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Common Insolvency Terms Explained

Receivership, administration, debt agreement, liquidation, bankruptcy and insolvency. These all mean the same thing, don’t they? Kind of.

Unless you work in the insolvency industry it can be easy to confuse these terms. This article aims to explain each term so if you ever come across it you know what it means.

Insolvency

Insolvency describes the financial status of a person or business in financial trouble, and the inability to pay their debts when they fall due.

This state generally precedes bankruptcy or liquidation. Both an individual (who may become bankrupt) or a business (which may enter liquidation) can be insolvent.

The causes of insolvency are numerous, often causing significant stress. If you suspect insolvency, acting early to understand your options is best. Common early indicators of insolvency include late payment of superannuation or tax debts, struggling to pay suppliers when due or getting knocked back for extra finance when cash is tight. Leaving it too late to act or seek help may mean bankruptcy or liquidation become inevitable.

When a person or business suspects that they may be insolvent, there are various duties upon them to act in the best interests of their creditors (the people they owe debts to). It is therefore recommended that they seek professional help.

Bankruptcy

In Australia, bankruptcy is a legal process for an individual (not a company) who is unable to pay their outstanding debts.

An independent person known as a bankruptcy trustee, or alternatively the Australian Financial Securities Authority (AFSA – the Government bankruptcy authority) is appointed to manage a person’s financial affairs.

This official will determine whether a bankrupt person owns any assets that may be sold or has disposed of any property which may be recovered. They will assess the individual’s liability for income contributions and also provide information and, (if sufficient funds are realised) pay dividends to their creditors.

The bankruptcy process generally lasts three years and can be initiated in one of two ways.

A person can apply to become bankrupt voluntarily by filing a Debtor’s Petition and Statement of Affairs with AFSA. Either AFSA or a bankruptcy trustee at an insolvency firm will be their trustee. Alternatively, a creditor whose debt is at least $5,000 can file a creditor’s petition at court for an order that the debtor be made bankrupt.

Liquidation

Liquidation is the process of winding up a company’s business: selling its assets, investigating its affairs, recovering any legal claims, and distributing the funds received to creditors and/or shareholders.

A liquidator, registered with the Australian Securities & Investments Commission (ASIC), will be appointed to the company to carry out the liquidation.

There are several different types of liquidation, as follows:

  • Court-ordered liquidation – A court-ordered liquidation occurs when a creditor applies to the court to wind up a company that owes it an outstanding debt. To begin the court liquidation process, a creditor can issue a statutory demand on a company to pay a debt pursuant to section 459E of the Corporations Act. This requires the company to pay its debt within 21 days. Should the company not comply with this demand, the creditor can apply to court to have the company wound up (placed in liquidation).If successful, a liquidator will be appointed to the company. Upon the liquidator’s appointment, the directors’ powers cease and the liquidator takes control of the company to carry out the above steps.
  • Creditors voluntary liquidation – Creditors voluntary liquidation (CVL) is similar to a court-ordered liquidation. However, it is commenced voluntarily by a company’s shareholders. No court application is required; it simply requires a shareholders’ resolution. Directors have a duty not to trade a company while it is insolvent. Accordingly, this option is appropriate where a company has outstanding debts that it cannot pay, and its business has ceased, or it cannot continue to trade viably.
  • Members voluntary liquidations – This type of liquidation is only available to solvent companies. It is a procedure initiated by the company’s shareholders and involves the winding up of the company’s affairs. Usually, its business has ceased, its assets sold, and perhaps a small amount of funds or loan account balances remain. The liquidator appointed will use the available funds to pay any remaining creditors and distribute any surplus assets to shareholders. Various tax benefits are made available through this process and it may be preferable to have an independent person review and finalise the company’s affairs

Receivership

Receivership is normally instigated by a creditor that holds security over a company in circumstances where that company has failed to pay the debt owed to the secured creditor. A creditor can take security over practically any property including real property, debtors and plant and equipment.

A Receiver’s role is to secure and realise the assets a creditor holds security over – be that collecting debtors, selling real estate or collecting and selling plant and equipment. This is all done for the sole benefit of the secured creditor.

Receivers will usually be appointed in one of two ways – the security documentation between the creditor and the company expressly provides the right to appoint receivers or by application to Court under section 92 of the Property Law Act Qld (all other states have similar sections in their respective property law acts).

Voluntary Administration

Voluntary administration is an alternative to liquidation for dealing with an insolvent company’s financial difficulties. It’s a process that provides an opportunity for a company’s business, property and affairs to be administered in a way that:

  • Maximises the chances of a company and/or its business continuing, or if this is not possible;
  • Results in a better return for the company’s creditors than would result from the immediate winding up of the company.

Usually, there will be a month or two period where the company continues to trade under the control of the administrators. A proposal (Deed of Company Arrangement) will then be put forward to creditors to vote on as an alternative to the company going into liquidation.

Personal Insolvency Agreement

A personal insolvency agreement (PIA) is an alternative to bankruptcy to deal with your unmanageable debts.

You may propose a PIA to your creditors under Part X of the Bankruptcy Act if you:

  • Are insolvent (unable to pay your debts as and when they fall due)
  • Have not proposed a PIA in the last six months.

Just like a voluntary administration, you should be putting forward a proposal to creditors that will give them a better return than if you went bankrupt.

Unlike proposing a debt agreement there are no debt, asset or income restrictions for proposing a PIA.

Debt Agreement

As the name states, this option involves a formal agreement with your creditors to pay a portion of the debts you owe and your creditors vote on whether to accept it or not. A majority need to vote in favour for it to be accepted.  If accepted you will pay instalments over time which will be distributed to creditors by your deed administrator. Debt agreements can last for up to 5 years. While this option avoids bankruptcy, it is still a formal insolvency appointment and will be recorded on the National Personal Insolvency Index and your credit report.

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About the Author

Elan
Nick Love is a Supervisor in Pearce & Heers Insolvency Accountants’ Brisbane office after completing a Bachelor of Laws in November 2015. Nick has significant experience in all types of personal and corporate insolvency appointments as well as informal debt settlements and general debt advice to individuals and businesses. Servicing the SME business community, Pearce & Heers focuses on achieving commercial outcomes for individuals and businesses that are suffering financial distress. Nick regularly posts articles on LinkedIn on various insolvency related topics and general business advice for Pearce & Heers and Cactus Consulting.