People normally use the terms “insolvency” and “bankruptcy” conversely. But are these two really the same? In fact, it’s important to recognise that the two are actually very different.
What is insolvency?
Insolvency applies to both individuals and businesses, it is the state of being unable to pay the money owed, on time.
What is bankruptcy?
Contrary to most people believe, it is actually impossible for an Australian company to become bankrupt. Under Australian law, bankruptcy is a legal process that only applies to individuals who are unable to pay their outstanding debts to their creditors.
What are the main differences between insolvency and bankruptcy?
In Australia, separate pieces of legislation are applying to different insolvency situations.
– The Corporations Act 2001 covers insolvency for companies and;
– The Bankruptcy Act 1966 covers insolvency for individuals.
How does a company become insolvent?
A company becomes insolvent when they are unable to pay and manage their debts. This may be caused by a number of factors; unforeseen disasters ( COVID-19 pandemic), poor management, market turns, and corruption.
There are many actions suggest a company is insolvent; generally, refer to a checklist that includes, but is not limited to:
checklist presented by J Rangiah in Pearce v Gulmohar Pty Ltd [2017] FCA 660
- Continuing losses
- Liquidity ratios below 1
- Overdue Commonwealth and State taxes
- No access to alternative finance
- Inability to raise further equity capital
- Suppliers placing [company] on COD, or otherwise demanding special payments before resuming supply
- Issuing of post-dated cheques
- Dishonoured cheques
- Solicitors’ letters, summons[es], judgments or warrants issued against the company
- Inability to produce timely and accurate financial information to display the company’s trading performance and financial position and make reliable forecasts
What happens when companies go insolvent?
The Australian Securities and Investments Commission (ASIC) administers the Corporations Act 2001. Under the Act, there are a number of insolvency provisions for businesses. They include:
Voluntary Administration
In this instance, the company’s directors or a secured creditor with a charge over most of the company’s assets will appoint an external administrator, called a voluntary administrator”.
The voluntary administrator will investigate the company’s affairs, and recommend that the company either go into liquidation, enter a deed of company arrangement, or continue to operate under the current directors.
Receivership
When a company goes into receivership, a process that is usually initiated by a secured creditor of the business, a receiver is appointed to sell all or some of the company’s secured assets to pay the debt owing to said creditor. Should the directors have provided any personal guarantees on debts, they can also be pursued by creditors.
Deed of Company Arrangement (DOCA)
This is a formal and binding agreement between the company’s directors and its creditors. The agreement outlines how the company’s affairs will be managed to best maximise the chance for the company to continue trading, or provide a better return to creditors as opposed to liquidation.
Liquidation
Liquidating a company involves the formal sale of all available company assets, the proceeds of which will go towards paying any outstanding company debts, with any surplus going towards company shareholders. If there are no funds left, the company is wound up and any outstanding debts will remain unpaid. There are two types of liquidation:
- Court liquidation: This is the result of a court order after an application is made to the Court (usually by a creditor of the business)
- Creditors’ voluntary liquidation: This is liquidation initiated by the company itself.
In some instances, as with a receivership, the director may have given a personal guarantee for the company’s debts. This is when pursuing bankruptcy (against the director) becomes an option.
What happens if a Company Director declares bankruptcy?
If a Company Director decides to declare bankruptcy, the bankruptcy is registered with the Australian Financial Security Authority (AFSA). They will no longer be able to manage corporations, and cease to be a Director, Alternate Director, or Secretary unless given leave by the Court to do so.
If they continue to do so and are found and convicted, this will result in a fine up to $8,500.00, one-year imprisonment, or both.
When dealing with corporate insolvency, it is crucial to get the advice of individuals who are experienced in the industry. Contact the team at Morrison Specter today to arrange a free consultation.
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