Author
Richard LawrenceDirector & ASIC Registered Liquidator
rlawrence@mackaygoodwin.com.au
03 9958 5931
Facing corporate insolvency is a reality many Australian business owners might confront. It’s essential to grasp what corporate insolvency is, its process, and its potential impact. This fundamental knowledge helps you avoid financial pitfalls and manage challenges effectively when they arise.
What is Corporate Insolvency in Australia?
Corporate insolvency occurs when a business cannot pay debts by the due date. It signifies that a company’s financial health is in jeopardy and demands immediate attention. There is no one reason corporations face financial distress, but recognising the early signs of insolvency can dramatically influence the course of action.
The three most common corporate insolvency procedures are:
- Voluntary Administration
- Receivership
- Liquidation
Let's explore the various options available depending on specific circumstances.
Different types of corporate insolvency
When a company faces serious financial difficulty, there are several formal processes that can be initiated. Understanding the main types of corporate insolvency can help directors and stakeholders navigate the road ahead.
Voluntary Administration
Voluntary administration, where an external administrator is involved, is a possible route for companies aiming to resolve their insolvency. It is particularly vital for viable businesses, as the purpose of the voluntary administration process is to provide much-needed breathing space. This allows you to hit pause on your company’s immediate financial pressures and consider all aspects of the business to devise a strategic plan.
An external administrator is appointed to take control of the insolvent debtor's financial affairs, assess the company’s position, and determine the best course of action for creditors.
The administrator will relieve the company directors of their duties and begin the process of providing an in-depth report to creditors. The report will outline critical information on the company assets, operational management, and current financial circumstances. These findings along with recommendations will be presented to the company creditors who will then vote on one of the following outcomes:
- Return control of the company to its directors.
- Approve a DOCA, which will specifically outline how debts are to be repaid.
- Appoint a liquidator and begin the process of winding up the company.
Small Business Restructure
Small business restructuring is another route taken during corporate insolvency, provided you are eligible to undergo this process. This process allows a business to reorganise its operations and debts to improve profitability and efficiency. The primary goal is to preserve the business while improving its financial standing, providing sustainable solutions for the company to continue operating. Directors can stay in control of the company's business during the restructuring process.
Receivership
The receivership process involves a secured creditor (usually a bank) or the court places a company into receivership for the purpose of repaying its debts. The receiver will then:
- Protect, collect, and sell some or all the company’s assets which may also include the business itself.
- Distribute all proceeds in priority order as per legislation.
It is important to note that a company in receivership may also have a liquidator or administrator appointed.
Liquidation
Liquidation is considered when other recovery options appear unviable. During the liquidation process, a registered liquidator assumes control of the company and oversees the following steps:
- Investigate company affairs.
- Prepares and submits a detailed report.
- Distributes any company assets accordingly.
- Deregisters the company.
While challenging, liquidation can minimise losses and provide a clear endpoint to financial distress, laying the groundwork for a fresh start. Liquidation might also be the best choice when business owners seek a definitive closure to move on to other endeavours. It allows owners to focus on their next paths without the ongoing burden of a struggling business.
Impact of Corporate Insolvency on Businesses
The implications of corporate insolvency extend beyond financial loss. Its ripple effects can touch every aspect of your business, so early recognition and action can mitigate these impacts and prevent formal insolvency appointments.
Reputation
Your company’s reputation is undoubtedly one of its most valuable assets, and insolvency can affect how clients, suppliers, and employees perceive your business. Solid relationships are the backbone of many enterprises, and insolvency can strain or even sever these connections. Suppliers may start demanding upfront payments, while clients might look elsewhere, wary of potential disruptions to their operations.
Future financing and investment
The shadow of insolvency may linger, affecting the ability to secure financing or attract future investors.
- Banks and financiers are generally cautious about lending to businesses that have faced insolvency.
- Investors may view your company as a high-risk proposition.
- Reduced investment can hamper growth plans and delay recovery efforts, even when your business is back on a firmer financial footing.
- Insolvency leads to resource shortages, disrupting day-to-day operations.
- Cash flow issues can force cost-cutting measures like lowering product quality or customer service, damaging your competitive edge.
Being proactive and recognising the signs of insolvency early gives you a fighting chance to reverse the tide. Engaging with our team of insolvency practitioners can open avenues you hadn’t considered, from restructuring to refinancing or negotiating more favourable terms with your creditors.
Seek Advice
Facing corporate insolvency is undoubtedly daunting, but it’s not the end. With proactive management, strategic planning, and the support of experienced professionals, businesses can emerge stronger, more resilient, and with a clear path forward. Navigating the complexities of corporate insolvency requires a deep understanding of legal and financial principles and a strategic approach to decision-making.
Mackay Goodwin offers comprehensive support for insolvent companies including initial financial assessments. Our team of qualified ASIC-registered liquidators have decades of experience managing insolvency procedures. We deliver tailored solutions for financially distressed businesses, whether working towards recovery or assisting with an orderly closure.
Book a free consultation today.
FAQs
What’s the difference between liquidation and receivership?
Liquidation involves winding up a company’s affairs and distributing its assets to repay creditors, often when recovery is unachievable. Receivership, however, is focused on repaying specific secured creditors and may not result in the company ceasing operations if other parts of the business remain viable.
What’s the difference between Corporate Insolvency and Bankruptcy?
It’s important to differentiate this from bankruptcy, which is a term often associated with personal financial insolvency rather than corporate. While corporate insolvency deals with a company’s inability to meet its financial obligations, bankruptcy specifically refers to a legal process that individuals undergo to resolve their debts.
Learn more about how a personal insolvency agreement can help settle debts without becoming bankrupt.
Can restructuring save my business from insolvency?
Yes, restructuring is an effective path to save a business facing insolvency. Companies can regain stability, improve cash flow, and sustainably continue operations by assessing and restructuring financial obligations and operational efficiencies. Smart strategies ultimately lead to a more sustainable business model. With our support, we work towards stabilising operations and setting a course for future growth.
What is insolvent trading?
Insolvent trading is when a company continues to operate and incur debts while unable to pay its existing debts on time. In Australia, company directors have a legal duty to prevent this and can be held personally liable if they allow it to happen.
A creditor, ASIC, or a liquidator may initiate legal proceedings against a director for insolvent trading. If it's established that the company failed to maintain adequate financial records during a specific timeframe, it is generally presumed that the company was insolvent for the entire period in question.
What is the penalty for trading while insolvent?
There are various penalties and consequences for insolvent trading. They include:
- Civil penalties up to $200,000
- Compensation proceedings for amounts lost by creditors. Can be initiated by ASIC, liquidator, or creditor
- Criminal charges: fines up to 2,000 penalty units ($444,000 on or after July 2020) and up to 5 years imprisonment.
In addition to the risk of insolvent trading action, directors may face other consequences when a company enters external administration or receivership. These consequences differ based on the type of administration involved.
I have just received a statutory demand from a creditor. What should I do?
If you have been served with a statutory demand, you have 21 days to act. Your main options are:
- Pay the debt
- Have the statutory demand set aside
- Arrange a payment plan to help pay the debt
- Do not pay the debt
Failure to pay the debt may result in a wind-up notice.
What is a 21-day Director Penalty Notice?
A Director Penalty Notice gives you 21 days to act. This is regarding any outstanding PAYG or Superannuation Guarantee Charge debts. It is important to note that the 21-day period starts from the date on the notice and not from the day that you receive it.
A failure to pay the notice could result in the company being placed in liquidation or voluntary administration. A Director Penalty Notice should not be disregarded or taken lightly. Directors should also be aware that payment arrangements can always be made with the ATO.
Can a director be made personally liable for company tax debts by a DPN?
Yes. Director Penalty Notice legislation outlines how directors are made personally liable for company tax debts. This includes any of the company’s unpaid superannuation.
Under the Corporations Act, a company’s directors are required to act in the best interests of the company and its creditors, particularly when the business is facing financial distress. Directors should be both aware and informed of their rights and responsibilities.
What are indicators of insolvency?
Indicators of insolvency can be seen across a number of key business areas including company property, equity and reporting.
They may include, and are not limited to, any of the following:
Assets
- Company debts outweigh assets.
- Assets have been sold off.
- Liquidity ratio below 1 – insufficient current assets to meet current liabilities when payable.
Liabilities
- Payments to creditors that are not reconcilable.
- Special arrangements and payment plans with creditors.
- Unpaid creditors.
Bookkeeping/Reporting
- Overdue taxes.
- Inability to create accurate reports and make reliable forecasts.
Equity
- No access to alternative finance.
- Inability to raise further equity capital.
- Unable to borrow further funds from the current bank.
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