Corporate insolvency occurs when a company is unable to pay its debts when they are due. The Corporations Act 2001 (Cth) prohibits an insolvent company from continuing to trade and incur debt. The company may enter into an arrangement such as voluntary administration with the objective of ‘trading out’ of its financial difficulties. If such an arrangement is not viable or successful, the company may be liquidated or wound up.
The liquidation of a company may arise voluntarily, by special resolution of its members or creditors, or compulsorily by the court.
What happens when a company is liquidated?
The liquidation (or winding up) of a company places its affairs in the hands of a liquidator for the purposes of bringing it to a legal end after distributing any available assets between the company’s creditors (usually unsecured creditors). Any surplus is distributed to the shareholders.
The role of the liquidator
The liquidator is appointed as an agent of the company. His or her role is to identify and convert any available assets to cash for distribution amongst the company’s creditors, and to ultimately bring the company’s legal existence to an end.
The liquidator has broad powers to carry on the company’s operations, dispose of property, pay creditors, compromise or enter arrangements with creditors, commence or defend legal proceedings on behalf of the company and appoint lawyers and agents to dispose of property.
The liquidator investigates the affairs and conduct of the company and its officers, meets and liaises with creditors and reports to the Australian Securities and Investments Commission.
Creditors
Essentially, the only option a creditor will have against the liquidated company will be to lodge a proof of debt with the liquidator. The debt must be verified and considered amongst other claims. Distributions will be made in the priority set out in legislation and in many cases, creditors will only receive a portion of the amount owed, if anything.
When a company enters liquidation, a party may not commence or carry on legal proceedings against it without leave of the court. The purpose for this general embargo is to facilitate a uniform and consistent winding up of the company as a whole, and to prevent further loss that might otherwise be incurred by separate and individual proceedings.
In very limited circumstances it may be desirable to seek leave to commence or continue proceedings against a liquidated company. In such cases an assessment should first be made with the assistance of a legal professional.
Employees
The employees of a company in liquidation are automatically dismissed however may be retained if the liquidator determines that it is in the best interests for the company to continue trading, pending a sale. Employees may claim unpaid entitlements through the Commonwealth Fair Entitlements Guarantee.
Directors
The appointment of a liquidator effectively removes control of the external affairs of the company from its directors. Power to deal with company assets is vested in the liquidator and the directors must cooperate and provide information so the liquidator can properly fulfil his or her role.
Directors of companies facing financial issues should obtain early professional advice to minimise the risk of being personally liable for the company’s financial loss through insolvent trading. In such cases, limited statutory defences may be available. Safe harbour provisions may also protect directors of companies facing insolvency who take positive steps that are reasonably likely to deliver a better outcome than administration or liquidation.
Often one of the biggest creditors of an insolvent company is the Australian Tax Office. Unlike most creditors of a company the ATO can issue director penalty notices to the directors of the company for payment of certain taxes such as PAYG and unpaid superannuation, commonly referred to as the superannuation guarantee charge (SGC). Whilst the penalty may accrue automatically against the director if the company does not meet its obligations in respect of lodgment of the company business activity statement or, if the company has lodged its business activity statement but the PAYG and SGC debt remains unpaid, the ATO cannot commence proceedings to recover the penalty until 21 days after a director penalty notice has been issued to the director.
Director penalty notices have serious consequences to directors and advice should be obtained immediately upon receipt of such a notice from the ATO.
The insolvency of a company can be extremely complex and difficult for all concerned. Directors lose control of the company and may be investigated for insolvent trading or other breaches of the Act; shareholders may face significant financial loss; and creditors must place their claims in the hands of the liquidator and stand in line with other creditors as they ‘wait out’ the results of an investigation into the company’s affairs. It is always better for everyone involved if the director seeks legal advice sooner, rather than later. Often by the time of the appointment of a liquidator it is already too late for an insolvency expert to assist.
Whether you are a director or creditor of a company in financial stress, taking proactive steps is essential to provide every opportunity to minimise loss.
All of the solicitors at ICL Lawyers have been recognised as accredited specialists in commercial litigation and insolvency by the NSW Law Society. We work with clients, large and small, to provide considered legal advice and to recommend approaches that deliver the best possible outcome in all the circumstances. If you need any assistance contact one of our lawyers at info@icllawyers.com.au or call 02 9138 7800 for a no-obligation discussion and for expert legal advice.