The appointment of an insolvency practitioner to a company owing debts is usually a bad sign for creditors. It is important to understand the differences between administration, receivership or liquidation and the implications each has for creditors seeking to recover the debts.
Section 95 of the Corporations Act 2001 (Cth) sets out the definition of solvency. Put simply, a company is solvent if it is able to pay its debts in full, as and when they become payable. It follows that a company will be considered insolvent if it cannot pay its debts when they become due and payable.
In determining whether a company is insolvent, at common law, the courts utilise the ‘cash flow test’ and ‘balance sheet test’. The cash flow test assesses the ability of the company to pay its debts as they become due and payable by considering the company’s existing debts, the date each of the debts will become due and payable and the company’s present and expected cash resources, including whether there is any expected company income. The cash flow test is the principal test used by the courts when determining whether a company is solvent or insolvent.
The balance sheet test assesses the solvency of a company by comparing the total sum of its assets against the total sum of its external liabilities. If a company’s liabilities are greater than the total sum of its assets, the company will be deemed insolvent under the balance sheet test.
In a voluntary administration, a company’s directors appoint an administrator to the company. The administrators’ role is to take control of the company and undertake investigations as to the solvency of the company.
At the conclusion of these investigations, the administrator reports to creditors who then vote to either enter a deed of company arrangement, place the company in liquidation or hand it back to the directors. A deed of company arrangement is an agreement between the company and its creditors to reconcile the company’s debts. In those circumstances, it is generally not possible for 100% of the debts to be reconciled.
In short, if a company is placed into voluntary administration, there is at least some chance the company may be saved and therefore creditors may still recover their debts in part or full.
Receivers are appointed by secured creditors over the assets in respect of which security is held to realise the value in those assets for the secured creditor. The secured creditor is often a lender. It is important to note that the receivers operate only for the secured creditor. It is often the case that the appointment of an administrator or liquidator will coincide with the appointment of a receiver.
Liquidation can be voluntary or compulsory. The distinction is relatively straightforward – voluntary liquidation describes a situation where a company chooses to enter liquidation by a decision of its directors and or members, whereas compulsory liquidation is where a company enters liquidation as a result of a court order that the company be wound up.
Compulsory liquidation is usually the result of a creditor applying to the court for the company to be wound up, and the court will generally appoint the liquidator nominated by the creditor making the application.
Compulsory liquidation is not promising for creditors hoping to recover debts owed to them. A positive aspect of such a situation is that the liquidator is required to reconcile the debts owed by the insolvent company as far as possible, in line with the rules of priority concerning secured and unsecured creditors. For more information on secured / unsecured creditors and unfair preference claims, read our article on defending unfair preference claims.
Voluntary liquidation can either be the result of a voluntary winding up of the company, or the result of voluntary administration. Voluntary administration is markedly more promising from the perspective of creditors, but can only occur in certain circumstances. A creditors voluntary liquidation can occur as the result of an administration whereas a members voluntary liquidation can only occur in circumstances where the company does not presently owe any debts and does not expect to be insolvent for at least 12 months. Voluntary liquidation as a result of a voluntary administration is more likely to result in an outcome where creditors will be able to recover all or a larger proportion of the debt owed to them.
The distinctions between administration, receivership and liquidation bear great significance for creditors in terms of any attempts to recover debts owed to them. Understanding these differences and their consequences is important for any creditor looking to understand the particular circumstances where they are more likely or less likely to recover part or all of the debt owed to them. Should you require advice or assistance in relation to debt recovery or the administration, receivership or liquation of a company, contact Stephanie Philippou or Carl Hagon.
This article was prepared by Conor Gillam and Carl Hagon.