and should be removed from the debtor’s ledger.

Determining these matters and removing these debtors from the ledger will result in an amount for trade debtors that can be considered collectable within a reasonable period and are available for debt repayment.

We can also look at this question in hindsight. This is done by calculating the amounts received from month to month and determining what part of these receipts are received from debtors and what percentage from cash sales. This will give us the amount of debtors that should have been collectable at the end of any month, as it is the amount that was actually collected in the period just after the end of the month.

We can do this as we are trying to prove whether the entity was insolvent – the fact – not what other parties thought at the time. Those considerations may become relevant in recovery actions.

(ii) Stock on Hand

Stock is the largest single asset in most retail businesses and being able to use it to pay debts will directly depend upon being able to sell that stock in a timely manner. Therefore, in businesses with stock, careful calculation needs to be undertaken of its value as a resource.

We start by asking how much of the stock is available, or will become available to pay debt. If a company holds $1 million in stock at cost, but only sells $200,000 of it on average in a month, what amount of stock is a resource? Strictly speaking none, as you cannot pay debt with stock. Practically though, allowance must be made for the sale of stock in the usual course of business in the reasonable period.

There are a number of ways of determining this, but the following factors will need to be considered:

(a) Are this year’s sale comparable to last year’s sales for a direct comparison?
(b) What are the average sales per month this year as opposed to the same time last year?
(c) How can this be compared to the expected next month’s sales?
(d) What can be realized in a discount sale?
(e) Is the stock being sold for cash or on extended credit terms. That is, when will you be paid for it? Turning stock into debtors will not assist in solvency.

Determining these matters will give a figure for the amount of stock that could reasonable be expected to be liquidated in the next month and might be available for debt repayment. We also have to consider whether these will be cash sales or credit sales. Credit sales may be irrelevant to the solvency question as the sales will be counted through the collection of debtors.

B. Due and Payable Debt
The question is what amount of debt is due for payment at the different times.

Some debts (bank overdraft and loans, director’s loans etc.) are usually not due and payable in full in the short term, unless demands have been made for repayment. Allowances must also be made for that portion of these debts that may become payable from time to time, like monthly payments under a loan agreement. Care is taken to determine whether other loans or finance arrangements have expired credit terms. This will require an examination of the balance sheet items and obtaining information on the terms of the credit from the financiers.

In many cases, trade creditors are the only significant due and payable debts. Credit is usually given under certain terms and, once those terms have expired, the debt becomes due and payable. The amount of due and payable debt will therefore be the dollar amount of debt that has passed its credit terms.

Determination of this amount may be easy if there is a reliable aged trade creditor ledger. Simply discounting all debt that has not reached its credit period and creditors that have extended credit terms will give this amount. Rarely this information is available in the records and, even when it is available, it may not be reliable. Therefore this amount may have to be calculated manually.

Albeit complex, the actual task is not actually difficult. Calculation of due and payable debt can be done without any reference to the business records. Creditors are simply asked to provide details of their debts, when they were incurred and when they are payable. In these cases, the banks’ and creditors’ records are used and sometimes prove better and more reliable evidence than the records of the company. In reality both procedures are used to verify the information gathered.

The result of this procedure is the calculation of due and payable debt. It is this amount that is to be compared with the resources at the relevant times.

Step Three – The Calculation
The last step is the mathematical calculation done at various points in time to find the earliest date, or the earliest convenient date, that the entity became insolvent, or whether it was insolvent at some point in time. It may be that we are not attempting to prove the initial date of insolvency, only just that the entity was solvent at or before a certain date – usually the date of a potentially void transaction.

Calculation of a shortfall is mathematical. You simply deduct the due and payable debts from the resources and determine whether there is a surplus or a shortfall. The calculation is:

Available Resources – Due and Payable Debts = Shortfall or Surplus

A surplus means that the entity has sufficient resources to meet its due and payable debts – it is solvent – regardless of whether it is actually paying its debts or not. A shortfall means that the entity does not have sufficient resources to meet all of its due and payable debts – it is insolvent at that particular time.

Indicators of Insolvency
The courts looked closely into the question of insolvency and indicators that directors and other parties should notice. In ASIC v Plymin (2003) 46 ACSR 126, the Judge (para 386) referred to a check list of indicators of insolvency as follows:

1. Continuing losses.
2. Liquidity ratios below 1.
3. Overdue Commonwealth and State taxes.
4. Poor relationship with present Bank, including inability to borrow further funds.
5. No access to alternative finance.
6. Inability to raise further equity capital.
7. Suppliers placing [company] on COD, or otherwise demanding special payments before resuming supply.
8. Creditors unpaid outside trading terms.
9. Issuing of post-dated cheques.
10. Dishonored cheques.
11. Special arrangements with selected creditors.
12. Solicitors’ letters, summons[es], judgments or warrants issued against the company.
13. Payments to creditors of rounded sums which are not reconcilable to specific invoices.
14. Inability to produce timely and accurate financial information to display the company’s trading performance and financial position, and make reliable forecasts.

There would be very few insolvencies where all of these indications are present at the one time. Just as there would be few cases of insolvency where none of these indications were present. Overall, they represent a reasonable set of circumstances that, cumulatively, would indicate insolvency.

Deemed Insolvency
Section 588E of the Corporations Act provides circumstances where a company may be deemed insolvent without having to prove insolvency through the method used above. There is no parallel provision in the Bankruptcy Act. These circumstances fall into two major categories:

1. Where it has been proven that a company was insolvent within 12 months of the winding up, it may be deemed to be insolvent thereafter. To rely on a previous finding that the company was insolvent, the company will have to have been found to be insolvent by a Court in another action.

This deeming of insolvency simply avoids the need for the liquidator to reprove matters already proven to the court. This is helpful where the liquidator is taking multiple actions for preference and or insolvent trading.

2. Where the company did not keep proper books and records in compliance with section 286 of the Corporations Act, the company may be deemed insolvent for some purposes throughout that entire period. This provision can only be used when prosecuting actions that involve related parties, not third party trade creditors.

Having a company deemed insolvent due to lack of records is not an easy task. The liquidator must show that the company did not keep records in a manner that complies with the Act. In Forem Freeway Enterprises Pty Ltd the Judge stated at paragraph 16:

.. “the requirements are that the financial records should both correctly record and explain a company’s transactions, financial position and performance and also enable true and fair financial statements to be prepared and audited”

Though the deeming provisions are available, they are not commonly used. It is usually beneficial and more reliable to prove insolvency from the information from the records and third parties.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

Introduction
Both bankruptcy trustees and liquidators have a duty to investigate insolvent entities, but that duty varies greatly between the Bankruptcy Act and the Corporations Act. Trustees must comply with sections 19 and 19A of the Bankruptcy Act. Liquidators have more limited statutory duties to investigate, and voluntary administrators must only do so in the context of the voluntary administration appointment.

Generally, there is a practical need to investigate to find assets, verify claims, discover offences and provide some sense of resolution to creditors. Some part of the investigation process involves obtaining information from someone. Formal examinations under either Act can prove useful for obtaining information that not is provided willingly. Examinations are conducted under oath or affirmation, so if the witness does not tell the truth, they may be charged with perjury.

There are a number of reasons that insolvency practitioners conduct public examinations, including:

(i) getting information from uncooperative persons;
(ii) obtaining documentation that would otherwise be unavailable;
(iii) obtaining detailed explanations on difficult matters in the estate;
(iv) uncovering offenses;
(v) determining whether there is a claim that may be made;
(vi) obtaining details of defenses to claims without having to commence proceedings; and
(vii) generally gathering information.

Public examination is the common name given to the process of an external administrator formally examining parties. Both the Corporations Act and the Bankruptcy Act have provisions to conduct these types of examinations and both Acts state that they are to be held in public. Anyone can attend and watch public examinations that are held in open Court. Rarely the court will order a closed session.

Though the name is not technically correct in all circumstances, we shall use it for all types of examinations in under both Acts in this paper.

What alternatives are available?
One of the benefits of the public examination process is that it is an inquisitorial process, not an adversarial one. The insolvency practitioner is not trying to prove a case with another party trying to disprove it. They do not use the usual rules of evidence or cross examination. They have nothing to lose. It is purely a fact-finding process.

Both the Bankruptcy Act and the Corporations Act provide a few alternatives to holding a public examination. Insolvency practitioners can simply rely on the records available; hold formal interviews themselves; issue 77A notices and hold 77C interviews (both limited to bankruptcies); obtain search warrants; or obtain orders for people to provide affidavits on certain issues (section 597A of the Corporations Act).

Each of these has its uses, but all have limitations in scope, effect and enforceability, and are often of limited benefit.

Who may apply for an examination?
An ‘eligible applicant’ may apply for an examination under the Corporations Act. An eligible applicant is the liquidator or provisional liquidator; an administrator or administrator of a deed of company arrangement; the ASIC or someone authorized by the ASIC. Who will ASIC authorize? They have granted authority to Receivers and Managers, creditors, regulatory authorities and trustees of related trusts.

An eligible applicant, in relation to a corporation, means:

(a) ASIC; or
(b) a liquidator or provisional liquidator of the corporation; or
(c) an administrator of the corporation; or
(d) an administrator of a deed of company arrangement executed by the corporation; or
(e) a person authorised in writing by ASIC to make:
(i) applications under the Division of Part 5.9 in which the expression occurs; or
(ii) such an application in relation to the corporation.

The trustee, the Official Receiver or any creditor of the bankrupt may apply to the Federal Court for an examination under Section 81 of the Bankruptcy Act. The main difference between the two Acts is that, under the Bankruptcy Act, any creditor (a person with a provable debt) has a right to ask for a examination of parties in their own right, without requiring the consent of the trustee or the Official Receiver.

That is, the range of people that may hold and conduct an examination of parties is very much wider under the Bankruptcy Act than the Corporations Act.

Generally the trustee of the bankrupt estate, whether the Official Receiver or a registered trustee, will make an application for the examination of the bankrupt, especially when that application also contains an application to examine other parties.

Who may be examined?

Who may be ordered to appear as a witness?
Regardless of Act under which the application is made, the court will have to be convinced that the proposed witness is likely to have information on ‘examinable affairs’ that would be useful to the external administrator. One limitation is that only real people may be witnesses to be examined, companies cannot ‘take the stand’. Information from companies is usually obtained from an order to produce records or for the proper officer (a real person) to be examined.

The areas of examination are limited to the examinable affairs of the insolvent company or bankrupt, so only people who may have information that falls under ‘examinable affair’ may be examined. This definition has been stretched over the years to include the witness’s ability to meet the claims that may be made against them and issues like the professional indemnity insurance cover that may cover potential claims. At times, the person asking the questions may have to convince the court that the questions fall into this area and should be allowed.

Certainly the applicant for the examination will have to satisfy the Court giving the Order that the proposed witness does have or should have information that falls under examinable affair, or the Order for the examination will likely not be granted.

Corporations Act
Section 596A provides for the mandatory examinations of past and present officers of a company. Officers include directors and secretaries, people who make decisions which affect the business or financial standing of the company, and people whose directions are acted upon by the directors. Mandatory means that an application for an examination must, in theory at least, be granted.

Section 596B provides the Court with a discretion to order the examination of other people. This section is used to obtain Orders for the examination of accountants, bankers, solicitors, employees and other related parties etc. Almost anyone can be ordered to appear to answer questions and to produce records to the court in an examination under the Corporations Act, if that person has any information on the ‘examinable affairs’ of the Company.

Before granting an order to examine someone under this section, the court will have to be convinced by the applicant that the witness has information that falls under examinable affairs, and that this person has either refused or neglected to give the information to the applicant, or that the information is best obtained under oath for some reason. The applicant must give an affidavit to the court setting out the type of information required from the witness, reasons why the applicant thinks the witness has that information, and why that information falls under the company’s examinable affairs.

Bankruptcy Act
Section 81 provides for an examination of the bankrupt and other “examinable persons”. Examinable persons include directors of associated entities, spouses of the bankrupt, people in possession of records, creditors of the bankrupt and debtors of the bankrupt, and accountants and solicitors.

Essentially, anyone who has advised or dealt with the bankrupt, or may have information on dealings with the bankrupt, may be examined.

As with the Corporations Act, witnesses can only be examined under the Bankruptcy Act on the ‘examinable affairs’ of the bankrupt.

The Court will allow appropriate questions to be put to the witness as long as those questions relate to the examinable affairs of the bankrupt, and in the areas where that witness may be able to supply information. Given the definitions above, the range of questions that may be put to the witness is wide, and the Court will only limit those questions in exceptional circumstances. Given that the process is inquisitive not adversarial, the court will generally allow most, even slightly relevant, questions.

Where is the examination held?
These examinations are held in court. The advantage of holding them in a court settling is that the witness sits in a court of law, with a Judge or Magistrate or Registrar, a bailiff, a witness box and most of the rules and protocols of the legal system. They are placed under oath and warned of the consequences of perjury.

Very few witnesses fail to be intimidated by this setting and this gives an immediate tactical advantage to the insolvency practitioner. Witnesses are then asked a series of questions, and they must provide answers. The immediacy of the answers gives little time to concoct a believable lie.

Generally under the Corporations Act, the Supreme Court will give the Order for an examination and then pass the actual conduct of the examination to the magistrates or similar Court.

The Bankruptcy Act has very similar provisions but the court that grants the Order will also hear the examination.

Questioning the Witness

Can a Witness be represented?
Witnesses have the right to be represented by counsel or a solicitor, but their role is very limited compared to their role in a trial as there is no case to prove or defend. The Bankruptcy Act allows for counsel or a solicitor to re-examine the witness. They will generally only ask questions to clarify a point, and they cannot call witnesses themselves.

The position is probably better explained in the Corporations Act. It provides that questions may be asked to explain or qualify any answers or evidence given by the witness.

Having counsel present and re-examining the witness usually proves to be useful to the practitioner. Witnesses tend to answer their own counsel’s questions more fully and provide more information. A lot of information can be obtained from the re-examination of witnesses.

Should people be represented at a public examination? Some people feel comfortable without representation when they know that they have nothing to hide and many witness are called purely to provide information. Some people feel more comfortable with their lawyer in the room, even if they expect not to need them. It is a personal question and most insolvency practitioners would not try to influence an examinee’s decision to be represented.

Witnesses must answer questions
There is no right to refuse to answer questions. However, if the witness formally objects to any question that may be incriminating to them, the answer may not be used against them in a later offense prosecution. But, they must still answer the question fully and truthfully.

In reality, this policy of objections does not usually concern the liquidator or trustee, as they do not take offense prosecutions and will not be using the information for that purpose. The information obtained is generally used by the liquidator or trustee for a commercial recovery action.

Corporations Act
The Corporations Act achieves this through 4 sub-sections. The first two state that questions can be put to the witness about the examinable affairs of the company, and state that the witness must take an oath or affirmation and answer the questions. False, untruthful or misleading statements could result in the witness being charged with perjury, with all of its consequences.

The other two state that the witnesses cannot refuse to answer questions because the answers may be incriminatory. All questions must be answered truthfully and fully, but some protection is available to witnesses against self-incrimination – but only against later actions involving criminal proceedings or where a penalty may be imposed. The answers will be available for use by the liquidator in any commercial proceedings taken by the liquidator, or other parties.

Bankruptcy Act
The Bankruptcy Act has the same provisions, except for the protection against self-incrimination. The Bankruptcy Act says that the witness must answer the questions and the person presiding at the examination can direct the witness to answer the question, but these answers may be used in later proceedings. Generally trustees will have no interest in criminal or any non-commercial proceedings against any party.

Can records be demanded?
A public examination is a fact finding or fact confirming process and often those facts are located in the records of the company or bankrupt, and just as often in the records of associated or third parties that have dealt with the company or bankrupt. These records may not be immediately available to the practitioner.

Sometimes one of main purposes of the examination is to obtain records from various parties, not particularly to examine those parties about those records at that time. Certain parties will, or can, only produce these records to the practitioner with an order of the Court.

The Corporations Act has provision for the court to include the production of certain books and records as part of the summons for a person to attend for an examination. Care must be taken by the practitioner to ensure that they have summonsed the correct person, or entity, to produce these records. Companies themselves cannot be summons, so the company will have to be summons through the proper officer of the company, who will have to produce the records under the summons.

Also, it is pointless summoning a director to produce records as the records are not the director’s or in their possession, they are the company’s. Applicants need to ensure that they summons the person – or entity through the appropriate person – who has the records and can produce them.

The records will have to be produced to the court. Sometimes the court may order that the records be delivered to the court some days before the examination is held so that the practitioner and their representatives can access these records and prepare questions to be put to witnesses.

This limits the need to have the examination over two separate days, the first to get the records, and the second – after a delay to inspect the records – to question the witness.

The Bankruptcy Act has very similar provisions, and can require the production of various records related to the examinable affairs of the company. Again, it is possible for the court to summons delivery of these records at some time before the conduct of the questioning of witnesses to allow inspection of the records by the trustee.

Questions of Privilege
Accountants and solicitors are often called to give evidence when their client becomes an insolvent under some form of administration, usually liquidation (company clients) or bankruptcy (for individuals). Sometimes the accountant or solicitor has some sensitive information – usually the information that the liquidator or trustee wants – and is hesitant to disclose it. Accountants may have had these clients for some time and feel some personal responsibility to protect them in some manner. To do so they sometimes claim professional or other privilege on some documents or information to avoid answering questions.

Privilege is one of those widely argued points of law, a subject that could be the sole topic of a book. But there are a few points that should be considered before trying to make such a claim.

In all likelihood in a liquidation the company is the client (rather than the director). The liquidator, having taken control of the company by resolution or court order, now controls the client. Effectively the witness is simply providing evidence to their own client (the liquidator becoming the client) and no claim for privilege can be made. In most cases, the same situation will apply in bankruptcies with the trustee being the client, standing in the shoes of the bankrupt.

In cases where transactions or files involve, or advice has been given to, the bankrupt or liquidated company and another party, the witness will have to provide all of the information except that part that relates solely to the other party. Even if the advice or document relates to the other party, if it is part of a file to which the insolvent is involved, and in normal circumstances the bankrupt or insolvent company would be entitled to access to it, the file must be provided to the insolvency practitioner.

Who conducts the examination?
It is common for a solicitor or barrister to be engaged to ask the questions, though the liquidator or trustee may do so. A solicitor will usually be involved in the examination process to make sure that all of the legal protocol is observed and, when needed, to give legal advice.

Barristers are usually engaged due to their knowledge of the court process and their skill in examining and cross examining witnesses. But there are pros and cons to this approach. On one hand, barristers make their living by asking questions, listening to the answers and exploring the detail with follow up questions. This is what they do, and they generally do it very well. On the other hand, no one is more conversant with the background of the matter than the trustee or liquidator, no matter how detailed the brief. Also the lawyers may not be as conversant with the financial details and accounting statements, ledgers etc, as the trustee or liquidator who is usually an accountant.

Examinations held under the Corporations Act are usually conducted by the liquidator or his representative. The ASIC may become involved in the process under section 597(5A), but will generally only do so when there is a large public interest factor in the matter, of where they suspect significant offenses have been committed.

The trustee or the Official receiver will generally conduct examinations, if for no other reason than very few creditors will apply for an examination. Generally the person that applied for the examination, or their representative, will conduct it. But the Bankruptcy Act allows any creditor or their representative to ask questions, regardless of whether they applied for the examination or not. Under the Bankruptcy Act, any creditor may attend the examination and put questions to any witness.

In practical effect, a creditor can turn up at an examination that is being conducted by the trustee and be allowed to put questions to a witness. The court will try to ensure that the questions are not repeats of questions already asked, and that they are limited to the examinable affairs of the bankrupt, but the Act allows any creditor to participate in the examination and be represented.

The Results of the Examination

Transcripts
Apart from any records produced, the only tangible result of many examinations is the transcript of examination. It is (or should be) a complete recording of the questions and evidence given by the witnesses. Both Acts state that transcripts should be produced. Both Acts also allow for the court to have the persons examined sign the transcript as a true copy of the evidence given. This transcript proves the evidence given.

Both Acts also provide that the transcripts may be used in other proceedings, including against the person that gave the evidence. The only limitation to that right is the use of incriminating evidence given in examinations under the Corporations Act, where the witness claimed privileged against self-incrimination.

Assets discovered during the examination
The Bankruptcy Act has two sub-sections that are not mirrored in the Corporations Act. They relate to the powers of the court to deal with assets that are discovered during the examination process.

The first section deals with money owed to the bankrupt. If the witness admits to owing money to the bankrupt, they can be ordered to pay that money, or part of that money, to the trustee at a specific point in time. This is an order of the court – and while we have seen no cases on the matter – we assume would hold the same standing as a Judgment, and could be used to issue a statutory demand (against a company) or Bankruptcy Notice (against a person) if the money is not paid as ordered.

The second section deals with physical assets belonging to the bankrupt, but held by the witness. The Court has the right to order that the witness deliver the asset to the trustee within a specific period. The witness would be in contempt of court if they do not comply with the order.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

Overview
Frequently, the courts assess whether or not a company or individual is insolvent and if so, when that insolvency started and when various stakeholders should have suspected it. It is also a critical factor for directors, when liquidators or creditors commence recovery actions for damages arising from insolvent trading or related claims.

In ASIC v Plymin (2003) 46 ACSR 126, the Judge referred to a checklist of 14 indicators of insolvency.
These indicators were identified as:

  1. Continuing losses
  2. Liquidity ratio below 1
  3. Overdue Commonwealth and State taxes
  4. Poor relationship with present bank including inability to borrow further funds
  5. No access to alternative finance
  6. Inability to raise further equity capital
  7. Suppliers placing the debtor on cash on delivery (COD) terms, or otherwise demanding special payments before resuming supply
  8. Creditors unpaid outside trading terms
  9. Issuing of post-dated cheques
  10. Dishonoured cheques
  11. Special arrangements with selected creditors
  12. Solicitors’ letters, summonses, judgments, or warrants issued against the company
  13. Payments to creditors of rounded sums, which are not reconcilable to specific invoices
  14. Inability to produce timely and accurate financial information to display the company’s trading performance and financial position and make reliable forecasts.

1. Continuing losses
Not every business that makes a loss, or a series of losses, is insolvent. When working capital is available to meet losses, insolvency can be avoided. Losses alone do not cause insolvency. Rather, insolvency is usually a combination of losses, and insufficient working capital.

Solely concentrating on losses without considering the company’s/business’s capacity to absorb those losses may not give a true picture of the solvency position. However, if the loss is significant enough, or over a long enough period, the ability of the company to absorb those losses is eliminated.

2. Liquidity ratio below 1
Liquidity measures the extent to which liquid assets are available to cover payable debts. A business liquidity ratio compares its current assets and current liabilities. If the ratio is greater than 1, this means there is more liquid assets than payable debts and indicates the business should be able to pay debts from its available assets. If the ratio is less than 1, the converse principle applies.

While the liquidity ratio provides a pointer to solvency, it is not a conclusive indicator. A liquidity ratio measures available assets at a specific time and does not factor in the dynamics of cash-flow or whether a debt is actually payable at that time. Some other factors that need to be considered is that the ratio usually uses funds in the bank, rather than allowing for possible borrowed funds and available overdraft facilities also need to be considered. Further, a liquidity ratio does not allow for whether some assets (such as stock and receivables) are truly liquid.

Business owners should examine the reasons for a liquidity ratio below 1, and decide whether action is needed.

3. Overdue commonwealth and state taxes
Many businesses regard the non-payment of taxes as the easiest way to save cash-flow and survive. This is commonly referred to as ‘borrowing the money from the government’. The rationale is that unlike general lending terms there are no application forms, no valuations, and no bank fees. In addition, there is no recourse of non-supply or repossession, and the application of interest can be delayed or negotiated.

Non-payment of tax commitments (GST or PAYG withholding) is a good indicator of insolvency. In most cases businesses that do not pay tax, cannot pay tax. Business owners should consider whether they are insolvent when taxes remain unpaid.

4. Poor relationship with present bank including inability to borrow further funds
Banks have a distinct advantage over other creditors. Banks know what funds are available and can analyse the flow of funds through a business account. If the business borrowed money from the bank, the business owners regularly provide the bank with financial information. Usually, none of this information is available to other creditors.

A poor relationship with a bank usually stems from:
1. The non-repayment of monies due
2. The bank regularly dishonouring cheques
3. The bank’s assessment of the financial position, or management of the business.

A poor relationship with a bank does not prove that the business is insolvent, just as a good relationship is not proof of solvency. The bank may also be unaware of a business’s insolvency, because the business has operated within the bank’s agreed limits, while not paying other creditors.

The bank’s lack of confidence in the business and its solvency can create a poor relationship. Certainly, if a bank refuses to advance further funds or calls up a loan or overdraft, its reason must be clear. If a bank refuses further funding it may, and often does, cause insolvency.

5. No access to alternative finance
Typically, two finance solutions are available to businesses in need of capital:
1. The debtor can convert short-term debt to long-term debt, which can be repaid on a certain date, or intermittently, over a period. If a debt is no longer ‘due and payable’ it will not form part of a strict solvency calculation.
2. Businesses may borrow funds to pay due debts. This creates a new debt to pay an old debt. Care must be taken not to mislead the lender, even if the loan is to satisfy the current debt and alleviate a current cash-flow problem. If the business later fails, the new loan may have personal liability consequences for the business owner.

6. Inability to raise further equity capital
An equity investor can inject funds into the business. Investors seek an eventual return from profits, and do not compete with the repayment priority of debts. Diligent equity investors will review the business finances and prospects to be satisfied that the return is commensurate with the risk.

An inability to use these finance solutions is a strong indicator that a business has a cash-flow problem and is possibly insolvent.

If business owners cannot get funding to pay outstanding debts, they should suspect insolvency.

7. Suppliers placing the debtor on cod terms, or otherwise demanding special payments before resuming supply &
8. Creditors unpaid outside trading terms
Creditors are the first to know that their invoices are not being paid on time. An efficient business will have systems to identify overdue accounts, and prompt collection action. Collection may consist of collection letters, or calls, and limiting further supply to a cash on delivery (COD) basis, or ceasing supply entirely. Being placed on COD terms is a warning sign that the supplier is concerned with a business.

When there are many creditors with outstanding accounts, suspicion may be aroused that a business is insolvent. However, some businesses may habitually pay late, even when they have sufficient funds.

Business owners must determine whether debts are unpaid because there is no money, or whether there is another reason.

9. Issuing of post-dated cheques
Issuing a post-dated cheque for a current debt is a classic sign of insolvency.

Understandably, some creditors view a post-dated cheque as a sign that their account will eventually be paid. However, issuing a post-dated cheque amounts to an admission of insufficient funds to pay at that time. Whether it also amounts to a creditor extending credit terms to the cheque date—is far less certain.

Solvent debtors rarely issue post-dated cheques. Therefore, these cheques should immediately raise suspicions of insolvency.

A debtor with a long history of issuing post-dated cheques is almost certainly insolvent and is relying on future monies to pay current commitments. Conversely, a debtor who infrequently resorts to post-dated cheques is more likely suffering a short-term, cash-flow problem, rather than insolvency.

10. Dishonoured cheques
Many post-dated cheques are dishonoured upon presentation. Generally, a cheque is dishonoured because there are insufficient funds available to cover the payment. On occasion, cheques can be dishonoured through no fault of the debtor. Therefore, one or two instances of dishonoured cheques should not be taken as clear evidence of insolvency.

However, when a debtor’s bank repeatedly dishonours cheques a conclusion of insolvency is unavoidable. Business owners must quickly establish why their cheques are dishonoured, and determine if the business is solvent or not.

11. Special arrangements with selected creditors
Not all creditor demands end in court summons and judgments. If a debtor does not dispute a debt, but cannot make immediate payment, a creditor may enter into a repayment agreement.

Entering into a repayment agreement is an admission that a business cannot meet the full debt when due. Commonly, repayment agreements are successful and both parties are satisfied with the outcome.

A debtor can cure its insolvency by negotiating extended payment terms with a creditor provided the creditor makes a clear agreement to extend the terms. Once the debt terms are extended, the full amount is no longer due and payable.

12. Solicitors’ letters, summonses, judgments, or warrants issue against a company
One letter of demand from a creditor (or their solicitor) is not proof of insolvency, as there may be a dispute between the parties. However, a series of demands from various solicitors should create a strong presumption of insolvency. It is unusual for a business to have several disputes with their suppliers at the same time.

If the creditor progresses beyond the demand stage and obtains a judgment that remains unpaid, the presumption of insolvency is all but confirmed. When execution of the judgment is undertaken by the creditor, a state of insolvency is certain.

13. Payments to creditors of rounded sums, which are not reconcilable to specific invoices
Round payments can be made to reduce a debt, if the creditor agrees. However, it is common to find round amount payments being made without an agreement. Round payments are usually made because the debtor cannot pay the debt in full, and cannot negotiate extended arrangements with creditors, and extended credit terms become implied through part-payment. If business owners use small amounts of cash to pay large debts, they are likely to be insolvent.

14. Inability to produce timely and accurate financial information to display the company’s trading performance and financial position and make reliable forecasts
Sections 286 and 588E of the Corporations Act 2001 consider the issue of deeming a company is insolvent due to not keeping proper books and records.

If the company has failed to keep financial records in accordance with section 286 of the Corporations Act the company is to be presumed insolvent for the period to which the records have not been kept as required.

While the fact that the company has not prepared accurate financial statements may not necessarily mean that a company is insolvent, the courts have noted that a correlation exists between insolvency and deficient financial records. Not only do insolvent entities largely have inadequate accounting records, they also frequently show a reluctance to prepare reliable, and timely accounts.

Commonly, without financial information, business owners do not know the extent of the deficiency and will be unable to convince bankers, or other creditors, that they have a solution to their problem.

Summary

How long can a short-term cash-flow problem last before it becomes a case of insolvency? A shortage of funds can only be described as a short-term cash-flow problem if it is certain it will be overcome in the short-term. Placing a timeframe on overcoming the problem is difficult, as some cash-flow problems are seasonal, or caused by specific contractual factors.

However, as a general rule a short-term cash-flow problem should be solved within three or four months with all debts being paid.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.01.2016

Anyone considering lending money wants reassurance that they have the best chance of being repaid, or should the loan go bad, that they can recover the maximum amount possible.

If the loan is improperly documented or if adequate security is not taken and/or properly registered, potentially only some of the money lent (if any) is recoverable. Protecting yourself against a loan being non-recoverable is not expensive or a time-consuming exercise, particularly when compared to the potential loss. However, protecting the loan must be done properly to be effective.

Why grant the loan?
The first consideration is why to lend the money. Usually, a loan is made for one of two reasons:

  1. To assist someone in a time of need.
  2. As a commercial venture to earn interest.

We don’t believe these loans should be treated differently.

Helping someone during a time of need may be noble, but their financial stability is probably under stress. If that is the case, you need to protect your money. If the loan is made with a view to earn interest, then all proper documentation and security arrangements should be undertaken, as a matter of good business practice.

How do I protect myself?
First satisfy yourself that the borrower (and the monies) will not disappear once the money is lent e.g. only deal with established people or businesses. Secondly, get assurance the borrower has the capacity to repay the loan. It would be prudent to have an accountant to look over the borrower’s records or business plans. Lenders should consider three steps before any money is handed over:

  1. prepare proper loan documentation
  2. obtain adequate security and register it
  3. obtain guarantees from third parties.

Why prepare documentation?
Without proper documentation, you may be unable to substantiate that monies were lent, the conditions of how the money is repayable, or what interest and other terms were applicable. Documentation creates certainty; without it you are relying on the good faith of the borrower (or their trustee or liquidator) or being able to convince a court that what you say is correct.

Are securities and guarantees necessary?
Necessary? No. Recommended? Yes. Think of securities and guarantees as insurance. You hope that the loan is repaid as expected, and suppose that preparing the documentation and obtaining securities and guarantees is a waste of time and money. But, if the loan goes bad, it may be the only way to get some money back.

You may not always be able to obtain securities and guarantees, but they should still be requested. Without a security, a loan is ‘unsecured’ and your rights are limited if the borrower goes bankrupt or is wound up—as you may end up ranking equally to all other unsecured creditors. Without a guarantee from another party, you may be left solely with your rights in the borrower’s estate with no avenue of obtaining payment from anyone else.

What documentation should be prepared?
The loan itself should be fully documented and should include:

  • amount lent and the repayment provisions
  • terms of interest and other charges
  • what constitutes a breach of the agreement and, your rights in breach situation and other matters.
  • dispute resolution provisions, who pays those costs, and provisions addressing your rights to exercise any security or guarantee held.

Most securities are invalid or unenforceable if not in writing and registered on the Personal Property Securities Register, particularly securities over assets owned by a company or under a Bill of Sale. The security documentation should detail all of the assets covered by the security, the powers to exercise the security over those assets, and the powers of any person appointed over those assets. It is critical you seek independent legal advice in regards to the form of security documentation and registration.

A guarantee must be in writing to be enforceable and should be prepared by a solicitor as they must contain certain clauses and be explained to the guarantor before they are signed.

What is a security?
A security is a right over an asset that allows the security holder to exercise rights to take possession of the asset to satisfy an outstanding debt.

What is the difference between a ‘PMSI’ and an ‘ALLPAP’?
An ALLPAP and a PMSI are both forms of security.

A Personal Money Security Interest (PMSI) is a security interest over asset/s that gives the holder of the security a ‘super priority’ over any other security registered. Most commonly, PMSI registrations are made by financiers of particular assets, such as stock or plant & equipment.

An All Present & After Acquired Property (ALLPAP) is a security taken out, generally by a major financier such as a bank, over all of the assets, which gives the lender a priority over any other creditors except for those who hold a PMSI.

Should the security be registered?
For a PMSI and ALLPAP to be enforceable they must be registered on the Personal Property Security Register in strict accordance with the requirements of the Personal Property Securities Act 2009. Failure to properly register a PMSI or ALLPAP may mean the security is unenforceable against a liquidator or bankruptcy trustee.

Lenders should seek legal advice on their securities.

PERSONAL GUARANTEES

Should I obtain personal guarantees?
Lenders do not need to get a personal guarantee, but it is desirable, particularly if the borrower is a company. If directors are not prepared to guarantee the repayment of the loan, they may not have sufficient expectations that the company will be able to do so. Anyone can give a guarantee e.g. no requirement to be officers of a company or related to the borrower. The guarantee allows you to seek payment from another party if the borrower defaults.

We recommend that a solicitor prepare the guarantee documentation and witness the guarantor signing it. Guarantees can be challenged if not properly executed and/or explained to the guarantors.

Can a guarantee ensure repayment?
No. If a guarantor has no assets or means of repaying the loan themselves, the guarantee is worthless. Some background checks on the guarantor should be undertaken before granting the loan. If a guarantor is resistant, you should be suspicious. You may also seek security over some of the guarantor’s assets, as a guarantee means you are an unsecured creditor in the event the guarantor is declared bankrupt.

OTHER CONSIDERATIONS

What if a security or a guarantee cannot be obtained?
If the borrower will not or cannot grant any security, and others do not give guarantees, think twice about lending any money. How much risk you are willing to take is your decision.

Consider these points before granting a loan:

  1. Ensure the entire arrangement (loan, guarantees and security) is in writing and executed by all relevant parties before any money is handed over.
  2. Ensure the lender keeps the complete executed originals. Usually multiple originals are executed—one for each party.
  3. Determine whether guarantees from the individuals or other related entities should be sought.
  4. Check that any asset(s) offered as security actually exist.
  5. Check who actually owns the asset(s) being charged i.e. is the entity offering the charge over the assets the owner?
  6. Check whether the security requires registration and who must register it.
  7. Check whether if another security has a higher priority over yours.
  8. Check whether the assets secured are worth more than the debt—on a ‘forced sale’ basis this is how a security holder must sell it. Should further security be sought to cover any shortfall?
  9. Check the rights for enforcement of any security or guarantee. Are they clear in the documentation and do they make sense? Do they create unnecessary hurdles before rights can be exercised?

How is the security enforceable?
Details of what the enforcement steps are and when they can be taken must to form part of the security documentation. Critically, loan documents must clearly state what is a breach of the loan, the periods for notice and rectification of the breach, and the action that may be taken to enforce the security. The type of action taken greatly depends on the type of assets secured. Recovery may be as simple as having the asset collected and sold at auction. If the security is over a business (such as an ALLPAP), the business may have to continue trade while it is sold. The documentation should provide the alternatives of who can, or should, take recovery action. The main options are:

  • to take the action yourself, or
  • to appoint an agent (commonly called an agent for the mortgagee in possession).

You can also appoint receivers, or receivers and managers. The security documents should provide for all of these alternatives.

Who should pay for setting up the loan?
The borrower should pay the costs of professionals’ fees and charges (searches etc.), by way of an application fee. If the borrower cannot or will not pay these administration costs, you should question whether you should grant the loan.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 16/12/2016

Every year thousands of businesses open their doors and commence trading. Many of these businesses will fail in the first few years, some will fail in the years after that, and only a few will prosper and survive in the long term. This is by no means a new phenomenon and the statistics change very little from year to year.

Based on our past experience dealing with business failures, we have prepared the following information which identifies what we call the Five Phases to Failure and the elements which are likely to be found at each phase.

No two business failures are identical so not all of the elements will be found in every case. But when you see enough failures patterns start to appear. We believe that the Five Phases to Failure can provide useful benchmarks for struggling businesses. Used as an early warning system, they may save some businesses from insolvency as business owners will identify the deterioration of their financial position early enough to take proactive action.

A failing business may display characteristics from more than one phase at one time and they may spend a little or a lot of time in each phase. These are not definite steps that can be predicted with any certainty to appear and last for definite periods. They are more like road signs that indicate the direction of business failure journey.

1. Confident Phase (The Rise)
The first phase occurs with the opening of the business and during the early periods of trading.

Business owners are full of confidence when they open the doors and start trading. They have high expectations about how the business will perform and exude enthusiasm, and this will blind some to seemingly obvious pitfalls. Many people starting businesses will have no business experience and little or no knowledge of budgeting, accounting or financial management. They may not seek advice in the early stages. Yet they are confident of success.

Turnover builds during these early days as customers take advantage of opening specials. New suppliers give generous discounts and extended terms to secure the new customer, and the owners will probably sign credit applications and guarantees. Financial information is prepared, if not analyzed in any detail, and expansion plans are made to fulfill the expected continued growth. This is the time when new motor vehicles are leased, new premises are considered and financial budgeting does not seem important. Owners believe that the business will continue to grow. The commitments entered into during this phase may have an effect on the business, and the owner’s personal lives, in the future.

But many businesses are seriously under-capitalized when they start, surviving on supplier credit and overdrafts. Where budgets are prepared (usually for banks and investors) they are not done in consultation with accountants, and are overly optimistic and incomplete. There will be no provision for slow payments by debtors, cost overruns, bad debts or losses in the first few months. Profit is not of major concern as none was expected in the first few periods, but the losses are not covered by capital, they are covered by debt. Growth of turnover is considered all important but the cost of making these sales, especially by discounting, is not fully understood.

During this phase we can expect to see:

(i) Good trading with a reasonable demand for the product or services offered.
(ii) Increasing turnover. New business is won at the expense of more established competitors, mainly by discounting.
(iii) Suppliers offering discounts and credit to win supply contracts.
(iv) The business products and the staff are innovative and ahead of competitors.
(v) Directors happy to sign personal obligations and guarantees.
(vi) Financial statements and budgets are prepared, although not necessarily deeply analyzed.
(vii) New premises and/or plant are brought online.
(viii) Expansion and trading often being funded on finance, because of limited capital.
(ix) Growth of turnover is considered all important but the cost of making these sales is not fully understood.
(x) Regular drawings by owners.
(xi) Great plans for future expansion being confidently discussed.
(xii) Staff bonuses and incentives are offered.

Some business owners realize that this period will end and seek advice from their accountants. Their accountants help them prepare for the inevitable start of phase two by keeping a realistic view of the level of sales, ensuring that overheads are kept under control and that sufficient capital is available when required. Phase two is where the future of many businesses is decided.

2. Consolidation Phase (The Plateau)
Eventually the honeymoon period ends and things settle down. Sales now have to be won from established competitors that are already adjusting to the new player in the market and heavy discounting is no longer affordable.

The effects of competition begin to be felt, as existing players bring their operations up to date and start actively competing for business. The owners recognize that to succeed it is not good enough simply to be new and energetic, it is also necessary to be disciplined, knowledgeable and pragmatic. Financiers, customers and suppliers need to be constantly reassured about the strengths of the business, its products, service and finances.

Suppliers will end their discounts and extended terms and now require payment. Some customers, having tried the new business and taken advantage of the discounts, will go back to their regular suppliers so sales will start to drop. The first question, now that sales have stabilized or have usually reduced from the early periods, is whether the business is profitable on the bottom line? Many businesses still have a gross profit, but cannot meet overheads. This affects under-capitalized business very quickly. The second question is whether profits are sufficient to repay any losses incurred in the opening phase of the business, as these losses are currently supported by suppliers and the bank.

To counter this problem, some people will make sales on extended terms or to anyone that will place an order, resulting in slow payments and bad debts. The difference between sales, profits and cash flow needs to be recognised.

At this point some businesses adapt to the new conditions and remain profitable, and some do not. The ones that do not will find new business harder to win. Financiers and investors will pay closer attention to the declining results and banks will notice the ever increasing overdraft balance. Financial information may be produced, but the owners may not have the skills or knowledge to interpret and use it to evolve a survival strategy. Importantly many of them will still not get advice, and when they do, some advisors will not want to deliver bad news. Left alone, profits will reduce or disappear and cash flow will tighten. Confidence and enthusiasm will start to decline. Many businesses will stay in this phase for long periods, struggling to survive.

Those that don’t adapt to the new conditions can expect to see:

(i) Sales getting harder to win and increased competition.
(ii) Turnover becoming stagnant or reducing for two or more consecutive periods.
(iii) Current asset ratio weakening
(iv) Closer attention from the bank and investors
(v) Margins being squeezed as suppliers end their early discounts and prices have to be dropped to get sales.
(vi) Credit being harder to obtain from suppliers who require guarantees from directors.
(vii) An intermittent inability to meet all commitments – the overdraft balance increases.
(viii) Grand plans quietly downgraded to more realistic levels or dropped entirely.
(ix) Uncertainty about the business’s ability to trade profitably in the future.
(x) Preparation of financial statements becoming less regular and less rigorous.
(xi) Directors and owners becoming less enthusiastic.
(xii) Long periods being spent on managing cash flow rather than managing profit.

Business owners who understand the trading results or seek advice from their accountants or trade groups will build on their foundations of budgets and capital and survive. But those who can not or will not rethink and adapt their business model eventually advance to the third phase.

3. Debt Phase (The Decline)
Tough trading conditions have led to real financial problems. A steady decline will continue until the business closes or sufficient bottom line profits are earned to cover past losses. The limited initial working capital would have been used up and cash flow is now entirely supplied by creditors, including the ATO and banks. The injection of further capital without making the business profitable just delays the inevitable failure.

Cash flow problems cause a series of other problems. The lack of working capital and continued losses mean that some debts are not being paid. Some creditors will now not supply further credit and only trade on a COD basis, plus they will require partial payments of old debt with payments for new orders. This makes cash flow even worse. Getting sufficient stock becomes a problem causing customers to shop elsewhere – compounding the problem with lower sales.

Business owners may use creative accounting when dealing with financiers and investors. Preparation of financial statements becomes intermittent and advice from accountants and bankers is generally ignored. All planning is done on a day to day survival basis. Some owners are solely concerned with getting enough money to pay the more urgent debt, borrowing from anyone that will lend or from family members, or selling or mortgaging houses to get cash injections. The business is technically insolvent and insolvent trading is now an issue for company directors.

The business must be made profitable before the problem of past losses can be solved. Profits may enable a company to propose a Deed of Company Arrangement, and a sole practitioner to propose a Personal Insolvency Agreement. These will provide some time for past debts to be paid without the threat of winding up or bankruptcy.

Importantly, people take the stress home at night causing problems in their family life, particularly when they have borrowed money from family members. Businesses owners are now risking more than money and assets.

A business in the Debt Phase is usually characterized by:

(i) Creative accounting being used for reporting to banks and investors.
(ii) Spending is reduced on non-core activities, including marketing.
(iii) Further and greater use of Tax Office funds and failure to remit superannuation monies.
(iv) Further slippage in turnover, margins and profits.
(v) Quality customers are lost as they find more stable suppliers.
(vi) A need for longer term “arrangements” with some creditors.
(vii) Some suppliers only supplying on C.O.D. basis.
(viii) Planning is done on a day by day survival basis.
(ix) Accountants consulted but advice generally either ignored.
(x) Internal systems and controls begin to break down.
(xi) Management’s main preoccupation is demands from creditors.
(xii) Insolvent trading is now an issue for company directors.

Some people will now admit that there is a problem and will seek help. This is a big step towards survival, but no guarantee that the business will survive. Sometimes advisors can only control the crash as the business fails and attempt to reduce the damage. But some will not seek advice and they will end up in the fourth phase.

4. Denial Phase
Ultimately businesses are run by people and now human nature plays a major role in their future. Some people will reach the denial phase. They will continue to trade, justifying their actions in the belief that a solution is just around the corner, or that next month’s trading will be better. No amount of financial statements or cash flow projections will make them change their minds. Their accountants may convince them to talk to advisors, but they leave the meeting adamant that any problems will work themselves out.

Other people see the situation differently. Employees begin to look for more secure employment. Financiers and investors make demands to try to reduce their exposure. Creditors start issuing proceedings and the remaining customers look for a more reliable supplier. Almost no financial statements are prepared and bad results are not believed. Owners do not know the extent of outstanding debts, and tax and superannuation has not been paid for some months. Cash flow is entirely dependent upon debtors making payments as all other sources of money, both personal and borrowed, are exhausted.

Blame is laid on everyone else (accountants, bankers and solicitors included). The only thing that advisors can do is keep putting the facts and figures to the business owners and ensure that their own professional obligations are fulfilled, and hoping that the business owner will start to believe that there is a problem. Some will come to that conclusion and appoint the necessary people to handle the business. Some will not. For them, this phase generally ends when Director Penalty Notices are received from the ATO or legal proceedings are served by creditors.

This is reflected in:

(i) A belief that problems that exist can be overcome relatively simply. Wishful thinking is the order of the day.
(ii) Greater losses are incurred but the true extent not acknowledged or known.
(iii) Management’s time allocated to non-core activities.
(iv) Bank and investor relations make demands to reduce their exposure.
(v) Management shows signs of complacency or arrogance.
(vi) Blamed for the situation is laid on everyone else.
(vii) Preparation of any financial statements is all but abandoned.
(viii) Demands from creditors are ignored and proceedings are issued.
(ix) A refusal to recognize the existence of bad debts and redundant stock.
(x) It becomes difficult to get supply on credit or at a reasonable cost.
(xi) Management becomes unavailable to make decisions, or if decisions are made, they are regularly countermanded.
(xii) Current asset ratio likely to be less than 0.5

This is where many business owners first seek advice from their accountants and solicitors, and when the only realistic advice is to see an insolvency practitioner.

5. The Collapse
Denial is superseded by reality. Reality may come quickly with the appointment of a liquidator or bankruptcy trustee, or come slowly as all sources of money are extinguished, remaining staff leave and the doors eventually close.

All working capital is long gone and owners start to look to protect their personal positions through asset protection strategies set up at the commencement of trading. Goodwill is non-existent, the landlord is changing the locks and the banks have cut off the overdraft. Creditor support has ended and customers have no faith in the business. Owners start to discover the extent of the debts and the number of personal guarantees they signed during the early days. Liquidation and bankruptcy are words now used in daily conversation.

This is where some people finally realize that they need help, but often it is too late to save the business. The best that accountants or insolvency practitioners may be able to do is control the financial crash. By this time there is little likelihood of saving the business, even under a Deed of Company Arrangement or Personal Insolvency Agreement. With luck, action at this time will save the people involved from bankruptcy.

In this phase we expect to see:

(i) All working capital has been used up.
(ii) Not adhering to arrangements with the Taxation Office.
(iii) Directors and proprietors look to protecting themselves.
(iv) Goodwill is lost.
(v) Bank and investors are not interested in further extensions.
(vi) Insufficient funds are available to pay wages, rent, or chattel leases.
(vii) The Australian Tax Office issues Directors Penalty Notices.
(viii) Administrators appointed and are expected to work miracles with virtually no working capital or reliable information.
(ix) Creditors fail to accept the director’s proposal or trading on and the business is closed.
(x) Sole proprietors become bankrupt.
(xi) Directors are subject to demands from guaranteed creditors and insolvent trading claims from liquidators and end up bankrupt.
(xii) Family situations reach a crisis stage, often leading to separation and divorce.

Conclusion
How do business owners get a business off this road to failure? Sometimes there are no answers. A business that is not profitable may survive on injections of funds, but eventually those funds have to run out. Some businesses simply do not have a large enough profitable market or an appropriately formed business model to survive, regardless of any actions taken or capital invested. Sometimes the business just will not work despite the effort and money put into it.

Business decisions are made by people and to start the recovery process these people have to admit that there is a problem, make some tough decisions, and be willing to take corrective action. Some people just will not do it in time to make a difference, and time is usually critical. Those who do make the tough decisions will generally achieve a much better outcome for themselves and their families.

The first step is to get an experienced accountant to prepare accurate and up to date financial statements. Using these statements, management should work with the accountant in the preparation of a realistic business plan and meaningful budgets. There is a need for management to be fully informed and to look at the position objectively.

It may be necessary to involve an insolvency practitioner, especially if help is desirable with managing creditors, or if it is clear that the business’s difficulties are more than a short term cash flow problem.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 25.09.2013

Introduction
The goods and services tax (GST) places additional tax obligations on taxpayers and on the insolvency practitioners appointed to those taxpayers. This Guide explains the more common issues arising from the appointment of external administrators and GST. It deals with who is responsible for any GST liability and when that liability will arise. However, the technicalities of GST are best left to tax accountants.

When an entity becomes insolvent, particularly through vesting of assets in a bankruptcy trustee, it does not automatically give rise to any GST consequences or liabilities as neither party (i.e. the bankrupt and the trustee) has incurred a ‘taxable supply’. However, when a trustee is appointed, it changes the entity’s status for GST purposes, and the practitioner assumes some of the taxpayer’s responsibilities. This means the trustee must start reporting GST in their own right.

These rules are governed by the A New Tax System (Goods and Services Tax) Act 1999 (Tax Act).

What is an incapacitated entity?
An entity (i.e. the taxpayer) becomes an incapacitated entity and an external administrator becomes a “representative of the incapacitated entity” if an administrator is appointed in relation to:

  • bankruptcy
  • controlling trusteeship
  • liquidation
  • receivership—even if only appointed over some of the assets
  • voluntary administration
  • executing a Deed of Company Arrangement (DOCA).

An incapacitated entity is defined (section 195-1 of the Tax Act) as:

(a) An individual who is a bankrupt; or

(b) An entity that is in liquidation or receivership; or

(c) an entity that has a representative.

The ‘catch all’ part of this definition is “an entity that has a representative”. This effectively includes all other insolvency appointments that are not bankruptcies, liquidations or receiverships. A ‘representative’ of the incapacitated entity is also defined in section 195-1 of the Tax Act as:

(a) a trustee in bankruptcy; or

(b) a liquidator; or

(c) a receiver; or

(ca) a controller (within the meaning of section 9 of the Corporations Act 2001); or

(d) an administrator appointed to an entity under Division 2 of Part 5.3A of the Corporations Act 2001; or

(e) a person appointed, or authorised, under an Australian law to manage the affairs of an entity because it is unable to pay all its debts as and when they become due and payable; or

(f) an administrator of a deed of company arrangement executed by the entity.

Nearly all formal appointments over a person’s or a company’s financial affairs create an incapacitated entity, and require the representative to register with the Australian Taxation Office (ATO). The appointment makes the representative (i.e. the practitioner) a new entity for GST purposes. Registration is only required if the incapacitated entity is, or was required to be, registered for GST purposes.

Two registrations
To register the representative (i.e. the practitioner), two parts are required. The first part is the incapacitated entity’s representative advising the ATO that a representative has been appointed. The second part is the representative’s registration for GST, if required. GST registration is required if the entity was—or should have been—registered before the appointment, regardless of whether the entity is expected to exceed the turnover limits after the appointment. If the entity was not registered, nor required to be registered for GST the representative will not have any GST responsibilities (e.g. a bankrupt that only has credit card debt).

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 58.20
Representatives are required to be registered

(1) A representative of an incapacitated entity is required to be registered in that capacity if the incapacitated entity is registered or required to be registered.

(2) This section has effect despite section 23-5 (which is about who is required to be registered). If the representative is required to register for GST, they must lodge returns in their own right, and report various matters to the ATO.

Under section 58.25 of the Tax Act, the ATO must cancel the representative’s GST registration if they believe that they do not need to be registered: “The Commissioner must cancel the registration of a representative of an incapacitated entity if the Commissioner is satisfied that the representative is not required to be registered in that capacity”.

In summary, if the entity becomes incapacitated:

1. The practitioner becomes the representative of the incapacitated entity and becomes a new tax entity in their own right. They must register their status with the ATO.

2. If the incapacitated entity was—or should have been—registered for GST, the representative must register for GST.

Under section 58.30 of the Tax Act, the registration ends when the appointment ends. The practitioner (the liquidator or trustee etc.) must notify the Commissioner within 21 days to cancel the registration.

How does the representative’s appointment affect tax periods?
Most insolvency appointments happen during a financial year, not as of 30 June. The incapacitated entity’s tax period is deemed to have ended on the day before the appointment. A new tax period commences on the day of the appointment.

Final BAS’s should be lodged for GST purposes as at the date of the appointment and the ATO will calculate any outstanding debt. The new tax period will end on the date that the normal tax period would have ended, and returns must be lodged separately for that period (i.e. the tax period is divided into two periods at the date of appointment).

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 27.39
Tax periods of incapacitated entities

(1) If an entity becomes an incapacitated entity, the entity’s tax period at the time is taken to have ended at the end of the day before the entity became incapacitated.

(2) If a tax period (the first tax period) ends on a particular day because of subsection (1), the next tax period starts on the day after that day and ends when the first tax period would have ended but for that subsection.

The representative’s tax period begins on the appointment date (i.e. the date of the new divided tax period described above), and each period has the same start and end dates as the incapacitated entity. So, the initial tax period is likely to be shorter than a normal tax period unless the appointment happened on the first date of a tax period.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 58.35
Tax periods of representatives

(1) If a representative of an incapacitated entity is required to be registered in that capacity, the tax periods applying to the representative in that capacity are the same tax periods that apply to the incapacitated entity.

(2) This section has effect despite Division 27 (which is about how to work out the tax periods that apply).

The representative’s obligations end when the appointment ends, but the entity may continue to exist after that date. The Tax Act provides that the entity will have a concluding tax period (i.e. its tax obligations will end) in the case of a person’s death, or if it ceases to exist (i.e. for business entities).

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 27.40
An entity’s concluding tax period

(1) If:

(a) an individual dies; or

(b) another entity for any reason ceases to exist; the individual’s or entity’s tax period at the time is taken to have ceased at the end of the day before the death or cessation.

(1A) If an entity ceases to carry on any enterprise, the entity’s tax period at the time is taken to have ceased at the end of the day on which the cessation occurred.

(2) If an entity’s registration is cancelled, the entity’s tax period at the date of effect of the cancellation (the cancellation day) ceases at the end of the cancellation day.

Who must lodge the business activity statement (BAS)?
Section 31.5 of the Tax Act provides that a GST representative must lodge a BAS in each tax period regardless of the activity or any GST amount owing, or refund due.

This section places GST responsibilities on the representative. If the entity or representative is required to be registered for GST purposes, the obligation to start lodging returns begins upon appointment, regardless of how the representative was appointed.

Who is liable for the GST?
Under section 58.5, the general principle is that the representative is liable for the tax consequences of transactions entered into during their appointment, regardless of their capacity. If the entity ceases to be an incapacitated entity and the representative resigns, the entity is liable for further GST on transactions that occurred while it was incapacitated.

Additionally, the entity is liable for, or entitled to, any GST consequences of transactions entered into during the representative’s appointment.

Furthermore, it places liability on the representative for the entity’s GST liabilities—when “within the scope of the representative’s responsibility or authority for managing the incapacitated entity’s affairs”.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 58.10
Circumstances in which representatives have GST-related liabilities and entitlements

General rule

(1) A representative of an incapacitated entity:

(a) is liable to pay any GST that the incapacitated entity would, but for this section or section 48-40, be liable to pay on a taxable supply or a taxable importation; and

(b) is entitled to any input tax credit that the incapacitated entity would, but for this section or section 48-45, be entitled to for a creditable acquisition or a creditable importation; and

(c) has any adjustment that the incapacitated entity would, but for this section or section 48-50, have; to the extent that the making of the supply, importation or acquisition to which the GST, input tax credit or adjustment relates is within the scope of the representative’s responsibility or authority for managing the incapacitated entity’s affairs.

The representative is not liable when the supply or acquisition of goods and services occurred prior  to becoming the incapacitated entity’s representative.

(2) This section does not apply to the GST payable on a taxable supply to the extent that one or more of the following apply:

(a) the incapacitated entity received the consideration for the supply before the representative became a representative of the incapacitated entity;

(b) if, under Division 83 or 84, the GST is payable by the recipient of the supply – the incapacitated entity provided the consideration for the supply before the representative became a representative of the incapacitated entity;

(c) if:

(i) the supply is a supply for which a voucher to which Division 100 applies is redeemed; and

(ii) the incapacitated entity supplied the voucher before the representative became a representative of the incapacitated entity; the consideration for the supply referred to in subparagraph (i) does not exceed the consideration provided for the incapacitated entity’s supply of the voucher.

(3) This section does not apply to an input tax credit for a creditable acquisition to the extent that the incapacitated entity provided the consideration for the acquisition before the representative became a representative of the incapacitated entity.

The entity is responsible for GST transactions, but the representative is liable if they entered into the transaction. The representative must lodge returns at the same time as the entity, but the commencement date for the first period depends on the appointment date.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 58.35
Tax periods of representatives

(1) If a representative of an incapacitated entity is required to be registered in that capacity, the tax periods applying to the representative in that capacity are the same tax periods that apply to the incapacitated entity.

(2) This section has effect despite Division 27 (which is about how to work out the tax periods that apply).

It is possible that two BAS should be lodged for an entity. For example, a DOCA that has its deed administrator file a BAS for the company’s tax consequences, and the company trades under its own right and lodges its own BAS for each period. Each party will report its own transactions on their individual BAS.

Adjustments to pre-appointment GST liabilities
In many insolvent administrations, GST is owed to the ATO. Adjustments to the GST consequences may be required to pre-appointment transactions that can cause the ATO to increase or decrease their outstanding debt. These are called ‘increasing’ or ‘decreasing’ adjustments.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 19.10
Adjustment Events

(3) An adjustment event:

(a) can arise in relation to a supply even if it is not a taxable supply; and

(b) can arise in relation to an acquisition even if it is not a creditable acquisition.

Accrual based accounting
The two most common adjustments under accrual accounting relate to the GST consequences from:

1. The non-collection of debtors where GST has been paid before the appointment (decreasing adjustment).

2. The non-payment of creditors where taxable credits are adjusted through a dividend where GST has been claimed pre-appointment (increasing adjustment).

Further, if a representative is reporting on an accrual basis, the GST effects of the entity’s transactions made before the representative’s appointment may be attributed to the first tax period of the representative.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 58.40
Effect on attribution rules of not accounting on a cash basis

(1) If:

(a) a representative of an incapacitated entity does not account on a cash basis; and

(b) because of section 58-10, all or part of the amount of GST payable on a taxable supply is payable  by the representative, or the representative is entitled to all or part of the input tax credit for a creditable acquisition then, to the extent that, but for this section, the GST or input tax credit would be attributable to a tax period that ended before the representative became a representative of the incapacitated entity, the GST or input tax credit is instead attributable to the first tax period applying to the representative in that capacity.

(2) This section has effect despite sections 29-5 and 29-10 (which are about attribution of GST on taxable supplies and of input tax credits for creditable acquisitions).

Writing off bad debts
For many reasons, insolvency practitioners commonly write-off pre-appointment debtors as uncollectible. It is also possible that the insolvent entity has accrued these debts before the appointment and may have paid or accrued GST on them. If these debtors are written off, the GST on those debts should in theory be refunded. In practice the GST is deducted from the outstanding GST debt.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 21.5
Writing off bad debts (taxable supplies)

(1) You have a decreasing adjustment if:

(a) you made a taxable supply; and

(b) the whole or part of the consideration for the supply has not been received; and

(c) you write off as bad the whole or a part of the debt, or the whole or a part of the debt has been overdue for 12 months or more.

The amount of the decreasing adjustment is 1/11th of the amount written off, or 1/11th of the amount that has been overdue for 12 months or more, as the case requires.

(2) However, you cannot have an adjustment under this section if you account on a cash basis.

Section 21.5 of the Tax Act states the adjustment cannot be made if the representative is reporting on a cash basis.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 58.15
Adjustments for bad debts

(1) For the purposes of determining whether an adjustment arises under section 21-5 or 21-15 for the whole or a part of a debt relating to a taxable supply or creditable acquisition for which a representative of an incapacitated entity is liable to pay GST, or is entitled to an input tax credit, under section 58-10:

(a) the adjustment cannot arise if, when the whole or part of the debt is written off, or has been overdue for 12 months, the representative accounts on a cash basis; but

(b) it does not matter whether the incapacitated entity accounts on a cash basis at that or any other time.

(2) This section has effect despite subsections 21-5(2) and 21-15(2) (which preclude adjustments for bad debts when accounting on a cash basis).

Non-payment of creditors
Unless sufficient assets can pay all creditors in full, some part of creditors’ debts will go unpaid. If the insolvent entity claimed the GST on these creditor amounts before the insolvency appointment, they should in theory refund these amounts to the ATO to the extent that the creditors were unpaid. In practice, however, the GST liability to the ATO increases.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 21.15
Bad debts written off (creditable acquisitions)

(1) You have an increasing adjustment if:

(a) you made a creditable acquisition for consideration; and

(b) the whole or part of the consideration is overdue, but you have not provided the consideration

overdue; and

(c) the supplier of the thing you acquired writes off as bad the whole or a part of the debt, or the whole or a part of the debt has been overdue for 12 months or more.

The amount of the increasing adjustment is 1/11th of the amount written off, or 1/11th of the amount that has been overdue for 12 months or more, as the case requires.

(2) However, you cannot have an adjustment under this section if you account on a cash basis.

Cash accounting
The two most common adjustments under a cash reporting system relate to the GST consequences from:

1. The collection of debtors where GST has not been paid before the appointment (increasing adjustment).

2. The payment of creditors through a dividend where GST has not been claimed pre-appointment (decreasing adjustment).

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 19.40
Where adjustments for supplies arise

You have an adjustment for a supply for which you are liable to pay GST (or would be liable to pay GST if it were a taxable supply) if:

(a) in relation to the supply, one or more adjustment events occur during a tax period; and

(b) GST on the supply was attributable to an earlier tax period (or if the supply was not a taxable supply, would have been attributable to an earlier tax period had the supply been a taxable supply); and

(c) as a result of those adjustment events, the previously attributed GST amount for the supply (if any) no longer correctly reflects the amount of GST (if any) on the supply (the corrected GST amount ), taking into account any change of circumstances that has given rise to an adjustment for the supply under this Subdivision or Division 21 or 134.

Collection of debtors
Sometimes practitioners collect amounts from debtors that were billed before the insolvency appointment. Under a cash reporting system, no GST would be paid on these amounts. In practice, this payment of the GST is an increasing adjustment to the ATO’s owed liability.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 19.50
Increasing adjustments for supplies

If the corrected GST amount is greater than the previously attributed GST amount, you have an increasing adjustment equal to the difference between the corrected GST amount and the previously attributed GST amount.

Payment of dividends to creditors
Under the cash accounting system, GST is not claimed on supplies from creditors until they are paid. No GST credit will have been allowed for outstanding creditors at the time of the appointment, but is allowed for when creditors are paid a dividend. The practitioner can claim the GST on dividends paid via a decreasing adjustment to the ATO liability for the dividend amount paid to relevant creditors.

A NEW TAX SYSTEM (GOODS AND SERVICES TAX) ACT 1999 – SECTION 19.55
Decreasing adjustments for supplies

If the corrected GST amount is less than the previously attributed GST amount, you have a decreasing adjustment equal to the difference between the previously attributed GST amount and the corrected GST amount.

Summary of adjustments
The below table sets out the general adjustments required for adjusting events occurring after the appointment for pre-appointment transactions.

 Cash ReportingAccruals Reporting
DebtorsWhere debtors are collected by the representative under a cash reporting system, GST is attributable to the amount collected. An increasing adjustment should be made to the ATO’s proof of debt.Where debtors are written off as non-collectable (and GST has been accrued on these debtors), the amount of GST attributable to the written-off debtors becomes a decreasing adjustment to the ATO’s proof of debt.
Dividend to CreditorsWhere dividends are paid to creditors under a cash system, GST credits arise for the payment amounts. These give rise to a decreasing adjustment to the ATO’s proof of debt.Where GST credits have been claimed and those creditors will not be paid, an increasing adjustment is made to the ATO’s proof of debt to add back the unpaid credits.

[table “5” not found /]

Representatives must notify the ATO of increasing adjustments, or the representative may become liable for the lost dividends that the ATO should have collected. The ATO then adjusts their proof of debt to reflect their debt on pre-appointment transactions once they know the result of those transactions.

Summary
The points following summarise the Tax Act provisions:

  • The appointment of an external administrator requires the administrator to register as a representative of an incapacitated entity.
  • If the incapacitated entity is required to be registered for GST, the representative will be required to register for GST.
  • The incapacitated entity’s tax year ends on the date of the appointment and a final BAS must be filed.
  • The representative registered for GST purposes has a responsibility to file BAS during their administration.
  • The representative must notify the ATO of any increasing adjustments due to collection of debtors and payment of dividends.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 27.01.2016

Overview
One of the roles of an insolvency practitioner is realising the assets owned by an insolvent person. The sale of some assets can create a liability under the capital gains tax (CGT) legislation. Insolvency practitioners are concerned with CGT to a limited extent.

There are three main issues with CGT and insolvent estates:

1. Who is responsible to pay capital gains realised in an insolvency administration?

2. What happens to capital losses available at the date of the appointment?

3. What are the tax implications on a holding company when a solvent wholly-owned subsidiary is wound up?

These issues are discussed in more detail below.

1. Who is responsible to pay capital gains realised in an insolvency administration?
The Income Tax Assessment Act 1997 (ITAA) includes provisions that deal with insolvent estates and capital gains that relate to bankruptcy, liquidation, or a secured creditor taking action under a security.

The provisions state that any actions or realisations that lead to a CGT liability are deemed to have been done by the company, bankrupt or debtor, and not by the insolvency practitioner. The provisions relate to:

  • bankruptcy trustees and Part X trustees
  • liquidators
  • other people formally acting under a security.

This means that an insolvency practitioner is not personally liable for any CGT liability. The liability is placed on the entity that originally owned the asset.

The insolvency practitioner starts the process by looking at the ‘vesting’ or otherwise of the asset. Section 104.10 of the ITAA states that the vesting of assets in a bankruptcy or liquidation, or the providing or redeeming of a security, is not a disposal of a CGT asset and the beneficial owner (the estate) does not change.

Income Tax Assessment Act 1997 – section 104.10
Disposal of a CGT asset: CGT event A1

(7) CGT event A1 does not happen if the disposal of the asset was done:

(a) to provide or redeem a security; or

(b) because of the vesting of the asset in a trustee under the Bankruptcy Act 1966 or under a similar foreign law; or

(c) because of the vesting of the asset in a liquidator of a company, or the holder of a similar office under a foreign law.

Bankruptcy
Section 106.30 of the ITAA confirms, in relation to CGT, “the vesting of the individual’s CGT assets in the trustee under the Bankruptcy Act 1966or under a similar foreign law is ignored”. The provisions related to bankruptcy are:

Income Tax Assessment Act 1997 – section 106.30
Effect of bankruptcy

(1) For the purposes of this Part and Part 3-3, the vesting of the individual’s CGT assets in the trustee under the Bankruptcy Act 1966 or under a similar foreign law is ignored.

(2) This Part and Part 3-3 apply to an act done in relation to a CGT asset of an individual in these  circumstances as if it had been done by the individual:

(a) as a result of the bankruptcy of the individual by the Official Trustee in Bankruptcy or a registered trustee, or the holder of a similar office under a foreign law;

(b) by a trustee under a personal insolvency agreement made under Part X of the Bankruptcy Act 1966, or under a similar instrument under a foreign law;

(c) by a trustee as a result of an arrangement with creditors under that Act or a foreign law.

This section has two effects on bankruptcy and CGT.

First, the vesting of property in the trustee is not deemed an asset disposal, so no CGT liability is automatically created from the vesting of assets. Second, any acts of the trustee under a bankruptcy, section 73 arrangement or Part X personal insolvency agreement (Part 10 of the Bankruptcy Act) that give rise to a CGT liability are deemed to have been done by the individual (i.e. the bankrupt or debtor) and not the trustee.

Secured creditors
Section 106.60 of the ITAA deems that if people holding or appointed under security documents take actions that accrue a capital gain, these actions are actually done by the entity that gave the security, not the entity that exercises the security. This extends to a controller appointed to assist a mortgagee in exercising a security.

It is important to note that exercising a security, or appointing a receiver or agent, does not change the asset ownership and does not accrue a CGT liability—as asset ownership does not change. Usually, controllers of property only act as agents for the owner of the assets, with powers to sell under the security. The only change is the security holder’s right to actually sell the asset on behalf of the debtor. Only the asset disposal (e.g. a sale) can create a CGT liability.

External administration summary
The appointment of a liquidator, trustee, controller, or the vesting of property and the exercising of a security, does not create a deemed acquisition or disposal of a CGT asset. Without the sale of the asset (disposal), a CGT liability will not accrue to any party. Where a capital gain arises that would lead to a tax liability, the insolvency practitioner will notify the Australian Taxation Office (ATO). The ATO can then lodge a proof of debt in the bankruptcy estate for that liability amount.

2. What happens to capital losses available at the date of the appointment?
The procedure for calculating an individual’s capital gains for tax purposes is set out in section 102.5 of the ITAA.

Two events can eliminate past CGT losses:

1. An individual is not entitled to bring forward any capital losses from prior years into a year in which they became bankrupt, or were released from their debts. The provision applies twice, once when the person is made bankrupt, and at discharge—which is usually three years later—when they are released.

2. An individual is not entitled to bring forward any capital losses into a year in which they are released from their debts under a law relating to bankruptcy. Discharge from such debts occurs at the end of bankruptcy, or at the end of a Part X or section 73 arrangement.

Under section 102.5 of the ITAA, any capital losses accrued before the bankruptcy or insolvency administration are lost at the end of that administration.

The timing of either becoming a bankrupt (i.e. commencement of bankruptcy) and the release of debts (usually at the end of a bankruptcy or the agreement) may need to be considered by the bankrupt.

A bankruptcy annulment eliminates the bankruptcy. Annulments obtained by payment of debts (through section 153 of the Bankruptcy Act) or through the court will reinstate capital losses, as there is no bankruptcy and no release of debts: they are paid. Annulments obtained through section 73 proposals still provide a release from debts, and therefore any CGT losses will be lost.

3. What are the tax implications on a holding company when a solvent wholly-owned subsidiary is wound up?
The first thing to note is that the subsidiary being wound up must be solvent. The ITAA gives specific tax relief for a holding company that receives an asset (i.e. a roll-over of an asset) from the liquidator of a subsidiary under a members’ voluntary winding up. This relief may only be a CGT reduction, not a full exemption.

This is partially because the liquidated company is solvent and the company will pay the ATO all outstanding tax liabilities—therefore no release of debts. Under section 126.85, CGT relief only applies if the roll-over of the asset was transferred due to the cancellation of the shareholding in the 100%-owned subsidiary that is being wound up. Effectively, the holding company receives the asset in consideration for the cancellation of the shares.

Income Tax Assessment Act 1997 – section 126.85
Effect of roll-over on certain liquidations

(1) A capital gain a company (the holding company) makes because shares in its 100% subsidiary are cancelled (an example of CGT event C2: see section 104.25) on the liquidation of the subsidiary is reduced if the conditions in subsection (2) are satisfied. The reduction is worked out under subsection (3).

Because post-CGT shares in its 100% owned subsidiary are cancelled on the liquidation of the subsidiary, the capital gain that a holding company makes from the roll-over of the asset is reduced if certain conditions are satisfied. Those conditions are:

  • There must be a roll-over of at least one ‘CGT asset’ (i.e. acquired on or after 20 September 1985) and the asset must be disposed of (transferred) by the subsidiary to the holding company in the course of its liquidation.
  • The disposal must either be part of the liquidator’s distribution in the course of the liquidation, or have occurred within 18 months of the dissolution of the subsidiary (if they are part of an interim distribution).
  • The liquidated company must be a 100% owned subsidiary from the time of the disposal until the cancellation of the shares.
  • The market value of the asset must comprise at least part of the capital proceeds for the cancellation of the shares.
  • One or more of the shares that were cancelled must have been acquired by the holding company on or after 20 September 1985 (i.e. they must be post-CGT shares).

The procedure to calculate this relief is outlined in section 126.85 of the ITAA. To summarise the position:

Income Tax Assessment Act 1997 – section 126.85
Effect of roll-over on certain liquidations

(3) The reduction of the capital gain is worked out in this way.

Method statement
Step 1. Work out (disregarding this section) the sum of the capital gains and the sum of the capital losses the holding company would make on the cancellation of its shares in the subsidiary.

Step 2. Work out (disregarding this Subdivision):

(a) The sum of the capital gains the subsidiary would make on the disposal of its CGT roll-over assets to the holding company; and

(b) The sum of the capital losses it would make except for Subdivision 170-D on the disposal of its CGT assets to the holding company; in the course of the liquidation assuming the capital proceeds were the assets’ market values at the time of the disposal.

Step 3. If, after subtracting the sum of the capital losses from the sum of the capital gains, there is an overall capital gain from step 1 and an overall capital gain from step 2, then continue. Otherwise there is no adjustment.

Step 4. Express the number of post-CGT shares as a fraction of the total number of shares the holding company owned in the subsidiary.

Step 5. Multiply the overall capital gain from Step 2 by the fraction from Step 4.

Step 6. Reduce the overall capital gain from Step 1 by the amount from Step 5. The result is the capital gain the holding company makes from the cancellation of its shares in the subsidiary.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 27.01.2016

Introduction
Secured creditors usually rely on their securities to satisfy their outstanding debts. But sometimes they may also wish to lodge a proof of debt in an insolvent estate to maximise their return. This applies when they know they will suffer a shortfall from the sale of the secured item (i.e. the value of the secured asset is less than the amount of the secured debt) and when there will be a dividend paid to unsecured creditors.

A secured creditor may also wish to vote on certain resolutions in the estate. They may have an interest in the conduct of the estate in their role as an unsecured creditor for the amount of that shortfall (i.e. that part of the debt not covered by the secured asset).

Both the Corporations Act 2001 and the Bankruptcy Act 1966 allow secured creditors to lodge proofs of debt and vote at meetings for their shortfall amounts. But only in voluntary administrations can they vote using the full secured debt. In all other administrations, secured creditors must be careful to complete their proof of debt correctly and only vote on the appropriate dollar amount, or they risk compromising their security.

A secured creditor can voluntarily surrender their secured asset and prove for the whole debt as an unsecured creditor. Secured creditors would only surrender their security if they believe the security is worthless, or when a substantial dividend is being paid to the unsecured creditors.

Proving for a shortfall
Secured creditors can prove for the shortfall amount they have suffered—or will suffer. The shortfall is quantified once the secured asset is sold and then a secured creditor can lodge a proof of debt for any shortfall. Effectively, they become an unsecured creditor because the secured asset no longer exists.

However, a secured creditor can lodge a proof of debt for an anticipated shortfall before the secured asset is sold. This can happen when the asset cannot be readily—or reasonably—sold before a dividend is paid into the estate. If a secured creditor believes that they will suffer a shortfall from the sale, the shortfall is calculated by estimating the secured asset’s value and deducting that amount from the outstanding debt. The proof of debt can then be lodged for the balance of the debt, i.e. the estimated shortfall.

The proof of debt form lodged by the secured creditor must have all of the relevant detail, and creditors should attach any documents to support their debt and the estimated security value.

A secured creditor should have a reasonable basis for the estimated security value, as amending their valuation affects certain rights and obligations between the insolvency practitioner and the secured creditor. These rights and obligations may cause the secured creditor to lose all, or part, of their rights under the benefit of their security.

Both Acts allow a secured creditor to issue a notice to an insolvency practitioner to determine whether they will redeem or force a sale of the secured asset. Once the notice is received, an insolvency practitioner must redeem or force a sale within three months, or they will lose their rights over the asset.

Amendment of valuation
Occasionally the original value estimate placed on a security is no longer appropriate. This happens when the asset’s value naturally changes with market conditions, or when the value of the asset changes after the proof of debt was lodged. Alternatively, the original estimate may have been incorrect and the correct value is now known, or capable of being estimated.

In these cases, the estimate must be corrected, whether that correction is an increase or a decrease. Both Acts allow the estimate to be amended under certain conditions.

An amendment is not an automatic process. A secured creditor must apply to the insolvency practitioner, or the court, for an amendment in their claim and must show that the original estimate was reasonable at the time (i.e. under the circumstances), or that the value has changed since the estimate was made. If the amendment occurs after a dividend is paid, this may create complications. If the secured asset is sold after the proof of debt was lodged, the estimated security value must be amended to the sales amount.

Adjustment of a paid dividend
If the estimate of the secured asset’s value is amended after a dividend is paid, the secured creditor may have to either refund any excess dividend received (i.e. if the estimate increases and the shortfall decreases), or they will be entitled to a catch up dividend (i.e. if the estimate decreases and the shortfall increases).

The payment of a catch up dividend is subject to money being available in the estate and cannot disrupt any past dividend paid. That is, if the amendment occurs after a final dividend, the secured creditor is unlikely to be paid a catch up dividend.

Conversely, monies received by the insolvency practitioner from a dividend refund will be paid into the estate.

Subsequent realisation of security
Once a secured asset is sold, the shortfall amount owed to the secured creditor can be quantified. Both Acts automatically amend value estimates made prior to asset realisation, and substitute the net amount received by the secured creditor. This automatically adjusts the shortfall and activates the repayment of an excess dividend and the catch up dividend provisions adjust any previous dividends received by the secured creditor.

Voting at meetings
A secured creditor’s actions may result in surrendering their security. In this regard the Acts vary slightly. Both Acts allow secured creditors to vote at creditors’ meetings for their shortfall amounts, if they have estimated the value of their secured asset (i.e. their shortfall amount). Their voting rights will be unaffected if they have already sold their secured asset as they are now, in effect, an unsecured creditor for the shortfall.

The Bankruptcy Act allows a secured creditor to vote for the shortfall—called the ‘excess of debt’—over the estimate declared on their proof of debt form. That is, they are only allowed to vote for their shortfall amount; they cannot vote for their secured debt amount (which is secured by the secured asset’s value).

The Corporations Act has the same provisions but also states that a security is deemed surrendered if a creditor votes for their full debt as an unsecured creditor. In essence, the secured creditor places a nil value on their security and is automatically redeemed.

However, the voluntary administration provisions allow a secured creditor to vote for the full amount of their secured debt without any risk of losing their rights.

Creditors must be aware of these implications before voting on resolutions as an unsecured creditor.

Disclaimer
The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission contained within this fact sheet.

Last Updated: 28.08.2015

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