2012 GUIDE TO CORPORATE INSOLVENCY

Transcription

1 2012 GUIDE TO CORPORATE INSOLVENCY worrells.net.au

2 PLAIN TALK. STRAIGHT ANSWERS. FAST RESULTS. EDITOR Chris Cook, Partner Worrells Brisbane DISCLAIMER The enclosed information is of necessity a brief overview and it is not intended that readers should rely wholly on the information contained herein. No warranty express or implied is given in respect of the information provided and accordingly no responsibility is taken by Worrells or any member of the firm for any loss resulting from any error or omission within this brochure. Liability limited by a scheme approved under Professional Standards Legislation.

3 1 2 3 GLOSSARY CORPORATE INSOLVENCY 10 INDICATORS OF INSOLVENCY 12 LIQUIDATION 16 VOLUNTARY ADMINISTRATION 19 DEEDS OF COMPANY ARRANGEMENT 22 MEMBERS VOLUNTARY WINDING UP 23 PREFERENCES IN LIQUIDATIONS 25 INSOLVENT TRADING 28 UNREASONABLE DIRECTOR RELATED TRANSACTIONS 31 UNCOMMERCIAL TRANSACTIONS 33 SECTION 588FH PREFERENCES TO RELATED PARTIES 35 DIRECTOR S LIABILITIES FOR COMPANY DEBTS 39 ENDING A LIQUIDATION 44 RELATED TOPICS 46 PRIORITY EMPLOYEE ENTITLEMENTS 48 DIRECTOR PENALTY NOTICES 52 LENDING MONEY 58 SUBCONTRACTORS CHARGES 61 SECURITIES OVER ASSETS 63 SECURED APPOINTMENTS 65 DETERMINING INSOLVENCY 67 LANDLORD RIGHTS 71 WORRELLS ARTICLES 74 SET-OFFS: WHEN ARE THEY AVAILABLE? 76 NEVER NEVER SAY NEVER 77 SUPERANNUATION CLAIMS IN INSOLVENCY 78 RECEIVERS, LIQUIDATORS AND EMPLOYEE ENTITLEMENTS 80 ATO GARNISHEE NOTICES 82 VOLUNTARY DEREGISTRATION OF COMPANIES AND DIRECTOR PENALTY NOTICES BEWARE!!!! 83 AM I LIABLE FOR THE COMPANY TAX? 84 86

4 A WORD FROM IVOR It has been said that our free enterprises, capitalist economy is the worst system of all... except for all of the others. But that is of little consolation to those who stand to lose all, or most, of their capital as a result of business failure and it is of no help to employees and creditors of failed businesses, who are left wondering what happened and how they can make good their losses. Worrells cannot change the way in which our economic system works. But what we can do, and what we have been doing for many years, is to bring to the insolvency profession a level of transparency and access to relevant information which is unparalleled. This latest volume of Worrells Corporate Insolvency Guide and its companion volume Worrells Personal Insolvency Guide seeks to explain, in simple terms, how the insolvency laws and processes work, and by doing so to demystify the topic. This, we believe, will allow all stake holders to better understand and cope with what is, for many, an extraordinarily stressful episode. Worrells Corporate Insolvency Guide has been prepared drawing on the combined experience of our 15 partners, who between them have managed more than 12,000 insolvencies over the 38 years since the inception of Worrells Solvency and Forensic Accountants. Our aim has been to produce an easily understood Guide providing dependable information relevant to corporate insolvency. Each topic is set out in a question and answer format and is explained in non technical terms, yet has sufficient detail to allow the reader to gain a broad understanding of insolvency concepts and practice. We have included with this Guide a selection of interesting and illuminating articles taken from our popular monthly Plain Talk e-updates. Our Guides are designed to assist both debtors and creditors and to provide a quick reference resource to our legal, accounting and banking colleagues. Our Guides contain an accurate yet broad statement of insolvency law and practice as it stands at the date of publication. Yet, each insolvency is unique in some way and insolvency laws change, which is why we encourage readers to obtain formal accounting or legal advice or to contact any of the Worrells partners for a confidential and obligation free consultation. Insolvency law is not about punishing business owners for commercial misjudgements, or lack of information. It s about removing impossible financial burdens in fair and transparent ways. We believe that our Insolvency Guides help demystify the insolvency process and so help all stakeholders deal with the inevitable pressures that accompany business failure. We believe also that our commitment to transparency in all we do is nowhere better exemplified than through the information shown on our web site (worrells.net.au) where a wealth of general and information is provided along with detailed daily updates on each current insolvency which we are managing. No other insolvency firm in Australia comes close to the level of disclosure which has been a feature of our operations for some over ten years. And if you like the e-update articles included in this Guide you will find many more at our web page. Although the practice of insolvency involves the interpretation and application of regulation and legislation, although it s to do with balance sheets, ledgers and accounts, at its base it is really about people. Businesses may founder and companies may be liquidated, but it is people that pay the price and feel the pain. Each of Worrells partners, and all of our staff members, recognises that both debtors and creditors must be treated with respect and consideration and that open and frequent communication is the key to a successful relationship. On a daily basis we strive to live up to our slogan of Plain Talk, Straight Answers and Fast Results. We see the publication and distribution of our Insolvency Guides as a practical way of doing this. We welcome feedback regarding these publications including suggestions on how we can improve subsequent editions. Finally, on behalf of all of the Worrells partners I would like to thank you for taking the time to review Worrells 2012 Guide to Corporate Insolvency. Ivor Worrell Coordinating Partner WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

5 TRANSPARENCY AND INFORMATION ARE THE KEYS TO A FAIRER INSOLVENCY REGIME 3

6 WORRELLS PARTNERS IT S OUR PEOPLE THAT DELIVER PLAIN TALK, STRAIGHT ANSWERS AND FAST RESULTS. WORRELLS ARE A TEAM OF FULL TIME SPECIALISTS. SOLVENCY MANAGEMENT, RESTRUCTURE OR INSOLVENCY ADMINISTRATION CAN BE A PERIOD OF GREAT STRESS. AN EXPERIENCED AND SPECIALIST TEAM CAN EASE THE PROCESS, ENSURING A FAIR OUTCOME FOR ALL PARTIES CONCERNED. At Worrells we re specialists - Solvency Accounting is all we do. 15 Partners, 15 Official & Registered Liquidators, 12 Registered Trustees, 3 Certified Fraud examiners, 5 east coast major metro locations, we can have experienced staff at any location, quickly. Quick decisive action by a highly skilled team acting in a caring, respectful and fair manner does make all the difference. Established over 38 years ago, Worrells draws upon over 200 years of experience. Using proprietary technology, our team have successfully completed over 25,000 assignments. Specialist accounting services, delivered by dedicated fulltime specialists, on time, on budget every time. 4 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

7 IVOR WORRELL BRISBANE FCA Official Liquidator Registered Trustee Member IPA Forensic Accountant Justice of the Peace RAJ KHATRI BRISBANE FCA Official Liquidator Registered Trustee Member IPA Commissioner of Declarations MORGAN LANE BRISBANE CA CPA (Fellow) Official Liquidator Registered Trustee Member IPA Justice of the Peace Ivor Worrell is a Registered Trustee in Bankruptcy and Official Liquidator. Ivor is a leading Queensland insolvency practitioner and in a career spanning 38 years he has developed experience in Corporate and Personal Insolvency, Receivership and Litigation Support. Raj Khatri joined the firm in 1986 rising to become a Partner in His area of specialty is Corporate Insolvency and has over 26 years experience in the field. Raj is a fellow of the Australian Institute of Chartered Accountants, an associate of the New Zealand Society of Accountants and the Institute of Corporate Managers, Secretaries and Administrators. Morgan Lane joined the firm in 1992 and became a full partner in His wealth of experience gained in both the private and public sectors adds further depth to our insolvency division. Morgan is a Fellow of CPA Australia accredited as a Specialist in Insolvency & Reconstruction, an Associate of the Institute of Chartered Accountants and The Institute of Corporate Manager, Secretaries and Administrators. 5

8 WORRELLS PARTNERS MICHAEL GRIFFIN BRISBANE CA Registered Liquidator Official Liquidator Registered Trustee Certified Fraud Examiner Member IPA Commissioner of Declarations Michael is a Registered Liquidator, Official Liquidator and a Registered Trustee in Bankruptcy. Michael is also a Member of the Institute of Chartered Accountants and the Insolvency Practitioners Association. Michael s experience includes all forms of personal and corporate insolvency matters. MICHAEL PELDAN BRISBANE FCA Registered Liquidator Official Liquidator Registered Trustee Certified Fraud Examiner Member IPA Commissioner of Declarations [email protected] Michael joined the firm as a graduate in 1991 after completing studies as a mature-aged student, and became a full partner in July Michael s experience includes all aspects of Corporate and Personal Insolvency and Financial Investigation. Michael is also engaged in Fraud Awareness Management and Education and is one of the firm s Certified Fraud Examiners. CHRIS COOK BRISBANE CPA CA Registered Liquidator Official Liquidator Member IPA Commissioner of Declarations [email protected] Chris is an Official Liquidator, Chartered Accountant, Certified Practising Accountant and a member of the Insolvency Practitioners Association of Australia. Chris joined the firm in February 1999 and has considerable experience in both the Corporate and Personal Insolvency Fields. Chris is the partner and heads a team that specialises in Corporate and Personal Insolvency. 6 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

9 ADAM WARD IPSWICH CPA Registered Liquidator Official Liquidator Registered Trustee Member IPA Commissioner of Declarations Adam Ward joined the firm in 2001 and became a partner in Adam is a Registered Liquidator, Official Liquidator and is a member of both CPA Australia and the Insolvency Practitioners Association. His experience includes all forms of Corporate and Personal insolvency matters. Adam is the Partner that leads a team at our Worrells Ipswich Office. JASON BETTLES GOLD COAST CA Official Liquidator Registered Trustee Member IPA Commissioner of Declarations [email protected] Jason is an Official Liquidator, Registered Liquidator, Registered Bankruptcy Trustee, Chartered Accountant and a member of the Insolvency Practitioners Association of Australia. He has worked exclusively in the field of insolvency since 1995, managing the Gold Coast Insolvency Division of a second tier accounting firm for two years before joining us in October Jason has experience in all forms of corporate and personal insolvency matters. He has provided recommendations on the most appropriate solutions to deal with insolvency issues to all types of parties. Jason s knowledge and experience allows him to consider informal arrangements to solve insolvency problems, as well as the formal insolvency administrations. PAUL NOGUEIRA SUNSHINE COAST CPA CA Registered Liquidator Official Liquidator Registered Trustee Member IPA Commissioner of Declarations [email protected] Paul joined Worrells in 1999 after completing his degree with the Queensland University of Technology. He was appointed a Partner in 2006 and opened the Worrells Sunshine Coast office in Paul is experienced in all forms of Corporate and Personal insolvency administrations over various industries and specialises in small to medium business turnaround management and solvency solutions. Paul adheres to the firm s Plain Talk, Straight Answers, Fast Results approach and is available to provide no obligation advice to any party that may find themselves faced with solvency problems. 7

10 WORRELLS PARTNERS NICHOLAS MALANOS SYDNEY CPA Registered Liquidator Official Liquidator Registered Trustee Certified Fraud Examiner Member IPA CHRISTOPHER DARIN SYDNEY CA Registered Liquidator Official Liquidator Justice of the Peace STEPHEN HUNDY CANBERRA CA Registered Liquidator Official Liquidator Registered Trustee Member IPA Nick has in excess of 27 years experience in all aspects of corporate insolvency. He has particular expertise in the areas of Voluntary Administration and Deeds of Company Arrangement which has now enabled numerous businesses to successfully continue on over the years. Chris is a Registered Liquidator, Official Liquidator and associate member of the Institute of Chartered Accountants in Australia. Chris joined the firm as partner of the Sydney firm in July 2008 having been in practice on his own account since Chris experience includes all aspects of corporate insolvency and adopts a consultative approach when exploring all financial avenues available to a distressed company. Chris also undertakes corporate advocacy appointments, assisting directors and companies in dealing with their debtors, creditors and other insolvency practitioners. Stephen Hundy joined Worrells Solvency & Forensic Accountants in 2011 as a partner and leads our Canberra office. Stephen has worked exclusively in the insolvency industry since 1995 and is able to provide assistance in all areas of personal and corporate insolvency. Stephen specialises in the provision of clear practical commercial advice on a wide range of business issues for individuals and small to medium enterprises. He adopts a hands-on approach being involved in all aspects of an appointment. In addition, Stephen also has experience in preparing fraud and financial investigation reports, undertaking financial viability reviews and has assisted with shareholder and partnership disputes. 8 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

11 PAUL BURNESS MELBOURNE CPA Official Liquidator Registered Liquidator Registered Trustee Certified Fraud Examiner Member IPA MATTHEW JESS MELBOURNE CPA Registered Liquidator Official Liquidator Registered Trustee Member IPA CON KOKKINOS MELBOURNE CPA Registered Liquidator Official Liquidator Paul Burness is a Certified Practising Accountant, an Official Liquidator and a Registered Trustee in Bankruptcy. He is also a member of the Insolvency Practitioners Association of Australia. Paul has considerable experience in all forms of Corporate and Personal Insolvency and Reconstruction, specialising in insolvency since graduating. Paul is the managing partner of the Melbourne firm. Matthew is an Official Liquidator and Certified Practising Accountant, who has considerable experience in the Insolvency, Commercial Accounting and Corporate Finance fields. Matthew s experience includes due diligence investigations, sale of business transactions, corporate reconstructions and financial turnarounds. Matthew has also completed the Advanced Insolvency Course with the Insolvency Practitioners Association of Australia. Con Kokkinos joined the Melbourne office on a full time basis in April Con has been a Liquidator since November 2001 and is a member of CPA Australia. Con brings with him over 15 years of insolvency experience with an emphasis in all aspects of corporate insolvency. 9

12 CORPORATE INSOLVENCY NUMBERS CONTINUE TO INCREASE, THAT S WHY AN UNDERSTANDING IN THIS AREA IS VITAL. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

13 1 CORPORATE INSOLVENCY INDICATORS OF INSOLVENCY 12 LIQUIDATION 16 VOLUNTARY ADMINISTRATION 19 DEEDS OF COMPANY ARRANGEMENT 22 MEMBERS VOLUNTARY WINDING UP 23 PREFERENCES IN LIQUIDATIONS 25 INSOLVENT TRADING 28 UNREASONABLE DIRECTOR RELATED TRANSACTIONS 31 UNCOMMERCIAL TRANSACTIONS 33 SECTION 588FH PREFERENCES TO RELATED PARTIES 35 DIRECTOR S LIABILITIES FOR COMPANY DEBTS 39 ENDING A LIQUIDATION 44 11

14 1 INDICATORS OF INSOLVENCY INDICATORS OF INSOLVENCY OVERVIEW The Courts frequently assess whether or not a company or individual is insolvent and if so, when that insolvency started and when various stakeholders should have suspected it. This usually occurs when a liquidator commences a recovery action. It is also a critical factor for directors, when liquidators or creditors commence recovery actions for damages arising from insolvent trading or related claims. Some judges have developed a schedule of indicators of insolvency that are considered in the claim. These should be readily and frequently used by all parties concerned when considering whether a person or business is insolvent. This issue was discussed in detail in ASIC v Plymin (2003) 46 ACSR 126, with the Judge referring to a checklist of 14 indicators of insolvency. These indicators were identified as the following: 1. Continuing losses 2. Liquidity ration below 1 3. Overdue Commonwealth & State taxes 4. Poor relationship with present bank including inability to borrow additional funds 5. No access to alternative finance 6. Inability to raise further equity capital 7. Supplier placing the debtor on COD terms, other otherwise demanding special payments before resuming supply 8. Creditors unpaid outside trading terms 9. Issuing of post dated cheques 10.Dishonoured cheques 11. Special arrangements with selected creditors 12. Solicitors letter, summons(es), judgments or warrants issued against the company 13. Payments to creditors of rounded figures, which are irreconcilable to specific invoices 14. Inability to produce timely and accurate financial information to display the company s trading performance and financial position, and make reliable forecasts. These are discussed in more detail below. 1. CONTINUING LOSSES Not every business that makes a loss, or a series of losses, is insolvent. As long as working capital is available to meet those losses, insolvency can be avoided. Losses by themselves do not cause insolvency. Rather, insolvency is usually brought about by a combination of losses and insufficient working capital. This statement may seem obvious, however some people concentrate solely on the losses without considering the capacity to absorb those losses. On the other hand, one large loss or series of losses may illustrate a trend which counters any defence that expected future profits will overcome what otherwise might be a shortterm problem, and raises questions of whether working capital is truly sufficient to absorb those losses. When assessing insolvency, consideration should be given to working capital and the extent to which it can absorb trading or other losses. 2. LIQUIDITY RATIO BELOW 1 Liquidity is a measure of the extent that liquid assets are available to cover payable debts. The business s liquidity ratio is a comparison of its current assets and current liabilities. If the ratio is greater than 1, there are more current or liquid assets than current or payable debts and an indication that the business should be able to pay debts from available assets. If the ratio is less than 1, the reverse applies. Whilst the liquidity ratio provides a pointer to solvency, it is by no means conclusive. A liquidity ratio measures available assets at a specific point in time and does not factor in the dynamics of cash flow and whether current debt is actually payable at that particular time. A further difficulty is that the ratio is usually determined using funds in the bank, rather than allowing for funds that might be borrowed from the bank. Amounts such as unused overdraft facilities will need to be included in a consideration of solvency. It also does not take into account whether some current assets (stock and receivables) are truly liquid. Business owners should examine the reasons for a liquidity ratio that is less than 1 and determine whether action needs to be taken. 3. OVERDUE COMMONWEALTH AND STATE TAXES Many short-of-cash businesses regard the non-payment of taxes as the easiest way of saving some cash flow that may be essential to survival. They see it as borrowing the money from the government. Rationale being that unlike general lending terms; there are no application forms, no valuations, no bank fees to pay and no recourse of non-supply or repossession, and in the case of interest its application could be delayed and potentially negotiable. So is non-payment of tax commitments (GST or PAYG) a good indicator of insolvency? The short answer is, yes. Putting aside those who simply have an extreme aversion to paying tax, businesses will normally meet their obligations to the tax office by the due date or soon thereafter if they have the ability to do so. 12 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

15 CORPORATE INSOLVENCY 1 In most cases those businesses that do not pay tax, cannot pay tax. Business owners need to carefully consider solvency whenever taxes remain unpaid. 4. POOR RELATIONSHIP WITH PRESENT BANK INCLUDING INABILITY TO BORROW FURTHER FUNDS Banks have a distinct advantage over the other creditors. The bank knows what funds are on hand and can analyse the flow of funds through the bank account. If the business has borrowed money from the bank, the business owners will usually have had to provide financial information from time to time. Usually none of this information is available to other creditors. A poor relationship with a bank usually stems from either: 1. the non-repayment of monies due to the bank, 2. the bank being placed in a position where it must regularly dishonour cheques, or 3. the bank s assessment of the financial position or management of the business. A strained relationship with a bank does not prove that the customer is insolvent, just as a good relationship is not proof of solvency. Cases occur where the bank is amongst the last to know of a customer s insolvency because the customer has operated within agreed limits with the bank, while not paying other creditors. Although a poor relationship may be the result of other factors, it may be the result of the bank s lack of confidence in the business and its solvency. Certainly if a bank refuses to advance further funds or calls up a loan or overdraft, the reasons for this needs to be established. Furthermore, the result of the bank refusing further funding may - and often will - cause insolvency. 5. NO ACCESS TO ALTERNATIVE FINANCE & 6. INABILITY TO RAISE FURTHER EQUITY CAPITAL Insolvency is determined on a cash flow basis - an ability to pay debts. This is reflected in the definitions contained in the Corporations Act (for companies) and the Bankruptcy Act (for individuals). An entity is insolvent if it cannot pay its debts as they fall due. The inability to pay debts is linked directly to the inability to obtain ready cash and to debts being due and payable. Three financing alternatives are available to businesses in need of cash: 1. The debtor can convert short-term debt to long term debt - repayable at a date in the future or intermittently over a period. If a debt is no longer due and payable it does not form part of a strict solvency calculation. But when creditors doing nothing to collect debts that are outside of agreed terms, it cannot be taken as an implied agreement to extend trading terms. 2. Businesses may borrow funds to be used to pay due debts. Essentially this is creating a new debt to pay an old debt. But care must be taken not to mislead the lender, even if the loan is to satisfy current debt and alleviate a current cash flow problem. If the entity eventually fails, the obtaining of the new loan may have consequences to the business owner or director. 3. The debtor can obtain funds in the form of equity capital. The Equity investor, while seeking an eventual return from profits, does not compete with the priority of repayments of debts. Potential equity investors, knowing that an eventual return may be delayed or uncertain, are likely to be diligent in reviewing the finances and prospects of the venture in an effort to be satisfied that the return is commensurate with the risk. Being unable to sufficiently convert a short-term debt to long term debt, or borrow money to overcome a cash crisis, or is unable to replace debt with equity to cure the lack of funds is a strong indicator that the business has at least a cash flow problem and is possibly insolvent - rather than simply suffering a cash flow problem that can be resolved in the short-term. If business owners cannot obtain funding from any of these sources to pay outstanding debts, they should at least suspect that they are insolvent. 7. SUPPLIERS PLACING THE DEBTOR ON COD, OR OTHERWISE DEMANDING SPECIAL PAYMENTS BEFORE RESUMING SUPPLY & 8. CREDITORS UNPAID OUTSIDE TRADING TERMS Creditors are the first to know that their invoices are not being paid on time. An efficient credit manager or business operator will have systems that identify overdue accounts and prompt collection action. Action may consist of collection letters or calls and may involve limiting further supply to a COD basis or ceasing supply entirely. Being placed on COD terms tells the customer that, at least temporarily, the supplier has no faith in the customer s ability to meet further credit commitments. Suspicion may be aroused when there are a range of creditors with outstanding accounts, that business must be insolvent. However, care must be taken to determine whether the business is just a habitual late payer of accounts, even when sufficient funds exist. Business owners have to determine whether debts are not being paid because there is no money to pay them or if there is another reason. INDICATORS OF INSOLVENCY 13

16 1 INDICATORS OF INSOLVENCY INDICATORS OF INSOLVENCY 9. ISSUING OF POST-DATED CHEQUES The issuing of a post-dated cheque for current debt is one of the classic signs of insolvency. It is also one of the major signs of optimism by both the debtor and the creditor that the money will be readily available when the cheque is presented. Understandably, some creditors take the receipt of a post-dated as a sign that their account will eventually be paid, but it must be remembered that the issuing of a post-dated cheque amounts to an admission by the debtor that there are insufficient funds to pay now. Whether it also amounts to a creditor extending the credit terms to the date shown on the cheque is far less certain. Solvent debtors very rarely issue post-dated cheques so these cheques (should) immediately raise suspicions of insolvency. A debtor who has a long history of issuing post-dated cheques is almost certainly insolvent and relies on future monies to pay current commitments. Comparatively, a debtor who infrequently resorts to post-dated cheques is more likely to be suffering a short-term cash flow problem rather than insolvency. 10. DISHONOURED CHEQUES Many post-dated cheques end up being dishonoured on presentation. The issuing of post-dated cheques often is sign of misplaced optimism and a strong indicator of insolvency. The dishonouring of a post-dated cheque sends a very clear message that the debtor s problems are more than simply a short-term cash flow problem. The dishonouring of a post dated cheque tells us that the debtor s cash flow is at best inadequate and that the debtor s bank has limited faith in the debtor arranging for funds to pay the account. Generally a cheque is dishonoured by the bank because there are insufficient funds available to cover the payment. Naturally on occasion, this can result inadvertently through no fault of the debtor. Accordingly the dishonour of one cheque or even a few cheques at the one-time should not necessarily be taken as clear evidence of insolvency. But when the debtor s bank repeatedly dishonours cheques the conclusion of insolvency is unavoidable. The lack of sufficient funds to cover cheques issued must equate to an inability to meet all debts when they fall due. That is the classic definition of insolvency. Business owners need to quickly establish why their cheques are being dishonoured, and determine whether they are still solvent or not. 11. SPECIAL ARRANGEMENTS WITH SELECTED CREDITORS & 13. PAYMENTS TO CREDITORS OF ROUNDED SUMS, WHICH ARE NOT RECONCILABLE TO SPECIFIC INVOICES Not all demands from creditors end in summons and judgments. If the debtor does not dispute the existence of the debt, but cannot arrange immediate payment, creditors demands may result in some form of repayment agreement. These repayment agreements usually allow for payments to be made over an extended period of time, and it is not unusual for the payments to be made in round dollar amounts. Entering into such an arrangement is an admission that the business cannot meet the full debt when due, otherwise the arrangement would not be necessary. It is not uncommon for such an arrangement to be completed as planned, with both parties satisfied with the outcome. Can a debtor cure its insolvency by negotiating extended payment terms with creditors? In our view the answer is yes, on the proviso that a clear agreement is made by the creditor to provide extended terms. Once the terms of a debt are extended, the full amount is no longer due and payable. Round payments may be made towards the reduction of a debt with the agreement of the creditor. But it is not unusual to find round amount payments being made without such an agreement. The payments are usually made in that fashion because the debtor cannot pay the debt in full and that the debtor is no longer confident of negotiating extended arrangements with creditors and hopes to obtain extended credit terms by making part-payment. This debtor is almost certainly insolvent. If business owners are shuffling the small amount of cash that they have to pay the large amount of debts outstanding, they are almost definitely insolvent. 12. SOLICITORS LETTERS, SUMMONS(ES), JUDGMENTS OR WARRANTS ISSUED AGAINST THE COMPANY. A single letter of demand from a creditor or their solicitor is not proof of insolvency, as there may be a dispute between the parties. A series of demands from a number of solicitors, however, should create a strong presumption of insolvency. It would be unusual for a business to have several of disputes with their suppliers at the same time. If the creditor progresses beyond the demand stage and obtains a judgment that remains unpaid, the presumption of insolvency is all but confirmed. When execution of the judgment is undertaken by the creditor, a state of insolvency is certain. 14 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

17 CORPORATE INSOLVENCY INABILITY TO PRODUCE TIMELY AND ACCURATE FINANCIAL INFORMATION TO DISPLAY THE COMPANY S TRADING PERFORMANCE AND FINANCIAL POSITION, AND MAKE RELIABLE FORECASTS This indicator has links to section 289 and section 588FE of the Corporations Act, which deal with the deeming of insolvency when a company has not kept proper books and records. It does not logically follow that a business is likely to be insolvent simply because it has not prepared accurate financial statements or reliable financial forecasts. We can certainly conceive of a solvent business that is unable to prepare accounts, at least in the short-term, because an incompetent accountant has allowed records to become disorganized. Yet experience tells the Courts that insolvency and having financial records in disarray generally goes hand in hand. Not only do insolvent entities almost always have inadequate accounting records, they also frequently demonstrate a real reluctance to prepare reliable and timely accounts. This is arguably the weakest of the indicators when viewed objectively, but subjectively provides an accurate indicator of the likelihood of insolvency. Historically we have found that insolvent entities that have up-to-date financial information are very much in the minority. Businesses in financial trouble generally expend efforts on trying to get out of financial trouble, not preparing the financial picture and planning the way out of trouble. Without financial information, the business owners will not know the extent of the deficiency (this is very common) and they will not be able to convince bankers or other creditors that there is a solution to their problem. SUMMARY How long can a short-term cash flow problem last before it becomes a case of insolvency? A shortage of funds can only be described as a short-term cash flow problem if it is certain that problem will be overcome in the short-term. Placing a time period on overcoming the problem is more difficult, as some cash flow problems may be seasonal or caused by specific contractual problems. We are unaware of any judicial rulings on that point. However, as a general rule, we would expect that a true short-term cash flow problem should be solved within a period of three to four months, and at that time all debts would be up to date. INDICATORS OF INSOLVENCY WORRELLS NEVERS... Never start a new year, or a new business, without a realistic budget. If the expected outcome cannot be expressed in a budget it s a gamble not a business. 15

18 1 LIQUIDATION LIQUIDATION WHAT IS LIQUIDATION? Liquidation is the process to wind up a company s financial affairs to provide for an orderly dismantling of the company s structure, by undertaking the appropriate investigations and enabling a fair distribution of the company s assets to its creditors. This occurs either because the company can t pay all of its debts (i.e. it is insolvent), or its members have a desire to bring an end to the company s existence and ultimately have it struck off the company register. 16 WHY CHOOSE LIQUIDATION? Liquidation is the only way to fully wind up the affairs of a company and end its existence. Having an independent party undertake the process protects creditors, directors and members interests while the company structure is dismantled. HOW CAN AN INSOLVENT COMPANY BE WOUND UP? A company can either be wound up by the Court, usually on the application of one or more creditors or voluntarily by resolution of its directors and if appropriate the members at the relevant meeting. Court Liquidation If a company is wound up by the Court, the applicant must demonstrate to the Court that the company is insolvent or can be deemed to be insolvent. The Court will then appoint a liquidator, usually one nominated by the creditor (applicant). The Court may also wind up a company when there are irreconcilable disputes between shareholders or directors, or for a limited number of other reasons. Voluntary Liquidation A voluntary liquidation is a method whereby the liquidator is appointed voluntarily by the company. Creditors have the right to change the liquidator. A voluntary liquidation can occur by one of two avenues, either by way of what is known as a Creditors Voluntary Winding Up or through the mechanism of a Voluntary Administration. 1. Creditors Voluntary Winding Up Under this method of appointment the directors determine that the company is insolvent and the directors and members resolve that the company be placed into liquidation. It is at this point that a liquidator is appointed. Once the liquidator is appointed, a meeting of creditors is then held within 18 days (11 day convening period and 7 days notice period) of the passing of the resolution winding up the company. At this meeting the creditors are given the opportunity to change the liquidator. This method of appointment is used in cases whereby the company is insolvent and there is no avenue for a Deed of Company Arrangement and the company simply needs to be liquidated. This is the more common voluntary method of winding up. What must be considered in such an appointment that this method of appointment is not available where an application to wind up the company has been filed, or where the Court has Ordered the company be wound up. 2. Voluntary Administration It is possible that a company may be wound up voluntarily through the voluntary administration process. This process is discussed in more detail in the relevant section of this Guide. However, in summary, under this process the directors will resolve to appoint voluntary administrators to the company. A resolution of the members is not required. After the resolution is passed the liquidators who consented to the appointment are then appointed. A meeting of creditors is held within 8 days of the appointment of the voluntary administrators. At this meeting creditors are given the opportunity to appoint alternative administrators. After the first meeting the voluntary administrators will then conduct investigations into the affairs of the company and a detailed report pursuant to Section 439A of the Corporations Act will be issued shortly thereafter outlining the findings of the investigations and will also provide the options available for creditors in respect of the future of the company. The resolutions available to creditors are as follows; To accept a Deed of Company Arrangement (if proposed), That the company be placed into liquidation, That the administration come to an end and the company be handed back to the directors. A second meeting of creditors is then held whereby the above options are considered. Voluntary Administrations are more geared towards a company that wishes to put up a Deed of Company Arrangement, however there are circumstances whereby this process may still be appropriate to place a company into liquidation. Such situations could be as follows; There are winding up proceedings on foot, therefore the Creditors Voluntary Winding Up process is not available The business is continuing to trade whereby it is more appropriate or advantageous for a Voluntary Administrator to manage this ongoing trading A Deed of Company Arrangement is being considered. Typically the Voluntary Administration process is more expensive due to the increased work involved. In most cases the Creditors Voluntary Winding Up process is the more appropriate method of the voluntary appointment of a liquidator. The liquidation process will be almost identical regardless of how it is commenced. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

19 CORPORATE INSOLVENCY 1 HOW DO YOU PROVE THAT A COMPANY IS INSOLVENT? A company is insolvent if it can t pay all of its debts as and when they fall due, even though the company may have an asset surplus but have no ability to liquidate those assets quickly. A company is deemed to be insolvent when it does or fails to do certain things prescribed in law. Most commonly it will be deemed insolvent if it fails to satisfy a statutory demand issued by a creditor. CAN SOLVENT COMPANIES BE WOUND UP? Yes. Solvent companies can be wound up by its members (a Members Voluntary Winding Up). Solvent companies can also be wound up by the Court on an application by its directors or members. This usually occurs when there is a conflict with the control or conduct of the company and the parties are unable to reach a resolution or cannot agree to appoint a liquidator voluntarily. WHAT IS PROVISIONAL LIQUIDATION? The Court may appoint a liquidator provisionally to exercise interim control over the assets and affairs of the company. The appointment will usually be for the period between the filing of the winding up application and when it is heard by the Court. Such an appointment may be made when the Court has reason to believe that assets may be at risk and it is in the interest of creditors that these assets are protected until the winding up application is heard. The appointment is provisional as the company may not ultimately be wound up at the hearing of the application, at which time control may pass back to its directors. WHO ADMINISTERS A LIQUIDATION? Liquidations can only be administered specialist accountants whom are authorised liquidators. There are two categories of liquidators: (i) Registered liquidators are registered with ASIC and can take all type of appointments, except those ordered by the Courts. (ii) Official liquidators are experienced registered liquidators who have been registered with the Courts, and who are able to accept Court and all other types of corporate appointments. WHAT POWERS DO LIQUIDATORS HAVE? The Corporations Act sets out the liquidator s powers. These include all of the powers that vested in the directors of the company, plus the powers to: investigate and examine the affairs of the company, identify transactions that are considered void, exam the directors and others under oath, realise the assets, conduct and sell any business of the company, admit debts and pay dividends. WHAT DOES THE LIQUIDATOR DO? The liquidator will: find and protect the assets of the company; realise those assets; conduct investigations into the financial affairs of the company and any suspicious transactions; make appropriate recoveries; issue reports to ASIC and creditors; make a distribution to creditors; make a distribution to shareholders (if a surplus exists) and apply to ASIC to deregister the company. WHAT IS THE EFFECT ON THE COMPANY? The company structure itself survives the appointment, but not the liquidation. The control of all assets, the conduct of any business and other financial affairs are transferred to the liquidator. The directors cease to have any authority. All bank accounts are frozen, any employment can be terminated, but necessary labour may be engaged by the liquidator. At the end of the liquidation, the liquidator will apply to ASIC for the company to be deregistered, after which the company will cease to exist. CAN A COMPANY TRADE WHILE IN LIQUIDATION? The liquidator may continue trading a business if they believe that it will be in the best interest of creditors. This is usually done if there is a prospect to sell the business as a going concern or to complete and sell any work-in-progress. The liquidator has the obligation to end trading and wind up the affairs of the company as quickly, but as commercially, as practical. WHAT MUST THE DIRECTORS DO TO HELP THE LIQUIDATOR? The directors must supply to the liquidator all of the information about the company s financial affairs and provide a Report as to Affairs (detailing the assets and liabilities of the company as at the date of appointment of the liquidator) and a Director s Questionnaire. The directors must also deliver all company books and records to the liquidator, and co-operate with the liquidator throughout the liquidation. There are various offence provisions that relate to directors who do not co-operate with liquidators. LIQUIDATION 17

20 1 LIQUIDATION LIQUIDATION 18 WHAT INVESTIGATIONS ARE DONE? The liquidator must establish the following: 1. Why the company is insolvent; 2. When the company became insolvent; 3. Whether there is a potential insolvent trading claim against the directors; 4. Whether there are any preferential payments to creditors that may be recovered; 5. Whether there are any offences that may have been committed by the officers of the company; 6. Whether any void transactions can be overturned; and 7. Whether any other recoveries may be made. These powers include holding public examinations, seizing books and records, gaining access to property, and detaining persons relevant to the investigation. Also, the liquidator must identify any offences committed by the directors and report these to ASIC. CAN THE LIQUIDATOR RECOVER PROPERTY SOLD BEFORE THE LIQUIDATION? The liquidator will look at any sales or transfers of property that have occurred within the years before the liquidation. If transactions appear improper, uncommercial or to have been undertaken to defraud creditors, that property or its value may be recoverable. The liquidator may also recover money from creditors who have received payments that gave them preferential treatment in the six months before the liquidation. WHAT IS INSOLVENT TRADING? There is a positive duty on directors to ensure that their company does not continue to incur debts at a time when it is insolvent. If the director breaches that duty, the liquidator of the company can bring an action against them for recovery of the amount of debts incurred during the period that the company was insolvent. The claim is made against the directors personally, and renders them personally liable to compensate the company for that amount. CAN A LIQUIDATOR ATTACK THE DIRECTOR S PERSONAL ASSETS? No. The liquidator can only take possession of the company s assets. However, if the liquidator can prove that company assets have been taken by the directors, the liquidator may recover those assets. If the company has loaned money to the directors, the liquidator will seek to recover the monies, and may instigate legal proceedings. If the liquidator can establish an insolvent trading claim against a director, they may take recovery action against that director and, if necessary commence bankruptcy proceedings against the director. This will allow a trustee in bankruptcy access to the director s assets to satisfy the claim of the liquidator. HOW DO PERSONAL GUARANTEES BECOME PART OF THE EQUATION? When executed by directors and other parties it becomes a personal arrangement between the creditor and the guarantor and therefore not affected by liquidation. WHAT EFFECT DOES THE LIQUIDATION HAVE ON SECURED CREDITORS? The rights of secured creditors are not affected by the liquidation. It is common for secured creditors to allow the liquidator to sell the assets whilst he or she recognises the rights of the secured creditor. The secured creditor may prove in the liquidation for any shortfall after their security has been realised. WHAT IS THE EFFECT OF THE LIQUIDATION ON UNSECURED CREDITORS? Creditors lose their right to recover money from the company, but gain a right to prove for dividends in the liquidation. CAN A LIQUIDATOR PAY DIVIDENDS? Yes. The ultimate role of the liquidator is to realise the company s assets and take all steps possible to recover sufficient funds to distribute the proceeds amongst creditors. ARE THE DIVIDENDS PAID UNDER CERTAIN PRIORITIES? Yes. The liquidator must pay dividends in the Order of priorities set out in section 556 of the Corporations Act. These include: (a) the costs and expenses of the liquidation; (b) the costs of the applicant creditor (if the company was wound up by the Court); (c) employee entitlements; and (d) other unsecured creditors. HOW LONG DOES THE LIQUIDATION LAST? There is no set time limit. The liquidation lasts for as long as is necessary to complete all of the tasks, but the liquidator will usually try to finalise the liquidation as soon as possible. HOW DOES THE LIQUIDATION END? The liquidation ends when either: (a) the company is dissolved by Court Order on the application of the liquidator; (b) the company is struck off the register of companies by ASIC at the request of the liquidator; or (c) the winding up is set aside or stayed by the Court. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

21 CORPORATE INSOLVENCY VOLUNTARY ADMINISTRATION 1 WHAT IS VOLUNTARY ADMINISTRATION? This is a process designed to assist insolvent companies satisfy their debts, by ensuring that they can either: (a) come to a formal arrangement with their creditors to pay those debts, or (b) are quickly and inexpensively placed into liquidation. The process is designed to maximise the chances of a company continuing to exist by giving it the opportunity to propose a Deed of Company Arrangement to its creditors. WHY CHOOSE VOLUNTARY ADMINISTRATION? A voluntary administration offers a co-operative approach to satisfying the company s debts. It restrains creditors from enforcing their claims, and can assist a company to trade out of short-term difficulties caused by either short-term cash flow restrictions or oneoff financial problems. If appropriate, it can also provide a way to restructure the business or the company itself to revive it to a healthier financial position. HOW DOES A VOLUNTARY ADMINISTRATION BEGIN? A voluntary administration begins when an appointment document is executed by either: (i) the directors - after they have resolved that the company is or is about to become insolvent, (ii) a liquidator - if they believe that a proposed Deed of Company Arrangement will provide a better return than the continued liquidation, or (iii) a secured creditor - after the terms of their finance agreement have been breached; and the administrator consents to the appointment. WHAT IS THE BASIC VOLUNTARY ADMINISTRATION PROCESS? A voluntary administrator is appointed to control a company s affairs. The administrator convenes two meetings of creditors. The first meeting is held within eight business days of the appointment. The second meeting is held about four to six weeks after the appointment. At that meeting creditors will choose the option which they believe will best serve their interests. The two most common outcomes of a voluntary administration are the execution of a Deed of Company Arrangement or the liquidation of the company. WHAT IS THE EFFECT ON SECURED CREDITORS? Secured creditors have 13 business days from the day of appointment to exercise their security. If they do not do so within that time, they are bound by a moratorium for the duration of the voluntary administration period. This decision period gives the secured creditor time to decide whether to exercise their charge, and the administrator some certainty during the rest of the administration period. WHAT IS THE EFFECT ON UNSECURED CREDITORS? A moratorium is imposed on actions which can be initiated by unsecured creditors. They cannot enforce their claims, or proceed with applications to wind up the company. Nor can a provisional liquidator be appointed to the company without the leave of the Court, and all proceedings or enforcement action against the company s property is placed on hold. HOW SHOULD THE COMPANY BE DESCRIBED? While in voluntary administration a company must advertise its status. For example, ABC Pty Ltd should be described as ABC Pty Ltd (Administrator Appointed) on all public documents. WHAT ARE THE ADMINISTRATOR S POWERS? The administrator assumes control of all of the company s business, property and financial affairs. The administrator assumes sole responsibility to perform all functions and exercise any and all powers that the directors of the company had or could exercise if the company was not under administration, including continuing to trade on the business and/or disposal of all or any part of the business or property as deemed appropriate. The directors and other officers lose all of these powers. WHAT DOES THE ADMINISTRATOR DO? During the voluntary administration, the administrator will: (a) take control of the company s assets; (b) investigate the company s affairs; (c) report any offences to ASIC; (d) assist the directors to form a proposal for a Deed of Company Arrangement; (e) report to creditors on which course of action provides for the best outcome; and (f) call the required meetings of creditors to decide the future of the company. DOES THE ADMINISTRATOR LOOK AT PREFERENCES ETC.? Look at? Yes, in a preliminary manner. Take recovery action? No. The administrator is required to investigate potential voidable transactions, but only to carry out sufficient investigations to justify any recommendations that they may give in the report to creditors. The administrator has no power to commence any recovery proceedings. These are solely the powers of a liquidator. VOLUNTARY ADMINISTRATION 19

22 1 VOLUNTARY ADMINISTRATION VOLUNTARY ADMINISTRATION HOW DOES THE VOLUNTARY ADMINISTRATION AFFECT RETENTION OF TITLE (ROT) CLAUSES? Holders of retention of title clauses are bound by the moratorium imposed on creditors. They cannot automatically collect their goods. An administrator will generally not dispose of property if it is owned by another person, including under a ROT clause, unless it is in the ordinary course of the business. If there is insufficient money from that sale to pay the ROT supplier, they will be an unsecured creditor for the balance. An administrator may also sell ROT items if they have: (a) the written consent of the ROT holder; or (b) leave of the Court; or (c) they account fully to the ROT creditor for the cost of the stock. HOW DOES THE VOLUNTARY ADMINISTRATION AFFECT A LANDLORD? A landlord is also bound by the same moratorium affecting all creditors - providing they had not commenced proceedings prior to the appointment. The administrator can occupy the company s leased premises for up to seven days without paying rent, but has to pay rent for the remainder of the voluntary administration period. The administrator s liability ends at the conclusion of the voluntary administration or when the premises are vacated - whichever comes first. If the administrator does not have possession of the property, they will not be liable for rent. This provision does not stop the company s continuing liability for the rent. HOW DOES A VOLUNTARY ADMINISTRATION AFFECT GUARANTEES? Creditors holding third party guarantees from directors are bound by the moratorium during the period of the administration. Guarantees can be enforced by the holder of them after the voluntary administration ends. CAN A VOLUNTARY ADMINISTRATOR PAY DIVIDENDS? No. A voluntary administrator does not have the authority to pay dividends. WHAT HAPPENS AT THE FIRST MEETING OF CREDITORS? The first meeting is held within eight business days after the appointment. There are only two matters that the Corporations Act requires to be considered at the meeting: (a) whether the creditors wish to replace the administrator with another administrator; and (b) whether the creditors wish to elect a number of representatives to form a committee which will advise and assist the administrator. WHAT HAPPENS AT THE SECOND MEETING OF CREDITORS? A second meeting of creditors is normally held between 20 to 30 business days after the appointment. Creditors will decide the future of the company at this meeting. Prior to this meeting the administrator will issue a report detailing the results of the investigations, offences (if applicable), the viability and suitability of each of the options available to creditors. All information provided must be sufficient for creditors to make an informed decision, and a recommendation to creditors. WHAT OPTIONS ARE AVAILABLE TO CREDITORS? The creditors can pass a resolution for one of the following courses of action: 1. accepting a proposal for a Deed of Company Arrangement (if one is proposed), 2. ending the voluntary administration and passing control of the company back to the directors, or 3. liquidating the company. HOW COMPLETE MUST A DRAFT DEED OF COMPANY ARRANGEMENT BE? It is not uncommon for the draft deed to be submitted to the administrator in summary form. This is usually not an acceptable format to be considered by creditors. It is preferable for a full draft deed to be tabled at the meeting of creditors, as the final deed will include many more technical provisions than the original proposal. Creditors should insist on the full draft, or at least as close to the final draft as practicable, before deciding upon it so that they are fully aware of all of the terms. The meeting can be adjourned to allow time for the production of a more satisfactory draft. VOTING AT MEETINGS? A vote can be determined on the voices if there is a clear majority in number of those present at a meeting. In this case, each person (whether a creditor or a proxy) only has one vote. If this is inconclusive, or if requested by creditors, the vote can be put to a poll. A poll is a vote which is determined on a majority in both numbers and value. In the event of a stalemate (e.g. majority of numbers voting one way and the majority of value voting another), the administrator will generally exercise a casting vote and make the final decision. Otherwise the resolution will fail. 20 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

23 CORPORATE INSOLVENCY 1 DO CREDITORS NEED TO DECIDE THERE AND THEN? No. The second meeting may be adjourned for up to 60 days for further investigations to be carried out, or for a proposed Deed of Company Arrangement to be amended. WHAT DOES A VOLUNTARY ADMINISTRATION COST? There is no definite answer. Each administration is different and will therefore have a different cost dependent on the work required. There are two types of work on insolvency files, statutory and nonstatutory but still necessary. Statutory work has to be performed on every file regardless of size, complexity or other unique factors. Statutory work includes: 1. notifying ASIC; 2. issuing notices to creditors; 3. issuing notices to utilities and statutory authorities (ATO etc.); 4. conducting the first meeting of creditors; 5. dealing with creditors inquiries; 6. conducting preliminary investigations into preferential payments, insolvent trading and other voidable transactions; 7. preparing and issuing a detailed report to creditors; 8. conducting the second meeting of creditors; 9. notifying creditors and ASIC of the results of the second meeting of creditors. Non-statutory but still necessary work may include the following tasks: (i) trading the business during the period of the administration; (ii) dealing with secured creditors; (iii) dealing with finance companies; (iv) collecting and selling some or all of the assets of the company or the business of the company; (v) more detailed investigations into potential recoveries, the ownership of assets and the viability of any proposal for a Deed of Company Arrangement. WHEN DOES A VOLUNTARY ADMINISTRATION END? The voluntary administration ends when: (a) a Deed of Company Arrangement is fully executed; (b) the creditors resolve to wind up the company; (c) the creditors resolve that the voluntary administration should end; (d) the Court Orders that the administration is to end; (e) the approved Deed of Company Arrangement is not signed within 21 days of the second meeting; (f) the period for calling the second meeting ends without the meeting having been called; or (g) the Court appoints a liquidator to the company. VOLUNTARY ADMINISTRATION WORRELLS NEVERS... Never rely on one customer, one product or a single employee for any more than 15% of your turnover. 21

24 1 DEEDS OF COMPANY ARRANGEMENT DEEDS OF COMPANY ARRANGEMENT WHAT IS A DEED OF COMPANY ARRANGEMENT (DOCA)? A DOCA is a formal agreement between the company and its creditors (and any other relevant third parties) to satisfy company debts. The DOCA will set out in its terms and conditions, warranties and indemnities, the extent or nature of obligations, and relationships between those persons who are a party to it. The deed binds all creditors, both secured (to the extent of any shortfalls on their secured facilities) and unsecured, and releases the company from its debts at least to the extent provided for within its terms and conditions. HOW LONG DOES A DOCA RUN? A DOCA runs as long as provided for in its terms, and until all obligations under the deed have been satisfied. The deed must state the duration of its operation and the moratorium period. A DOCA which does not specify an end date or ending conditions is not valid. ARE SECURED CREDITORS BOUND BY THE DOCA? A secured creditor is only bound by a DOCA if they become a party to the deed or otherwise agree to be bound by it. The Court may make an Order which limits the rights of the secured creditor, but this is not common. As mentioned above, if a secured creditor suffers a shortfall, then that debt falls within the provisions of the DOCA. HOW DOES A DOCA AFFECT GUARANTEES FROM DIRECTORS? Creditors holding guarantees from directors or other people are bound by the moratorium during the voluntary administration period. Guarantees can be enforced once a DOCA is signed or the company is wound up. The release of the company s debt under the terms of the DOCA does not discharge a guarantor s liability for any shortfall. CAN CREDITORS VARY THE DOCA AFTER IT HAS BEEN EXECUTED? Yes, creditors can vary or terminate the DOCA by resolution at a meeting of creditors. This meeting must be convened by the administrator at the request of at least ten percent of the value of all creditors. Alternatively, the administrator may convene such a meeting of creditors if he or she believes a variation would be beneficial. Any amendment to the terms of the DOCA must also have the consent of the company. Creditors also have the right to make an application to the Court for the DOCA to be varied or indeed, terminated. WHAT HAPPENS TO TAX LOSSES? A company proposing a DOCA is likely to have tax losses. These losses are usually preserved, however they may be lost or reduced if a company fails to pay its creditors 100 cents in the dollar. Directors should seek tax advice before proposing a DOCA which contemplates tax losses being available after the end of the DOCA. CAN A DEED ADMINISTRATOR PAY DIVIDENDS? Yes. A deed administrator s ultimate role is to pay a dividend to creditors. HOW SHOULD THE COMPANY BE DESCRIBED? While subject to a DOCA a company must advertise its status. For example, ABC Pty Ltd should be described as ABC Pty Ltd (Subject to Deed of Company Arrangement) on all public documents. WHEN DOES A DOCA END? The Deed of Company Arrangement ends when its terms are fully completed, or if a creditor makes application to the Court for it to be terminated and subsequently the Court grants such an Order. WHAT HAPPENS IF THE COMPANY DOES NOT COMPLY WITH THE DOCA? If the terms of a DOCA are not satisfied, it will be considered to be in default. Usually a default notice will be issued by the Deed Administrator within a few days after the default. If the default is not rectified within the period set out in the notice, the agreement will be breached. The DOCA may contain enforcement provisions or the deed administrator may have access to guarantees etc. The DOCA may also be terminated by: (i) the provisions of the agreement, automatically terminating the DOCA; (ii) the passing of a resolution at a meeting of creditors; or (iii) an application to the Court, and the granting of an Order. These options usually result in the company being placed into liquidation. 22 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

25 CORPORATE INSOLVENCY MEMBERS VOLUNTARY WINDING UP 1 WHAT IS A MEMBERS VOLUNTARY WINDING UP? This is the process of winding up a solvent company. It is done when the members no longer wish to retain the company structure. There can be a number of reasons for the members wanting to do this, but usually it is because the company has reached the end of its useful life. If the company is wound up at a meeting of its members, it is called a voluntary winding up. If the company is solvent when it is wound up, it is a called members voluntary winding up. WHY CHOOSE A MEMBER S VOLUNTARY WINDING UP? This is the only process for fully winding up the affairs of a solvent company. It ensures that outstanding creditors are paid in full and protects the members interests while the company structure is dismantled and any surplus assets are distributed to its members. WHEN IS A COMPANY SOLVENT? Usually a company is only considered solvent if it can pay all of its debts as and when they fall due. This strict definition does not apply to member s voluntary winding up. A company is deemed solvent if it will be able to pay its creditors within 12 months after the appointment. The liquidator must convert the members voluntary winding up (for a solvent company) to a creditors voluntary winding up (for an insolvent company) if they form the opinion that all creditors will not be paid in full within that 12 month period. HOW IS THE PROCESS STARTED? The directors will resolve to call a meeting of the members to wind up the company. The directors must complete a declaration of solvency stating that the company is solvent and that the company can pay all its debts within 12 months. This declaration is lodged with ASIC prior to the members meeting. At the meeting the resolution is passed to place the company into liquidation. The solvent company is wound up on the resolution of its members at the duly convened meeting. WHAT IS THE EFFECT ON THE COMPANY? The company structure itself survives the appointment, but not the liquidation. The control of all assets, the conduct of any business and other financial affairs are transferred to the liquidator. The directors cease to have any authority. All bank accounts are frozen, any employment can be terminated, but necessary labour may be engaged by the liquidator. At the end of the liquidation, the liquidator will apply to ASIC for the company to be deregistered, after which the company will cease to exist. CAN A COMPANY TRADE WHILE IN LIQUIDATION? The liquidator may continue trading a business if they believe that it will be in the best interest of creditors. This is usually done if there is a prospect to sell the business as a going concern or to complete and sell any work-in-progress. The liquidator has the obligation to end trading and wind up the affairs of the company as quickly, but as commercially, as practical. WHAT MUST THE DIRECTORS DO TO HELP THE LIQUIDATOR? The directors must supply to the liquidator all of the information about the company s financial affairs and provide a Report as to Affairs (detailing the assets and liabilities of the company as at the date of appointment of the liquidator) and a Director s Questionnaire. The directors must also deliver all company books and records to the liquidator, and co-operate with the liquidator throughout the liquidation. There are various offence provisions that relate to directors who do not co-operate with liquidators. THE INVESTIGATION PROCESS There is no need for many of the investigations that would normally be carried out in other types of liquidation. As the company is solvent and creditors should be paid in full, there is no need for any recovery actions to be initiated. Issues like preferential payments and insolvent trading do not apply as most of these recovery actions require the company to have been insolvent at the time of the transaction or a loss to creditors. Liquidators may have to verify what assets are available to them. It is not uncommon that some of these assets are loans that have been made to shareholders, and sometimes these loans are either in dispute or not well recorded. Sometimes the liquidator will have to reconstruct these loan accounts to determine the extent and amounts of the debts. The liquidator will also have to ensure that the proper distribution is made to members through the capital accounts of the company. This entails some investigation work into the company s balance sheet, particularly capital reserve accounts and franking accounts. Generally the company s external accountant will be able to provide a detailed and up to date balance sheet showing all equity accounts. The liquidator will strive to pay the distribution to members in the most tax advantageous manner. This is generally why the liquidator will want the Balance Sheet prepared in some detail and will want to satisfy himself that the distribution is done correctly. MEMBERS VOLUNTARY WINDING UP 23

26 1 MEMBERS VOLUNTARY WINDING UP MEMBERS VOLUNTARY WINDING UP HOW LONG DOES THE PROCESS LAST? The liquidation lasts for as long as is necessary. Selling assets and paying creditors will usually occur within the first few months. The process of completing the company s financial statements and final tax returns could potentially delay the distribution to members, particularly if there is a dispute between the members. Clearance from the ATO is essential before a member s voluntary liquidation can be finalised. CAN A LIQUIDATOR PAY DIVIDENDS? Yes. The role of the liquidator is to sell the company s assets and distribute them amongst: (a) the company s creditors as a dividend; and then (b) the shareholders of the company as a distribution. ARE THE DIVIDENDS PAID UNDER CERTAIN PRIORITIES? Yes. The liquidator must pay dividends under a set of priorities. These include: (a) the costs and expenses of the liquidation; (b) employee entitlements; (c) non-priority creditors; then (d) members. While these priorities will be followed by the liquidator, all creditors should be paid in full within the first 12 months. HOW DOES THE PROCESS END? The process ends when the liquidator calls a final meeting of the company s members. This meeting will be called only after all creditors have been satisfied, all other issues have been resolved and any surplus has been distributed to the members. This meeting is a statutory process and attendance by members is optional. The company will be automatically de-registered by ASIC three months after the final meeting is held. WORRELLS NEVERS... Never deal in cash. It will ruin your judgment, your reputation and your balance sheet. More than what you save in tax is lost in personal and business capital. 24 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

27 CORPORATE INSOLVENCY PREFERENCES IN LIQUIDATIONS 1 WHAT ARE PREFERENCES? These are payments or transfers of assets that gives a creditor a preference or advantage over other creditors. Any payments or transfers made to a creditor prior to the liquidation may be recovered by liquidators in certain circumstances. Preferences are usually payments of money, though a variety of transactions could be deemed preferential. WHO MAY RECOVER PREFERENTIAL PAYMENTS? In corporate insolvencies, only liquidators may recover preferential payments, however it may require an Order of a Court to perfect the entitlement to recovery. Recovering preferences is within the ambit of the liquidator and is not available to provisional liquidators, voluntary or deed administrators or receivers and managers. WHY DO LIQUIDATORS VOID PREFERENTIAL PAYMENTS? The liquidator s main role is to distribute the company s assets between its creditors on a pari passu or equal basis. To do so they must determine whether any creditor has received treatment that would have given them a distribution, before the liquidation, that was not equitable when compared to the distribution to other creditors in the liquidation. Liquidators are able to void transfers that involve one creditor so that they can make a more equitable distribution to all creditors, including the creditor who may have received the preference. WHAT ARE THE ELEMENTS OF A PREFERENTIAL PAYMENT? Before a Court will Order the recovery of a preferential payment, it must be satisfied that: (a) a transaction was entered into (this is usually a payment of monies); (b) it was between the company and a creditor of the company; (c) it occurred at a time when the company was insolvent; (d) it occurred within the statutory period before the liquidation commenced; (e) the transaction gave the creditor an advantage over other creditors; and (f) the creditor suspected or had reason to suspect that the company was insolvent. WHEN IS A COMPANY INSOLVENT? The Corporations Act defines solvency as the state of being able to pay one s debts as and when they fall due. Conversely, if a company is not solvent it is therefore insolvent. In simple terms, insolvency means an inability to pay ones debts as they become due and payable. In the context of preferences, the company must have either been insolvent at the time of the transaction, or became insolvent because the transaction was made. The reasoning is that a solvent company has the capacity to pay all of its debts (whether they actually did or not) and therefore no creditor could have been advantaged over the others. WHO HAS TO PROVE INSOLVENCY? The onus of proving insolvency lies with the liquidator. THE MAIN ELEMENTS OF A PREFERENCE (a) there must be a debtor/creditor relationship The transfer must have involved or been done at the direction of a creditor, and must have satisfied a debt that would have been a provable debt if the transfer had not been done. A cash on delivery (COD) payment for goods is not a payment to a creditor by its very nature, so can never be deemed as preferential. However, we often see situations where suppliers will provide goods on a COD basis with an additional requirement for further payment towards satisfaction of an existing debt. This additional payment is deemed preferential and could therefore be recovered by the liquidator. A payment in advance for future works or the future supply of goods cannot be preferential, but would be required to be repaid to the company in the case of liquidation pursuant to other provisions. (b) there must be a transaction There must be a transaction between the parties. It is common for a transfer to be a payment of monies from a company s bank account, although any asset passing from the company to the creditor will be sufficient to establish a transaction. For example, the return of stock which is not subject to retention of title (ROT), or an assignment of a debt would be a transaction for the purposes of the preference provisions. (c) the relevant time period The transaction must have occurred during a specific time period before the relation back day. The actual time period depends on whether the recipient is related to the company, and the intention of the directors of the company. These time periods are: six months - for non-related parties; four years - if the recipient is related to the company; and ten years - if there is evidence of any attempt to defeat, delay or interfere with the rights of creditors. PREFERENCES IN LIQUIDATIONS 25

28 1 PREFERENCES IN LIQUIDATIONS PREFERENCES IN LIQUIDATIONS The relation back day is the date on which the liquidation is deemed to have commenced. For the various types of Liquidations, the relevant days are as follows: (i) for a liquidation which follows a voluntary administration or Deed of Company Arrangement, it is the day that the voluntary administrators were first appointed; (ii) for other voluntary liquidations, it is the date of the members meeting at which the liquidators were appointed; (iii) for an official liquidation (a Court appointment) it is the day that the application was filed in the Court. (d) the debt must be unsecured A preference cannot be given to a creditor holding a valid and subsisting security over company assets, where the value of the assets secured is greater than the amount of the payment. But if the security is not properly created or registered, or the value of the security is less than the amount of the payment, the payment may be rendered void by the liquidator and the debt may be deemed unsecured. Other provisions also apply to securities provided to related entities and created within six months of the commencement of the liquidation. The creation of a security itself within the six months can also be a preference. (e) continuing business relationship The continuing business relationship provision is similar to what was known as a running account. It is used to determine the amount of any preference received by a particular creditor by taking into account all of the transactions between the relevant dates. It determines whether the debt owed to the creditor increased or decreased during that period. If the balance owing during this period to the creditor decreased, the decrease is the potential preference amount (all other factors considered). If the balance owing increased over the period, there is no preference as the creditor has actually been disadvantaged by the series of transactions. The period under review commences on a date determined by the liquidator and concludes on the date of the commencement of the winding up. (f) the creditor must obtain a preference The creditor must have received more than they would have received if they had refunded the monies and proved for that amount in the liquidation process. This is purely a mathematical calculation. If the creditor did not receive more by way of the payment than they would have received from a dividend, there is no advantage or preferential treatment. WHAT DEFENCES ARE AVAILABLE TO CREDITORS? Section 588G of the Corporations Act provides a number of defences which may be available to creditors who have received preferential payments. A recipient of a likely preference must be able to satisfy all three conditions of the defence. If they cannot satisfy even one of the conditions, the defence is not available. It is up to the recipient to prove the satisfaction of the conditions, not for the liquidator to disprove them. The three conditions of the statutory defence are: 1. The creditor gave valuable consideration for the payment; 2. The creditor received the payment in good faith; and 3. The creditor had no reason to suspect the insolvency of the company. We explore each of these conditions in detail below: (a) What is valuable consideration? The easiest condition to prove is usually that the recipient gave valuable consideration. If the recipient is a trade creditor, the initial supply of goods or services would provide the valuable consideration. A loan creditor can rely upon the initial loan to the company. The creditor will only have to show that they have given something of value in consideration for receiving the payment. (b) What is good faith? The creditor must not have acted in any manner that would indicate that they were not acting in good faith or under normal trading conditions. Actions that may repute good faith are; commencing proceedings or issuing statutory notices to the company, ceasing supply to the company, changing to a COD basis etc. They must not have forced the payment to be made by any form of threat or action. (c) What is needed to suspect insolvency? The creditor must not have received or have known of any information or circumstance that would lead them (or a reasonable person in their position) to suspect that the company was insolvent. It is not necessary that the creditor knew, or believed, or even expected that the company was insolvent to lose the benefit of this defence. The mere suspicion of a reasonable person is enough. Actions such as receiving post dated cheques, having cheques dishonoured, entering into repayment agreements, knowing of other creditors that are unpaid and pressing for payment can reasonably lead to this suspicion. Whether or not a person should have suspected insolvency is often difficult to determine particularly as the Courts recognise a distinction between a shortterm cash flow problem and insolvency. 26 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

29 CORPORATE INSOLVENCY 1 WHAT SHOULD CREDITORS DO IF A LIQUIDATOR CLAIMS A PREFERENTIAL PAYMENT? They should ensure that: (i) the transaction was entered into within the relevant time period; (ii) they are not a secured creditor; (iii) they are (or were) a creditor when the transaction was made and that the payment was not a COD type transaction; (iv) the liquidator demonstrates that they received an advantage over other creditors by virtue of the payment. These are the basic points and are usually easy to show. The following points are more difficult to determine: 1. Whether the creditor gave extra credit to the company after the payment or transfer was received. It is possible that the claim may be reduced or eliminated by the amount of extra credit granted. That is, to determine whether the creditor had a continuing business relationship with the company; 2. That the liquidator can show insolvency at the time of or before the payment was received; 3. Whether the creditor has a realistic chance of convincing WHAT CAN CREDITORS DO IF THEY ARE REQUIRED TO REFUND MONEY TO A LIQUIDATOR? Creditors refunding preferences may lodge a proof of debt with the liquidator for the amount refunded. They may also have some rights under any guarantees given by other parties who support that debt. HOW LONG DOES THE LIQUIDATOR HAVE TO MAKE A CLAIM? Claims have to be commenced within three years after the relation back day. It is not sufficient for the liquidator to only have made a formal demand within that period; they must issue proceedings within that time period. An extension of this time-frame may be granted by the Court, but the application must be made within the three year period after the relation back day, and the liquidator will need to demonstrate to the Court a reasonable reason for the delay in initiating the claim. PREFERENCES IN LIQUIDATIONS WORRELLS NEVERS... Never overlook getting accurate and up to date accounts. If your accountant cannot get them done, get an accountant who can. 27

30 1 INSOLVENT TRADING INSOLVENT TRADING WHAT IS INSOLVENT TRADING? Insolvent trading occurs when a director allows their company to incur debts at a time when it was insolvent. A claim for compensation may be made by the liquidator against that director if those debts are left unpaid when the liquidation commences. The director may be held personally liable to compensate creditors for the amount of those unpaid debts incurred from the time the company became insolvent to the date of commencement of the liquidation. WHY DO LIQUIDATORS MAKE THESE CLAIMS? Directors have a duty to stop a company from incurring debts that it is not able to pay. Allowing an insolvent company to incur those debts is a breach of the director s duty required by the Corporations Act, which is designed to prevent directors from recklessly incurring debts and avoiding personal liability. Directors may have to pay compensation to the company for losses creditors have incurred under that breach of duty. WHO MAKES INSOLVENT TRADING CLAIMS? Liquidators have the first opportunity to make these claims. If it is decided not to take such action, creditors may commence their own actions, but these claims are limited to the amount of their individual debts only. WHAT ARE THE FACTORS IN AN INSOLVENT TRADING CLAIM? Apart from the company being in liquidation: 1. the claims must be made against people who were directors of the company at the time that the debts were incurred; 2. the company must have been insolvent when the debts were incurred; 3. there were reasonable grounds for the director to suspect that the company was insolvent; and 4. the debts must remain unpaid at the time of the winding up. WHO ARE DIRECTORS? Directors are not exclusive to being appointed as directors, and recorded in the company register or notified to ASIC. People who act as a director, even if not formally appointed, may be defined as such. Shadow or de facto directors, or other parties that controlled the company at the relevant time may be exposed to an insolvent trading claim. The Corporations Act definition of director is: (a) a person who: (i) is appointed to the position of a director; or (ii) is appointed to the position of an alternate director and is acting in that capacity; regardless of the title of their position; and (b) unless the contrary intention appears, a person who is not validly appointed as a director if: (i) they act in the position of a director; or (ii) the directors of the company or body are accustomed to act in accordance with the person s instructions or wishes. The definition excludes people who give advice as part of their normal professional role. This exclusion will include accountants, managers and other paid consultants. The exclusion reads: Subparagraph (b)(ii) does not apply merely because the directors act on advice given by the person in the proper performance of functions attaching to the person s professional capacity, or the person s business relationship with the directors or the company or body. WHEN IS THE COMPANY INSOLVENT? A company is insolvent when it cannot pay its debts as and when they become due and payable. The test is an inability to pay debts when they need to be paid. The legislation defines solvency and insolvency in the following terms: Section 95A - Solvency and Insolvency (1) A person is solvent if, and only if, the person is able to pay all the person s debts, as and when they become due and payable. (2) A person who is not solvent is insolvent. A person is defined to include a corporation. WHY MUST THE COMPANY HAVE BEEN INSOLVENT WHEN THE DEBT IS INCURRED? The company must have either been insolvent at the time of incurring the debt, or became insolvent because of incurring the debt, for the claim to exist. A solvent company has the capacity to pay all of its debts as they fall due and, hence, the directors could reasonably believe that any debt incurred would be paid when due, even if it had not been paid when the liquidation commenced. Claims against directors are based on a breach of the Act, and that breach contemplates a director knowing that the company would not be able to pay the debt and yet still allowed the company to incur it. 28 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

31 CORPORATE INSOLVENCY 1 WHAT ARE DEBTS INCURRED AND DEBTS ACCRUED? The debt must be incurred, not just accrued, when the company is insolvent. There is a distinction between the two. Incurring a debt is the legal creation of a debt that did not previously exist. Accrued debts usually relate to ongoing contractual agreements. These types of contractual agreements are incurred at the time of entering into the original agreement and only become payable (or accrue) at a later date. As long as the original agreement was entered into while the company was solvent, and the later amounts only accrue because of that original contract, they will not form part of an insolvent trading claim as they were not incurred - they did not come into existence - when the company was insolvent. For example, lease payments which become due on a regular basis, under contract that was entered into prior to the insolvency of the company will not form part of the insolvent trading claim HOW DO DIRECTORS BECOME LIABLE FOR THESE CLAIMS? Section 588G sets out the director s duty to prevent insolvent trading and sets the parameters by which the liquidator can initiate the process for making a claim against the director. Directors contravene this section by allowing the company to incur the debt when they are aware that there were grounds for suspecting that the company was insolvent. Once a director has breached the duty set out in section 588G, the provisions of section 588M will allow a recovery of compensation from that director. A claim is possible where the director has contravened section 588G; the creditors suffered loss or damage because of the company s insolvency; and the debt was wholly or partly unsecured. Section 588G Director s duty to prevent insolvent trading by company (1) This section applies if: (a) a person is a director of a company at the time when the company incurs a debt; and (b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including the debt; and (c) at that time, there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, as the case may be; and (d) that time is at or after the commencement of this Part. (2) By failing to prevent the company from incurring the debt, the person contravenes this section if: (a) the person is aware at that time that there are such grounds for so suspecting; or (b) a reasonable person in a like situation in a company in the company s circumstances would be so aware. Breaching this provision gives grounds for the liquidator to make a claim against the director. Once this breach of 588G occurs, the provisions of section 588M will allow a recovery action to be taken against that director by the liquidator. The circumstances where recovery action is possible pursuant to section 588M are as follows: (1) This section applies where: (a) a person (in this section called the director) has contravened subsection 588G(2) or (3) in relation to the incurring of a debt by a company; and (b) the person (in this section called the creditor) to whom the debt is owed has suffered loss or damage in relation to the debt because of the company s insolvency; and (c) the debt was wholly or partly unsecured when the loss or damage was suffered; and (d) the company is being wound up; whether or not (e) the director has been convicted of an offence in relation to the contravention; or (f) a civil penalty Order has been made against the director in relation to the contravention. (2) The company s liquidator may recover from the director, as a debt due to the company, an amount equal to the amount of loss or damage. WHAT DEFENCES ARE AVAILABLE TO DIRECTORS? The Corporations Act provides statutory defences that may be available to directors. They can be summarised as: 1. The director had reasonable grounds to expect (not just suspect) that the company was solvent; 2. A reasonable, competent person was producing information that would reasonably lead to a belief that the company was solvent; 3. The director had a good reason for not taking part in the management of the company at the relevant time (not whether he did or not, but whether he had a good reason not to); or 4. The director took all reasonable steps to stop the company from incurring the debt, including attempting to appoint a voluntary administrator to the company. The burden of proving the defences is placed upon directors. The Courts have made it clear that the position of director carries certain responsibilities which cannot be avoided, including the duty to keep informed about the company s solvency. INSOLVENT TRADING 29

32 1 INSOLVENT TRADING INSOLVENT TRADING IS INSOLVENT TRADING AN OFFENCE? Yes. Insolvent trading may be an offence and may be referred to ASIC for further investigation and possible criminal prosecution. These matters are best dealt with by directors by seeking their own legal advice. Section 588G - Director s duty to prevent insolvent trading by company goes on to stipulate: (3) A person commits an offence if: (a) the person is a director of the company when it incurs a debt; and (b) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and (c) the person suspected at the time when the company incurred the debt that the company was insolvent or would become insolvent as a result of incurring that debt or other debts (as in paragraph (1)(b); and (d) the person s failure to prevent the company incurring the debt was dishonest. CAN CREDITORS TAKE INSOLVENT TRADING ACTIONS? Yes. If a liquidator does not make a claim, the creditors of the company (individually or in a group) may make a claim themselves. The creditors may commence an action at any time with the written consent from the liquidator. Creditors may ask the liquidator to give them consent up to six months after the liquidation commences. Creditors can only take actions against directors for their individual debts. Unlike liquidators, they cannot group all creditors debts into their claim. The Corporations Act will stop the creditor from commencing action when the liquidator has begun proceedings or has intervened in an application for a civil penalty Order. That is, claims will be restricted when the liquidator has already started their own action. HOW LONG DO LIQUIDATORS HAVE TO TAKE AN INSOLVENT TRADING ACTION? The Corporations Act allows liquidators six years from the beginning of the liquidation to commence an action for insolvent trading. Proceedings must have been commenced within that six year period. It is not sufficient just to issue a demand. WHAT SHOULD YOU DO IF A LIQUIDATOR MAKES A CLAIM? You should ask the liquidator to demonstrate: 1. That the company was insolvent during the appropriate period; and 2. That the debts were incurred after that time; and 3. That you were a director at that time (whether formally appointed as such or not). If you are able to settle the matter with the liquidator, you should ensure that the settlement is sanctioned by the Court (usually by way of a Consent Order). This will provide protection from any future potential claims made by creditors of the company. WORRELLS NEVERS... Never sink your money into a business that you don t fully understand. There is no better recipe for disaste r. 30 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

33 CORPORATE INSOLVENCY UNREASONABLE DIRECTOR RELATED TRANSACTIONS 1 WHAT IS AN UNREASONABLE DIRECTOR RELATED TRANSACTION? A transaction is an unreasonable director related transaction if it involves a director or close associate (as defined) of the company and had no or little benefit to the company (i.e. it was unreasonable for the company to enter into the transaction). The Corporations Act sometimes will require the other party to the transaction to return an asset or make a payment to the liquidator. WHO RECOVERS AN UNREASONABLE DIRECTOR RELATED TRANSACTION? Only liquidators may seek recovery of these transactions. They are not available to provisional liquidators, voluntary administrators, deed administrators or controllers. It is also not available to trustees in bankruptcy. WHAT IS THE BASIS OF THE CLAIM? The liquidator must prove that: 1. a transaction was entered into; 2. a director or close associate of the director was involved in the transaction; and 3. either there was no benefit to, or there was a detriment to the company. WHY RECOVER AN UNREASONABLE DIRECTOR RELATED TRANSACTION? One of a liquidator s functions is to examine whether the company entered into any transactions that reduced the amount of assets that are available for distribution in the winding up. If there are such transactions, the liquidator will seek recovery of those assets transferred or money in compensation in Order to make a more equitable distribution to creditors. WHAT AMOUNT MAY BE RECOVERED? The liquidator may recover the difference between the value that was provided by the company and the value that was provided to the company in the transaction. Only the excess between the two values is recoverable. WHAT ARE THE MAIN ELEMENTS OF UNREASONABLE DIRECTOR RELATED TRANSACTIONS? 1. the transaction - There must be a transaction involving the company. It may have been a payment, a transfer or disposition of property, the issue of securities, or incurring an obligation or commitment to make a payment, disposition or issue. The section is designed to cover money or assets actually leaving the company, or commitments like security interests being made over money or assets. 2. a director or close associate must have been involved. The payment, disposition or issue must involve one of a few parties related to the company, or more correctly, the director of the company. One of the other parties to the transaction must be either a: (i) (ii) a director of the company, a close associate of a director of the company, or (iii) a nominee person acting on behalf of or for the benefit of a director or their close associate. This third class of people has been added to stop a director related party disguising their involvement by including another person in the transaction, but where the related party still receives the benefit of the transaction. WHO IS A DIRECTOR? A director is defined as someone that: (i) is appointed to the position of a director; or (ii) is appointed to the position of an alternate director and is acting in that capacity; regardless of the name that is given to their position; and (b) unless the contrary intention appears, a person who is not validly appointed as a director if: (i) (ii) they act in the position of a director; or the directors of the company or body are accustomed to act in accordance with the person s instructions or wishes. WHO IS A CLOSE ASSOCIATE? A close associate is: (1) a relative or de facto spouse of a director, or (2) a relative of a spouse or of a de facto spouse, of the director. A relative is a spouse, parent or remoter lineal ancestor, son, daughter or remoter issue, or brother or sister of the person. 3. Why is a transaction unreasonable? The company must benefit from the transaction for it to be reasonable. If the benefits of the transaction to the company are outweighed by the detriment to the company, it is deemed unreasonable. The liquidator will look for a reduction in the net asset position of the company caused by the transaction to determine whether it is reasonable or not. WHAT IS A REASONABLE PERSON TEST? The Court will look at the transaction from the eyes of a reasonable person in the company s circumstances. This is someone that has knowledge of the financial position of the company, who is not trying to gain a personal benefit or give a benefit to anyone else, or cause a loss to the company. It may be assumed that a reasonable person would not enter into a transaction that would cause detriment or reduction in assets to the company. UNREASONABLE DIRECTOR RELATED TRANSACTIONS 31

34 1 UNREASONABLE DIRECTOR RELATED TRANSACTIONS UNREASONABLE DIRECTOR RELATED TRANSACTIONS WHAT TIME PERIOD IS INVOLVED? An unreasonable director related transaction must have been entered into within four years before the relation back day, or between the relation back day and the appointment day. The relation back day is the day on which the liquidation legally commences. There are three possibilities: 1. For a liquidation that followed a voluntary administration - it is the day that on which the administrators were first appointed to the company, even if a Deed of Company Arrangement was in effect in the intervening period; 2. For an official liquidation (Court appointment) - it is the day on which the application was filed. This is usually a few weeks before the Order; 3. For a creditor s voluntary winding up - it is the date of the members meeting resolving to wind up the company. DOES THE COMPANY NEED TO BE INSOLVENT? No. The company does not need to have been insolvent at the date of the transaction, or have become insolvent because of the transaction. This also means that the statutory defences available to parties in other recovery actions - the defence of good faith and no reasonable grounds to suspect insolvency - are not relevant. In fact they are specifically excluded. WHAT RELIEF IS AVAILABLE TO THE LIQUIDATOR? Recovery applications are limited to a relief available under section 588FF, but these cover almost every practical option. The most common relief sought is the return of the monies or assets received by the other party. In this case however, recovery is limited to the excess, or the unreasonable benefit of the transaction. The whole transaction is not voided, unless there was no reasonable part to it. Therefore a recovery is generally the payment of money. HOW LONG DOES THE LIQUIDATOR HAVE TO MAKE A CLAIM? Claims must be made within three years after the relation back day. That is, an application for recovery must be filed within that three year period. It is insufficient for the liquidator to only have issued a demand within that period. WORRELLS NEVERS... Never advance funds to your own company, or guarantee your company s debts, without taking a security from the company at the same time. 32 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

35 CORPORATE INSOLVENCY UNCOMMERCIAL TRANSACTIONS 1 WHAT ARE UNCOMMERCIAL TRANSACTIONS? Liquidators investigate transactions that they believe either not be beneficial to, or were in fact detrimental to, the company. These transactions are called uncommercial transactions. The Corporations Act permits the voiding of these transactions and stipulates the provisions in which the other party to the transaction to return an asset or make a payment to the liquidator. WHO MAY VOID UNCOMMERCIAL TRANSACTIONS? Only liquidators may seek to void uncommercial transactions. This recovery is not available to provisional liquidators, voluntary administrators, deed administrators or controllers. There are similar provisions under the Bankruptcy Act that apply to personal insolvency estates. WHAT MAKES AN UNCOMMERCIAL TRANSACTION VOIDABLE? The transaction must: 1. have had no financial benefit to or have been detrimental to the company; 2. have occurred at a time when the company was insolvent; and 3. have involved another party who must have or should have suspected that the company was insolvent. WHY VOID UNCOMMERCIAL TRANSACTIONS? One of a liquidator s functions is to make an equitable distribution of the company s assets to its creditors. To do so they must determine whether the company entered into any transaction that reduced the amount of assets available for distribution. The liquidator will want to recover these assets or its monetary equivalent in Order to make that equitable distribution. WHAT MAKES A TRANSACTION UNCOMMERCIAL? A transaction is uncommercial if it had no or limited financial benefit, or was detrimental to the financial position of the company. The usual test is whether the transaction reduced the net asset position of the company. This is generally determined by whether a reasonable person in the company s position would have entered into the transaction given those circumstances. The heart of the section is commerciality. Although not limited to these, two major circumstances that are uncommercial are when (a) the company disposes of an asset for less than its true value; or (b) the company purchases something at a price that is more than its true value. These are usually done with related entities. MUST THE COMPANY BE INSOLVENT AT THE TIME? The company must have either been insolvent at the time of the transaction, or became insolvent because of the transaction. Section 95A defines insolvency as not being able to pay ones debts as and when they fall due. The reasoning that the company must be insolvent is that a solvent company has the capacity of paying all of its debts and the transaction could not have caused a detriment to creditors. WHAT IS THE TRANSACTION? Uncommercial transactions are generally sales, transfers or purchases of assets or services, though under these provisions any transaction can be included. What may be considered a transaction is very, but there must be an identifiable transaction. WHAT IS THE REASONABLE PERSON TEST? The Court will look at the transaction from the eyes of a reasonable person in the company s circumstances, who has knowledge of the financial position of the company, and who is not trying to gain a personal benefit, or give a benefit to anyone else, or cause a loss to the company. The Court assumes that a reasonable person would not enter into a transaction that causes a detriment or reduction of assets to the company. WHAT TIME PERIODS ARE APPLICABLE? There are various time periods before the relation back day during which the transaction must occur. These are: six months - for non-related parties; four years - if the recipient is related to the company; and ten years - if there is any attempt to defeat, delay or interfere with the rights of creditors. The relation back day is the day on which the liquidation is deemed to have commenced. For a liquidation which follows a voluntary administration, it is the day that the administrators were first appointed. For other voluntary liquidations, it is the date of the members meeting winding up the company. For an official liquidation (a Court appointment) it is the day that the application was filed in the Court. UNCOMMERCIAL TRANSACTIONS 33

36 1 UNCOMMERCIAL TRANSACTIONS UNCOMMERCIAL TRANSACTIONS WHAT DEFENCES ARE AVAILABLE TO THE OTHER PARTIES TO TRANSACTIONS? The Corporations Act sets out the statutory defences that are available to parties to a transaction. The other party to the transaction must be able to prove all three arms for the defence in Order to rely on it. The three arms of the statutory defence are: 1. valuable consideration was given 2. the creditor acted in good faith 3. there was no reason to suspect insolvency A creditor must be able to prove all three parts of the statutory defence. If they cannot prove even one of these arms, the entire defence fails. The onus is on the recipient to prove their defence, not the liquidator to disprove them. WHAT IS VALUABLE CONSIDERATION? The easiest condition to prove is usually that the recipient gave valuable consideration. If the recipient is a trade creditor, the initial supply of goods or services would provide the valuable consideration. A loan creditor can rely upon the initial loan to the company. The creditor will only have to show that they have given something of value in consideration for receiving the payment. WHAT IS GOOD FAITH? The creditor must not have acted in any manner that would indicate that they were not acting in good faith or under normal trading conditions. Actions that may repute good faith are; commencing proceedings or issuing statutory notices to the company, ceasing supply to the company, changing to a COD basis etc. They must not have forced the payment to be made by any form of threat or action. WHAT IS NEEDED TO SUSPECT INSOLVENCY? The creditor must not have received or have known of any information or circumstance that would lead them (or a reasonable person in their position) to suspect that the company was insolvent. It is not necessary that the creditor knew, or believed, or even expected that the company was insolvent to lose the benefit of this defence. The mere suspicion of a reasonable person is enough. Actions such as receiving post dated cheques, having cheques dishonoured, entering into repayment agreements, knowing of other creditors that are unpaid and pressing for payment can reasonably lead to this suspicion. Whether or not a person should have suspected insolvency is often difficult to determine particularly as the Courts recognise a distinction between a shortterm cash flow problem and insolvency. Often the other party to the transaction is a related party and proving knowledge or suspicion of insolvency is easier. HOW LONG DOES THE LIQUIDATOR HAVE TO MAKE THE CLAIM? Claims have to be commenced within three years after the relation back day. It is not sufficient for the liquidator to only have made a formal demand within that period; they must issue proceedings within that time period. An extension of this time-frame may be granted by the Court, but the application must be made within the three year period after the relation back day, and the liquidator will need to demonstrate to the Court a reasonable reason for the delay in initiating the claim. WORRELLS NEVERS... Never confuse cash flow with profits. 34 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

37 CORPORATE INSOLVENCY SECTION 588FH PREFERENCES TO RELATED PARTIES 1 INTRODUCTION Section 588FH is one of the recovery provisions in the Corporations Act available to liquidators. The section allows liquidators to recover monies from entities related to the company, where: (a) an unfair preference has been made to a third party creditor under section 588FA, or an uncommercial transaction under section 588FB has been entered into, and (b) the effect of that transaction is to release the related entity from an obligation to that creditor. In most cases the transaction under examination is an unfair preference and we will explore that premise further. Under the above circumstances, the liquidator will be able to claim the unfair preference from the creditor, and claim the amount of the payment (or more correctly the amount of the reduction in the obligation) from the related entity. The maximum amount that the liquidator can recover from both parties combined is the amount of the payment - they cannot recover the full amount twice. The reasoning behind this section of the Act, is that the creditor was likely to have been preferred (received the preferential payment) in Order that the related party (usually a family member of the director or the director them self) is released from a financial obligation. The creditor received preferential treatment by receiving the payment, but the related party also receives preferential treatment by having their obligation reduced or eliminated. PROVING THE CLAIM The liquidator will need to prove two separate things to be able to make a claim against the related party. They are: 1. that the creditor received an unfair preference or was party to a transaction void under section 588FE; and 2. the related party had an obligation released. The liquidator will not be able to take the claim against the related party if they cannot prove both of these components. The job is made slightly easier as the liquidator only needs to prove that the unfair preference to the creditor is voidable under section 588FE, not that the statutory defences available to the creditor can be defeated. This could lead to a position where the creditor received a preferential payment and can rely on the defences, but the related party is still liable under the section. To prove the positive factors of an unfair preference, the liquidator will need to show the transaction: (i) gave the creditor a preference or advantage over other creditors; (ii) was an insolvent transaction (it was done while the company was insolvent); and (iii) was entered into within the relevant time period (usually 6 months before the relation-back day); These factors are summarised below. PREFERENCE TO A THIRD PARTY The transaction must be preferential to the creditor, but it does not have to be collectable from the creditor if the defences apply. To be preferential, the creditor must be an unsecured creditor and have received more from the transaction than they would have if they had proved for their debt in the liquidation and received a dividend. This is generally a simple mathematical calculation. Practically these positive factors are relatively easy to prove. Section 588FA states: CORPORATIONS ACT - SECTION 588FA Unfair preferences (1) A transaction is an unfair preference given by a company to a creditor of the company if, and only if: (a) the company and the creditor are parties to the transaction (even if someone else is also a party); and (b) the transaction results in the creditor receiving from the company, in respect of an unsecured debt that the company owes to the creditor, more than the creditor would receive from the company in respect of the debt if the transaction were set aside and the creditor were to prove for the debt in a winding up of the company; even if the transaction is entered into, is given effect to, or is required to be given effect to, because of an Order of an Australian Court or a direction by an agency. (2) For the purposes of subsection (1), a secured debt is taken to be unsecured to the extent of so much of it (if any) as is not reflected in the value of the security. INSOLVENT TRANSACTIONS To be preferential, the transaction to the creditor must be an insolvent transaction as defined by the Act. A transaction is an insolvent transaction if it is: 1. an unfair preference or an uncommercial transaction, and 2. it was entered into at a time when the company was insolvent, or the company became insolvent because of the transaction. ` SECTION 588FH PREFERENCES TO RELATED PARTIES 35

38 1 SECTION 588FH PREFERENCES TO RELATED PARTIES SECTION 588FH PREFERENCES TO RELATED PARTIES CORPORATIONS ACT - SECTION 588FC Insolvent transactions A transaction of a company is an insolvent transaction of the company if, and only if, it is an unfair preference given by the company, or an uncommercial transaction of the company, and: (a) any of the following happens at a time when the company is insolvent: (i) the transaction is entered into; (ii) an act is done, or an omission is made, for the purpose of giving effect to the transaction; or (b) the company becomes insolvent because of, or because of matters including: (i) entering into the transaction; or (ii) a person doing an act, or making an omission, for the purpose of giving effect to the transaction. If the company was not insolvent at the time of the transaction or did not become insolvent because of the transaction, there will be no unfair preference and no section 588FA or section 588FH claim. The definition of solvency and insolvency is set out in section 95A CORPORATIONS ACT - SECTION 95A Solvency and insolvency (1) A person is solvent if, and only if, the person is able to pay all the person s debts, as and when they become due and payable. (2) A person who is not solvent is insolvent. THE TIME PERIOD To be a preferential payment, the insolvent transaction must be a voidable transaction under section 588FE. To be voidable, the transaction must have occurred within the relevant time periods as set out in section 588FE. An unfair preference that is attached to the reduction of an obligation to that creditor is usually made to a non-related creditor who holds a guarantee from a related party. Therefore the most common time period considered under section 588FE starts six months before the start of the winding up (called the relation-back day). If the unfair preference was made to a related party a four year period will apply. CORPORATIONS ACT SECTION 588FE Voidable transactions (2) The transaction is voidable if: (a) it is an insolvent transaction of the company; and (b) it was entered into, or an act was done for the purpose of giving effect to it: (i) during the 6 months ending on the relation-back day; or (ii) after that day but on or before the day when the winding up began. The relation-back day is variable depending on how the company was originally wound up. The three common ways for a company to be wound up and therefore three possible relation-back day calculations: 1. the date of the filing of the winding up application (Court appointment); 2. the date of the appointment of a voluntary administrator - if a liquidation results from that appointment; or 3. the date of the member s resolution appointing a voluntary liquidator - if the company was wound up voluntarily. relation-back day, in relation to a winding up of a company or Part 5.7 body, means: (a) if, because of Division 1A of Part 5.6, the winding up is taken to have begun on the day when an Order that the company or body be wound up was made-the day on which the application for the Order was filed; or (b) otherwise-the day on which the winding up is taken because of Division 1A of Part 5.6 to have begun. Once these three factors have been proved, the liquidator will determine whether the positive factors of an unfair preference apply and a prima facie claim can be made against the creditor, and whether or not a claim can be made against the related entity. THE RELATED ENTITY WHAT IS A RELATED ENTITY? A creditor must have received the unfair preference, but the obligation that was released must have been given to that creditor by an entity related to the company as defined in the Corporations Act. The 588FH claim is brought about because the related party received a benefit from the fact that the creditor received an advantage from the original unfair preference. The related entity is usually a director or member of the company; a beneficiary under a trust of which the company is the trustee; or a close relative of any of theseentities. The definition is as follows: related entity, in relation to a body corporate, means any of the following: (a) a promoter of the body; (b) a relative of such a promoter; (c) a relative of a spouse of such a promoter; (d) a director or member of the body or of a related body corporate; (e) a relative of such a director or member; (f) a relative of a spouse of such a director or member; (g) a body corporate that is related to the first-mentioned body; 36 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

39 CORPORATE INSOLVENCY 1 (h) a beneficiary under a trust of which the first-mentioned body is or has at any time been a trustee; (i) (j) a relative of such a beneficiary; a relative of a spouse of such a beneficiary; (k) a body corporate one of whose directors is also a director of the first-mentioned body; (l) a trustee of a trust under which a person is a beneficiary, where the person is a related entity of the first-mentioned body because of any other application or applications of this definition. relative, in relation to a person, means the spouse, parent or remoter lineal ancestor, child or remoter issue, or brother or sister of the person. The liquidator must show that the party that had the obligation released (not the creditor that received the payment) falls into one of these categories. RELEASE FROM AN OBLIGATION The provisions allow recovery of compensation from a related entity when a transaction was entered into that: (a) disadvantaged the body of creditors by reducing the available assets (the unfair preference), and (b) advantaged the related entity by releasing a obligation that they had granted. The amount of the compensation claim is the amount of the advantage received by the related party, which is the amount of the obligation released because of the payment. That advantage may not be the same amount of the payment - but it usually is. For example: A creditor is owed $1,000 and the related party had guaranteed that debt to a limit of $800. An unfair preference is paid to the creditor of $1,000 leading to a 588FA claim against the creditor for $1,000. But because the obligation released was only for $800, the 588FH claim against the related party is limited to $800. Also: If the creditor was owed $2,000 and was fully guaranteed by the related party (to the amount of $2,000), but only received an unfair preference of $1,000 - the creditor would be subject to a $1,000 claim and the related party would be subject to a $1,000 claim as their obligation had been reduced by that amount. But only one of these amounts (or a combined total of $1,000) maybe collected. That obligation released is commonly a guarantee given by the related entity, but it can be any obligation and under any other form of security or document (e.g. a registered security or mortgage over the related party s property). The liquidator just needs to show that this commercial obligation existed and was at least partially released. CORPORATIONS ACT - SECTION 588FH Liquidator may recover from related entity benefit resulting from insolvent transaction (1) This section applies where a company is being wound up and a transaction of the company: (a) is an insolvent transaction of the company; and (b) is voidable under section 588FE; and (c) has had the effect of discharging, to the extent of a particular amount, a liability (whether under a guarantee or otherwise and whether contingent or otherwise) of a related entity of the company. (2) The company s liquidator may recover from the related entity, as a debt due to the company, an amount equal to the amount referred to in paragraph (1)(c). LIMITATION OF CLAIM The Act limits the amount that may be claimed from the creditor to the amount of the unfair preference less what has already been collected from the related party, if anything. The claim against the related party may be limited to the amount of the reduction in the obligation less any amount already recovered from the creditor, if anything. The Court will look at what amounts have already been recovered and adjust the amount of any later claims accordingly. The unfair preference recovery - a claim under 588FA - is sought under section 588FF of the Act. That section provides relief for all claims that are void under section 588FE. Claims under section 588FH are not void under section 588FE, they are void under 588FH. The 588FH claim against the related party is sought under subsection (2). CORPORATIONS ACT - SECTION 588FH Liquidator may recover from related entity benefit resulting from insolvent transaction (2) The company s liquidator may recover from the related entity, as a debt due to the company, an amount equal to the amount referred to in paragraph(1)(c). But the amount of any recovery under section 588FF for the unfair preference, the Court must take into account any recovery made against the related party. CORPORATIONS ACT - SECTION 588FH Liquidator may recover from related entity benefit resulting from insolvent transaction (3) In deciding what Orders (if any) to make under section 588FF on an application relating to the transaction, a Court must take into account any amount recovered under subsection (2) of this section. SECTION 588FH PREFERENCES TO RELATED PARTIES 37

40 1 SECTION 588FH PREFERENCES TO RELATED PARTIES SECTION 588FH PREFERENCES TO RELATED PARTIES There is no particular Order in which the liquidator has to take these two actions. They are likely to take the easiest claim first, and due to the fact that the statutory defences are not available to the related entity, the easiest claim is likely to be against the related entity. Once a recovery action is taken against the related party, that party will then gain the same rights that they would have received if they had discharged the obligation to the extent of the payment. For example the related party made a payment to the creditor under the guarantee. These rights would generally arise from a right to indemnities or subrogation into the creditor s position. CORPORATIONS ACT - SECTION 588FH Liquidator may recover from related entity benefit resulting from insolvent transaction. (4) If the liquidator recovers an amount under subsection (2) from the related entity, the related entity has the same rights: (a) whether by way of indemnity, subrogation, contribution or otherwise; and (b) against the company or anyone else; as if the related entity had paid the amount in discharging, to the extent of that amount, the liability referred to in paragraph (1)(c). DEFENCES AND TIMEFRAME STATUTORY DEFENCES - NOT AVAILABLE The Act provides statutory defences for creditors against claims by liquidators for recovery of unfair preferences. These defences are set out in section 588FG of the Act. Importantly, these defences are only available to the creditor that received the preference, and not to the related entity that had the obligation released. That is, they are not technically available when considering whether the creditor received a preference or not for the purposes of this section. In Order to make a claim against the related party, the liquidator only needs to show that the transaction (the preference) is a voidable transaction under section 588FE, not that it is actually recoverable from the creditor when the defences are taken into account. The reasoning is that the defences apply to the actions and knowledge of a party that has had dealings with the company, usually at arm s-length. The related party has not had those types of dealings in relation to the obligation released and is not at arm s-length. Because the defences are available to the creditor, it is possible that recovery may be possible against the related party, but not against the creditor. TIMEFRAME FOR CLAIMS A liquidator does not have an endless time period to investigate and commence claims against creditors for unfair preferences. The Act provides that these claims must be made within three years after the relation back day, that is, an application to Court must be made within that three year period. It is insufficient for the liquidator to only have made a demand within that period An extension may be granted by the Court, but the application for the extension must be made within the three year period, and the liquidator will need a good reason for the delay. CORPORATIONS ACT - SECTION 588FF Courts may make Orders about voidable transactions (3) An application under subsection (1) may only be made: (a) within 3 years after the relationback day; or (b) within such longer period as the Court Orders on an application under this paragraph made by the liquidator within those 3 years. Section 588FH does not require an Order under section 588FF and the section does not set any time limit for the claims to be made against the related entity. CORPORATIONS ACT - SECT 588FF Courts may make Orders about voidable transactions pursuant to Section 588F(1) of the Corporations Act, if a Court is satisfied, on the application of a company s liquidator, that a transaction of the company is voidable because of section 588FE. The claim against the related party can be made even though no claim has been made against the creditor within the time period. Using the same logic as is the case with the statutory defences, the preference only needs to be void under section 588FE. The time limit applies to claims made against the creditor under section 588FF, which does not apply in relation to claims made against the related party. 38 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

41 CORPORATE INSOLVENCY DIRECTOR S LIABILITIES FOR COMPANY DEBTS 1 CAN DIRECTORS BE LIABLE FOR COMPANY DEBTS? Yes, and this may happen even when the directors have taken some remedial action in an attempt to solve the company s financial problems. The areas of potential liability: (a) Insolvent Trading Compensation Claims; (b) Unreasonable Director-Related Transactions; (c) Loss of Employee Entitlement Claims; (d) (e) (f) Taxation Debts; Personal Guarantees; Directors of Corporate Trustees. WHAT ARE THE DIFFERENCES BETWEEN THESE CLAIMS? The three main differences are: (a) who has the right to take the claim; (b) whether the company has to be in liquidation or not; and (c) how the liability arises. In summary: 1. Insolvent trading claims are made by a liquidator or creditors of a company, only when the company is in liquidation, and arise from a claim for compensation under the Corporations Act. 2. Unreasonable director related transaction claims are made by a liquidator of a company, only when the company is in liquidation, and arise from a claim for compensation under the Corporations Act. 3. Loss of employee claims are made by a liquidator or creditors of the company, only when the company is in liquidation, and arise from a claim for compensation from a contravention of section 596AB of the Corporations Act. 4. Personal liability for taxation debts are collected by the Australian Taxation Office (ATO) and arise from the provisions of the Tax Act. The company does not need to be in external administration. 5. Claims under personal guarantees are made by the creditors holding the personal guarantees and arise from the guarantee document. The company does not need to be in external administration. 6. Corporate trustee claims arise from the provisions of the Corporations Act. The company does not need to be in external administration and the creditor may make the claim. WHO IS A DIRECTOR? Section 9 of the Corporations Act provides a broad definition of the term director that includes appointed directors, and de facto and shadow directors. This is applicable to people that act in the capacity of a director, albeit when they are not appointed as such. That is, people do not have to be formally appointed as a director of a company to be liable for some of these claims. INSOLVENT TRADING WHEN IS A DIRECTOR LIABLE FOR INSOLVENT TRADING? Section 588G of the Corporations Act provides that directors have a duty to prevent a company from insolvent trading. Insolvent trading occurs when a company incurs a debt that it cannot (and does not) pay, at a time when the director knew or should have known that the company was insolvent. The Corporations Act makes a director liable to pay an amount of compensation equal to the amount of the debts. IS A DIRECTOR AUTOMATICALLY LIABLE? Liability arises automatically from the provisions of the Corporations Act, but in reality, the claim will have to be proven by the liquidator or the creditor. The liquidator does not need to issue any notices or demands to make the director liable for this claim. Conversely the ATO has to issue director penalty notices to be able to collect tax debts. ARE THERE ANY DEFENCES AVAILABLE TO DIRECTORS? Section 588H provides defences available to directors to defend these claims. Directors will not be liable if they can establish: (a) (b) (c) they had reasonable grounds to expect that the company was solvent; they did not participate in management due to illness or some other good reason; they took all reasonable steps to prevent the company from incurring the debt. WHAT ARE ALL REASONABLE STEPS? The Act gives the Courts some guidance by stating: the matters to which regard is to be had include, but are not limited to: (a) (b) (c) any action the person took with a view to appoint an administrator of the company; and when that action was taken; and the result of that action. The appointment of a voluntary administrator or a liquidator to a company will mitigate a directors exposure to insolvent trading, but may not eliminate a claim for debts incurred prior to the appointment. WHAT AMOUNT MAY BE RECOVERED? The claim is for compensation for losses resulting from insolvent trading. The amount of the claim is equal to the amount of debts incurred through the period that the company was insolvent and remain unpaid at the time of liquidation. 39 DIRECTOR S LIABILITIES FOR COMPANY DEBTS

42 1 DIRECTOR S LIABILITIES FOR COMPANY DEBTS DIRECTOR S LIABILITIES FOR COMPANY DEBTS 40 WHAT TIME PERIOD DOES THE LIQUIDATOR HAVE TO MAKE THE CLAIM? The liquidator has six years from the date of appointment to commence a recovery action against a director for insolvent trading. UNREASONABLE DIRECTOR RELATED TRANSACTIONS WHEN IS A DIRECTOR LIABLE FOR THIS CLAIM? Directors will be liable to compensate the company for losses if they cause the company to enter into a transaction that may be classified as a director related transaction and was unreasonable when considering the benefit of the transaction to the company. WHAT IS A DIRECTOR RELATED TRANSACTION? The types of transactions encompassed under these provisions are: (a) payments of money made by the company; (b) conveyances, transfers or other dispositions by the company of property of the company; (c) the issue of securities by the company; or (d) the incurring of an obligation to make such a payment, disposition or issue (including contingent obligations). To be director-related, the transaction must involve one of the following types of people: (i) a director of the company; (ii) a close associate of a director of the company; (iii) a person on behalf of, or for the benefit of, a one of a director or close associate. WHAT IS A CLOSE ASSOCIATE? A close associate is defined in section 9 as a relative or de facto spouse of the director; or a relative of a spouse, or of a de facto spouse, of the director. WHAT MAKES A TRANSACTION UNREASONABLE? A transaction is unreasonable if a reasonable person in the same circumstances as the company would not have entered into the transaction when considering: (a) any benefits that the company may have obtained; (b) any detriment to the company; (c) any benefits to other parties to the transaction; (d) any other relevant matters. Essentially if a reasonable person who was not going to personally benefit from the transaction would not have entered into that transaction, it is likely to be classified as unreasonable. HOW A DIRECTOR IS MADE LIABLE? The director automatically becomes liable to compensate the company s liquidator for the amount of the transaction, but in reality the liquidator will have to prove the elements of the claim. The Act outlines the types of relief available, but the type of compensation is dependent on the type of the transaction. WHAT IF THE TRANSACTION WAS ORDERED BY THE COURT? Even in the case of Court Ordered transactions, if it meets the criteria the director will be liable under section 588FDA: (3) A transaction may be an unreasonable director-related transaction under subsection (1): (a) whether or not a creditor of the company is a party to the transaction; and (b) even if the transaction is given effect to, or is required to be given effect to, because of an Order of an Australian Court or a direction by an agency WHAT AMOUNT MAY BE RECOVERED? The claim is for the amount of loss suffered by the company as a result of entering into the transaction. Any extra consideration given above that which would have been reasonable compared against the benefits received from the transaction, can be recovered from the director or close associate. That is, if an asset was sold for undervalue to a director, the director will have to pay extra consideration to that which would have been reasonable for that asset. WHAT TIME PERIOD IS APPLICABLE? The transaction must also have occurred, or action was taken for the purposes of giving effect to the transaction, during the four years before the winding up commenced. LOSS OF EMPLOYEE ENTITLEMENTS CLAIMS HOW CAN THE DIRECTOR BE MADE LIABLE FOR THESE DEBTS? The liquidator or employees have a right to make a claim against a director if the company entered into a transaction that reduced the amount of assets available to pay priority employee entitlements in a liquidation. These are described as an agreement or transaction to avoid employee entitlements. WHAT CAUSES A CONTRAVENTION OF THESE PROVISIONS? Section 596AB(1) of the Corporations Act says: A person must not enter into a relevant agreement or a transaction with the intention of, or with intentions that include the intention of: (a) preventing the recovery of the entitlements of employees of a company; or (b) significantly reducing the amount of the entitlements of employees of a company that can be recovered. A director is in contravention if they cause the company to enter into one of these agreements or transactions and have the requisite intention in doing so. A contravention of this section activates section 596AC and gives the liquidator the right to make a recovery claim. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

43 CORPORATE INSOLVENCY 1 WHEN DOES A DIRECTOR BECOME LIABLE FOR THAT CLAIM? A director becomes liable to either the liquidator, or in some circumstances an employee, if they: (a) contravene section 596AB in relation to the entitlements of employees of a company; and (b) the company is being wound up; and (c) the employees suffer loss or damage because of: (i) the contravention; or (ii) action taken to give effect to an agreement or transaction involved in the contravention. WHAT AMOUNT MAY BE RECOVERED? The amount of a claim is calculated as an amount equal to the loss caused by entering into that transaction. The loss itself is limited to the amount of priority employee entitlements that cannot be paid due to reduction in the available assets caused by the transaction or agreement. WHAT HAPPENS WHEN MONIES ARE RECOVERED? Employees are given priority to any compensation recovered by the liquidator under the Act. Priority also extends to other parties that would have been entitled to priority claims under section 560. TAXATION DEBTS CAN A DIRECTOR BE LIABLE FOR THE COMPANY S TAX DEBTS? Yes. Directors are exposed to the company s tax liabilities if the company fails to remit a tax instalment or other deductions, and does not comply with a director s penalty notice. Directors may also become liable if the ATO has to refund monies to a liquidator under the unfair preference provisions (section 588FGA of the Corporations Act), or when the company enters into and breaches a section 222ALA Income Tax Assessment Act( ITAA ) repayment agreement. WHAT ARE THE DIRECTOR S RESPONSIBILITIES? At the due date for the payment of tax, the director must cause the company to: 1. pay the amount deducted; 2. enter into an arrangement with the ATO for payment of the amount; 3. appoint a voluntary administrator to the company; or 4. wind up the company (within the meaning of the Corporations Act). If the director does not do one of these things before the tax is due, they will become personally liable for a penalty in the amount of the unremitted tax. However, the ATO is not able to collect that penalty. WHAT IF THE ATO DOES NOT HAVE DETAILS OF THE AMOUNT OF TAX DUE? If the amount of the tax liability is unknown, an estimate of the debt may be made by the ATO and any recovery action may be based on that estimate. An estimate is only made after the due date for payment has passed and when the returns have not been lodged. The company is automatically liable for these debts. The director is also personally liable, but the amount cannot be collected until the ATO takes further steps and permits the director another opportunity to take remedial action. WHAT DOES THE ATO HAVE TO DO TO MAKE A DIRECTOR LIABLE? Nothing. If a company fails to pay its tax debts by the due date, the directors automatically become liable for a penalty equal to the unremitted amount or the estimate calculated by the ATO. The penalty is referred to as a parallel liability, as it is a separate liability from the company s liability. That is, both the director and the company owe the full amount separately. Payment of one amount, however, will reduce the amount of liability of the other. CAN THE ATO RECOVER THE AMOUNT FROM THE DIRECTOR WITHOUT FURTHER ACTION? No. Recovery from a director can only occur after the director has been given written notice of the penalty in the form of a director s penalty notice. Provided the director causes the company to adopt one of the above four choices set out in that notice within 21 days of the date of the notice, the penalty due by the director (not the debt of the company) will be deemed as remitted in full. That is, the director may avoid having to pay the penalty, but the company will still be liable for the original debt. WHAT IF THE DIRECTOR DOES NOTHING IN THE 21 DAYS AFTER THE DPN IS ISSUED? Failure to take one of the specified actions within the 21 days of the DPN being issued (usually mailed) will allow the ATO to collect the penalty from the director. Commissioner must give notice of penalty (1) The Commissioner must not commence proceedings to recover from you a penalty payable under this Subdivision until the end of 21 days after the Commissioner gives you a written notice under this section. Content of notice (2) The notice must: (a) set out what the Commissioner thinks is the unpaid amount of the company s liability under its obligation; and (b) state that you are liable to pay to the Commissioner, by way of penalty, an amount equal to that unpaid amount because of an obligation you have or had under this Division; and (c) explain the main circumstances in which the penalty will be remitted. (3) To avoid doubt, a single notice may relate to 2 or more penalties, but must comply with subsection (2) in relation to each of them. DIRECTOR S LIABILITIES FOR COMPANY DEBTS 41

44 1 DIRECTOR S LIABILITIES FOR COMPANY DEBTS DIRECTOR S LIABILITIES FOR COMPANY DEBTS ARE THERE DEFENCES AVAILABLE TO THE DIRECTOR? Yes. The Tax Act contains certain statutory defences similar to the Corporations Act insolvent trading defences. Directors have a defence if: (a) due to illness or some other good reason [the director] did not take part in the management of the company at the time the remittance was due to be paid; (b) the director took all reasonable steps to cause the company to comply; or (c) no such steps could have been taken. WHAT ABOUT PREFERENCES RECOVERED FROM THE ATO? Section 588FGA of the Corporations Act makes directors liable to the ATO for payments originally made by the company to the ATO and subsequently set aside as preferential and refunded to the liquidator. That is, if a liquidator forces the ATO to return money, the directors become liable to the ATO for that amount, plus any costs that the ATO is Ordered to pay to the liquidator. The Act states: (1) This section applies if the Court makes an Order under section 588FF against the Commissioner of Taxation because of the payment of an amount in respect of a liability under any of the following provisions of the Income Tax Assessment Act 1936: (aa) section 220AAE, 220AAM or 220AAR; (a) section 221F (except subsection 221F(12)), section 221G (except subsection 221G(4A)) or section 221P; (b) subsection 221YhDC(2); (c) subsection 221YhZD(1) or (1A); (d) subsection 221YN(1); (e) section 222AhA; WHAT ABOUT SECTION 222ALA REPAYMENT AGREEMENTS? Sometimes companies enter into repayments agreements with the ATO under section 222ALA of that Act. This is a formal agreement to allow the company to repay a debt over a certain period. The directors of the company - any person that was a director when or after the agreement was entered into are responsible to comply with the agreement and making all of the relevant payments. If that agreement is breached, directors will automatically become personally liable for any amounts that remain unpaid under the agreement. This liability arises under the ITAA and the ATO does not need to issue any notices or make any demands to make the directors liable. They will generally just issue a demand for payment. (1) If a company incorporated under the Corporations Act makes an agreement with the Commissioner under section 222ALA of this Act, the persons who are directors of the company from time to time must cause the company to comply with the agreement. (2) If the company contravenes the agreement by failing to pay a specified amount on or before the specified day, or by contravening a special condition, each person who was a director of the company at any time during the period beginning on the day when the agreement was made and ending on the day of the contravention is liable to pay to the Commissioner, by way of penalty, an amount equal to the balance payable under the agreement. PERSONAL GUARANTEES WHAT IS A PERSONAL GUARANTEE? A personal guarantee is a binding agreement entered into by a third party (in this case a director) and a creditor of the company where the guarantor agrees to pay the debts of the company to that creditor, if the company does not pay them. DOES AN INSOLVENCY ADMINISTRATION DISRUPT THIS AGREEMENT? No. A personal guarantee is a separate third party agreement between the director (the guarantor) and the creditor. Nothing that happens to the company, or any action by an administrator or liquidator, will disrupt the validity of the personal guarantee. The only exception is that a personal guarantee cannot be exercised during the period of a voluntary administration, but can be exercised immediately after that period ends. DOES THE CREDITOR NEED TO DO ANYTHING TO MAKE THE GUARANTOR LIABLE? No, the guarantee document itself makes the guarantor liable. WHAT IF THE GUARANTOR PAYS THE CREDITOR? If a guarantor pays the creditor in full, they have the right to stand in the shoes of the creditor under a right of subrogation. This effectively replaces the creditor with the guarantor and the guarantor will have the same rights against the company as the creditor. The important factor is that the creditor must have been paid in full for any right of subrogation to exist. This right does not exist partially. Under this section liability extends to being a director at the time of the original payment to the ATO and not just when the company was wound up. 42 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

45 CORPORATE INSOLVENCY 1 WHAT IS THE AMOUNT OF THE LIABILITY? That depends on the guarantee, but typically it will be the full amount owing to the creditor by the company. WHEN DO DIRECTORS USUALLY ENTER INTO PERSONAL GUARANTEES? Directors commonly sign guarantees when they enter into a credit agreement with a supplier. The guarantee is generally in the terms and conditions or sometimes will be a separate document. Guarantees are also part of any funding package from banks and other inancial institutions. DOES THE COMPANY HAVE TO BE IN LIQUIDATION FOR A CLAIM TO BE MADE? No. As the guarantee is a separate agreement between the director and the creditor, the company does not been to be in liquidation, or even insolvent, for the guarantee to be exercised. DIRECTORS OF CORPORATE TRUSTEES WHAT IS A CORPORATE TRUSTEE? WHEN ARE DIRECTORS LIABLE FOR DEBTS? For the director to be liable under these provisions, the following general circumstances must be present: (a) The company must be acting as a corporate trustee of a trust; (b) There must be an unpaid trust debt in the name of the company that was incurred while the company was acting as trustee of the trust; (c) The company must not be entitled to be fully indemnified against the liability out of trust assets (even if there are not sufficient assets) because of one or more of the following: (i) a breach of trust by the corporation; (ii) the corporation s acting outside the scope of its powers as trustee; (iii) a term of the trust denying, or limiting, the corporation s right to be indemnified against the liability. The main factor is that the corporate trustee, the company, cannot be entitled to be indemnified from the trust assets. If the company does have a full indemnity this section will not apply. However this will not eliminate a potential claim for insolvent trading. IS A DIRECTOR AUTOMATICALLY LIABLE? Yes. The liability is generated by statute, though it is common for directors to dispute the claim. Section 197 states: (1) A person who is a director of a corporation when it incurs a liability while acting, or purporting to act, as trustee, is liable to discharge the whole or a part of the liability if the corporation: (a) has not, and cannot, discharge the liability or that part of it; and (b) is not entitled to be fully indemnified against the liability out of trust assets. This is the case even if the trust does not have enough assets to indemnify the trustee. The person is liable both individually and jointly with the corporation and anyone else who is liable under this subsection. WHAT AMOUNT MAY BE RECOVERED? The amount is equal to the amount of the debts that are in the name of the corporate trustee and cannot be met from the assets of the trust. DIRECTOR S LIABILITIES FOR COMPANY DEBTS It is a company that acts in the capacity of a trustee of a trust. WORRELLS NEVERS... Never fool yourself into thinking that all of the items in your inventory have value. Probably much of it is obsolete or unsalable. Clear it out and write it off. 43

46 1 ENDING A LIQUIDATION ENDING A LIQUIDATION HOW CAN A COMPANY GET OUT OF LIQUIDATION? A liquidation usually ends with the in deregistration of the company. However, there are two other methods that a liquidation could end in. One involves a decision of the directors and the liquidator, and the other requires an Order of the Court. These alternatives are: 1. The liquidator appointing a voluntary administrator to the company which leads to a Deed of Company Arrangement; or 2. The Court Ordering the stay or termination of the winding up. WHEN WILL A LIQUIDATOR APPOINT A VOLUNTARY ADMINISTRATOR? Liquidators will appoint a voluntary administrator to a company when they believe creditors will receive a greater return under a proposed Deed of Company Arrangement (DOCA), rather than under the liquidation. The liquidator will have to be convinced that the proposed DOCA is worthwhile and is likely to be accepted. Once the DOCA has been accepted and signed, an application will be made to the Court to end the liquidation. WHEN DOES THE COURT END A LIQUIDATION? An application for an Order staying or terminating the winding up generally occurs shortly after the initial winding up was Ordered, but this is not essential. Technically the application can be made at any time, though it becomes less viable the longer the liquidation continues. WHICH COURT CAN MAKE A STAY ORDER? The power to wind up companies resides with the Federal Court of Australia, the Supreme Courts in each state and the Family Court of Australia. These Courts also have the jurisdiction to Order the stay or termination of a winding up. In most cases the application for a stay will be made in the Court that made the original winding up Order. However, it may be made to any of these Courts, and they may transfer these applications between the Courts. WHO CAN APPLY FOR THESE ORDERS? Most people would expect that the directors would apply for these Orders, effectively having the company resist the liquidation. However, the powers of directors are removed while the company is in liquidation. The residual powers of the directors only allows them to resist or appeal against the original winding up application or Order. Section 471A of the Act states: (1) While a company is being wound up in insolvency or by the Court, a person cannot perform or exercise, and must not purport to perform or exercise, a function or power as an officer of the company. Usually the liquidator will make the application after a Deed of Company Arrangement is signed, and a contributory or member of the company will make the application to stay or terminate the winding up. Section 482 contains the relevant provisions: (1) At any time during the winding up of a company, the Court may, on application, make an Order staying the winding up either indefinitely or for a limited time or terminating the winding up on a day specified in the Order. (1A) An application may be made by: (a) in any case - the liquidator, or a creditor or contributory, of the company; or (b) in the case of a company registered under the Life Insurance Act APRA. WHY WOULD THE COURT MAKE AN ORDER ENDING A LIQUIDATION? There are a number of reasons why an Order may be made in this scenario, including: (a) The winding up application and other material was not served upon the company in the proper manner, or in a way that did not allow the company to suitably defend it. That is, the process of winding up the company was deficient; (b) The company is solvent and should not have been wound up; (c) The liquidator has appointed a voluntary administrator and this has resulted in the company entering into a Deed of Company Arrangement. The liquidation would no longer be necessary; (d) It is just and equitable to do so for any other reason. WHAT FACTORS ARE CONSIDERED BY THE COURT? A 2002 decision by the NSW Supreme Court provides some insight to what the Courts may look for when considering these applications. The Judge in that case listed eight criteria: 1. The granting of a stay is a discretionary matter, and there is a clear onus on the applicant to make out a positive case for a stay; 2. There must be service of a notice of the application for a stay on all creditors and contributories, and proof of this; 3. The nature and extent of the creditors must be shown, and whether or not all debts have been or will be discharged; 44 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

47 CORPORATE INSOLVENCY 1 4. The attitude of creditors, contributories and the liquidator is a relevant consideration; 5. The current trading position and general solvency of the company should be demonstrated. Solvency is of significance when a stay of proceedings in the winding-up is sought; 6. If there has been non-compliance by directors with their statutory duties as to the giving of information or furnishing a Report as to Affairs, a full explanation of the reasons and circumstances should be given; 7. The general background and circumstances which led to the winding-up Order should be explained; 8. The nature of the business carried on by the company should be demonstrated, and whether or not the conduct of the company was in any way contrary to commercial morality or the public interest. WHAT HAPPENS TO THE COMPANY AFTER THE WINDING UP IS STAYED? The directors of the company will usually take control of the affairs of the company as soon as the Order is given. This may not be appropriate in some circumstances, particularly if the company was wound up due to disputes between directors and/or shareholders. If there is some disagreement between the directors and shareholders, the Court may make directions on the matter. The Act provides that: Where the Court has made an Order terminating the winding up, the Court may give such directions as it thinks fit for the resumption of the management and control of the company by its officers, including directions for the convening of a general meeting of members of the company to elect directors of the company to take office upon the termination of the winding up. ENDING A LIQUIDATION WORRELLS NEVERS... Never make an investment based on a perceived tax benefit. A tax benefit can make a good decision better but it can never make a bad decision good. 45

48 INSOLVENCY IMPACTS MANY STAKEHOLDERS DIFFERENTLY, ACROSS VARIOUS INDUSTRIES AND SECTORS, SOME OF WHICH ARE EXPLORED IN THIS SECTION. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

49 2 RELATED TOPICS PRIORITY EMPLOYEE ENTITLEMENTS 48 DIRECTOR PENALTY NOTICES 52 LENDING MONEY 58 SUBCONTRACTORS CHARGES 61 SECURITIES OVER ASSETS 63 SECURED APPOINTMENTS 65 DETERMINING INSOLVENCY 67 LANDLORD RIGHTS 71 47

50 2 PRIORITY EMPLOYEE ENTITLEMENTS PRIORITY EMPLOYEE ENTITLEMENTS HOW ARE EMPLOYEES AFFECTED BY THE INSOLVENCY OF THEIR EMPLOYER? Employees are usually the first creditors to be affected as their jobs will be at risk and there is a chance that some of their outstanding entitlements will not be covered by GEERS. Employees are a special class of creditor because the failure of their employer will often terminate their only source of income. Their position can be contrasted with most other creditors, who are likely to have other customers and may have taken security or obtained personal guarantees to support their debts. Because of this, both the Bankruptcy Act and the Corporations Act provide certain priorities for employee entitlements. WHO IS AN EMPLOYEE? The definition of employee under the Corporations Act is: employee, in relation to a company, means a person: (a) who has been or is an employee of the company, whether remunerated by salary, wages, commission or otherwise; and (b) whose employment by the company commenced before the relevant date. The Bankruptcy Act does not define employee, but gives priority to amounts payable by way of allowance or reimbursement under a contract of employment or under an award or agreement regulating conditions of employment. Usually it will not be difficult to determine if a person is an employee or an independent contractor. As a general rule services from a company, partnership or trust will not be regarded as having been supplied by an employee, especially if the service was supplied under an ABN. This definition is blurred when a sole person gives full-time service to one customer as an independent contractor. DOES THE CORPORATIONS ACT OR BANKRUPTCY ACT APPLY? This will depend on the legal status of the employer - whether the employer is a company, or an individual or partnership. (a) If the employer is a company or is incorporated under that Act - the Corporations Act applies; and (b) If the employer is a natural person(s) - or a business owned by a natural person(s) - the Bankruptcy Act will apply. These two Acts deal with employee entitlements differently. Employees need to be sure of the legal status of their employer when making a claim. If the employer is in administration under either Act, the external administrator will make this distinction clear to employees. SHOULD EMPLOYEES PROVIDE A TAX FILE NUMBER TO THE EXTERNAL ADMINISTRATOR? Yes. Employees will have tax withheld from their dividends at the top marginal rate if a Tax File Number (TFN) is not provided. Most employee proofs of debt forms provide a space for TFNs. WHAT PRIORITY DOES THE CORPORATIONS ACT PROVIDE? Section 556 lists the priorities for dividends including employee entitlement priorities in a liquidation and, unless employees disagree in a DOCA. The following extract of section 556 should be read in conjunction with the remainder of the section, but it gives an indication of the priority provisions: (e) subject to subsection (1A)-- next, wages, superannuation contributions and superannuation guarantee charge payable by the company in respect of services rendered to the company by employees before the relevant date; (f) next, amounts due in respect of injury compensation, being compensation the liability for which arose before the relevant date; (g) subject to subsection (1B)--next, all amounts due: (i) on or before the relevant date; and (ii) because of an industrial instrument; and (iii) to, or in respect of, employees of the company; and (iv) in respect of leave of absence; (h) subject to subsection (1C)--next, retrenchment payments payable to employees of the company. Entitlements will be paid in the Order of the priorities. Each level must be paid in full before any payment can be made on the next level. Any level not paid in full will be paid on a pro-rata basis. Usually the priorities paid in most liquidations are: All wages and superannuation Leave entitlements Retrenchment payments WHO IS AN EXCLUDED EMPLOYEE? These priorities are modified for some amounts owing to current and past directors, and for relatives of directors. These people are called excluded employees. Subsections (1A), (1B) and (1C) limit the amount available to an excluded employee to a statutory amount. The definition of an excluded employee is: 48 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

51 RELATED TOPICS 2 An excluded employee, in relation to a company, means: (a) an employee of the company who has been: (i) at any time during the period of 12 months ending on the relevant date; or (ii) at any time since the relevant date; or who is, a director of the company; (b) an employee of the company who has been: (i) at any time during the period of 12 months ending on the relevant date; or (ii) at any time since the relevant date; or who is, the spouse of an employee of the kind referred to in paragraph (a); or (c) an employee of the com any who is a relative (other than a spouse) of an employee of the kind referred to in paragraph (a). WHO ELSE HAS PRIORITY UNDER THE ACT? There are two other parties that may obtain a priority over unsecured creditors for employee entitlements. They are: 1. GEERS This is the government scheme that provides payment of most of the employee entitlements (excluding superannuation). GEERS is subrogated into the position of the employees when it makes payments to; Section 560 gives people who provide money to the company for the payment of employee entitlements the same priority as the employee would have had if the money had not been provided and the employee could make a priority claim. This is essentially the same subrogation of the priority as GEERS. 2. Section 560 gives people who provide money to the company for the payment of employee entitlements the same priority as the employee would have had if the money had not been provided, the employee had not been paid and the employee could make a priority claim. This is essentially the same subrogation principle as the priority for GEERS. DO EMPLOYEES HAVE PRIORITY OVER SECURED CREDITORS? Sometimes. Secured assets can be either fixed or floating depending on their nature. Employees will usually have priority over floating assets. This priority is granted by section 561 of the Corporations Act. WHAT PRIORITY DOES THE BANKRUPTCY ACT PROVIDE? Section 109 (e) fifth, in payment of amounts (including amounts payable by way of allowance or reimbursement under a contract of employment or under an award or agreement regulating conditions of employment, but not including amounts in respect of long service leave, extended leave, annual leave, recreation leave or sick leave), not exceeding in the case of any one employee $1,500 or such greater amount as is prescribed by the regulations for the purposes of this paragraph, due to or in respect of any employee of the bankrupt, whether remunerated by salary, wages, commission or otherwise, in respect of services rendered to or for the bankrupt before the date of the bankruptcy (f) sixth, in payment of all amounts due in respect of compensation payable under any law of the Commonwealth or of a State or Territory relating to workers compensation, being compensation the liability for which accrued before the date of the bankruptcy; (g) seventh, in payment of all amounts due to or in respect of any employee of the bankrupt, whether remunerated by salary, wages, commission or otherwise, in respect of long service leave, extended leave, annual leave, recreation leave or sick leave in respect of a period before the date of the bankruptcy; Employees are only entitled to receive a limited amount of their wages entitlements as a priority, but they are permitted their full amount of leave entitlements. Any amount above the wages limit will rank alongside other creditors as non-priority. There is no priority for retrenchment payments. WHAT IS GEERS? GEERS is a program for employee entitlements introduced in 2001 by the Department of Workplace Relations in response to some of the spectacular failures of major public companies. These failures left thousands of employees owed many millions of dollars in entitlements that they were never likely to receive. GEERS was put in place to make certain that some payments would be made to employees of insolvent employers. To be able to make a claim under the scheme, employment must have been terminated due to the employer s insolvency - a liquidation in the case of a corporate employee. If the reason for the termination of employment is not insolvency, no claim will be possible. The GEERS systems cover the following employee entitlements: (a) All unpaid wages; (b) All accrued annual leave; (c) All accrued long service leave; (d) Up to five weeks pay in lieu of notice; and (e) Up to eight weeks redundancy entitlements (as per community standards). PRIORITY EMPLOYEE ENTITLEMENTS 49

52 2 PRIORITY EMPLOYEE ENTITLEMENTS PRIORITY EMPLOYEE ENTITLEMENTS CAN ALL EMPLOYEES MAKE A CLAIM? No. If the termination was not due to the insolvency of the employer, or if the employment was transferred to another entity (usually along with the business), no claim will be possible. No claim will be possible at all if; (i) the employee was a shareholding director or a relative of a shareholding director; (ii) the employee was a defined relative of the former employer That is, the employee would be classified as an excluded employee under the Corporations Act. Employees also cannot make a claim if: (i) they were an independent contractor; (ii) they lodge their claim more than 12 months after the employment was terminated; or (iii) they resigned from their employment (in most cases). HOW IS A CLAIM MADE? The insolvency practitioner will calculate the entitlements owed to the employees and will determine whether there are sufficient funds available for payments of entitlements. If there are not sufficient funds, they will prepare a claim with GEERS. Employees will need to complete the standard claim form and will forward these to the practitioner to be submitted with the other claims. This form sets out and verifies the claim made by the employee. After payment of the claims to the employee, the Department will be substituted into the place of the employees and receive any dividend that would have been paid under the priority provisions. WHAT ABOUT UNPAID SUPERANNUATION? Employers are required to remit employer superannuation contributions within 28 days after the end of each quarter. If the employer fails to do so, they are expected to lodge a Superannuation Guarantee statement with the ATO. Failure to do so, will enable the ATO to make a default assessment of outstanding superannuation. If the ATO makes an assessment of unpaid superannuation, default or otherwise, they can lodge a proof of debt for the Superannuation Guarantee shortfall. The superannuation guarantee Shortfall comprises of: 1. The super not remitted; 2. A penalty; and 3. Interest. WHO CAN PROVE FOR UNPAID SUPERANNUATION? In simple terms, only the Australian Tax Office can lodge a proof of debt for outstanding statutory superannuation. Section 553AB of the Corporations Act provides that outstanding superannuation contributions are not provable if those contributions form part of a superannuation guarantee charge assessed by the Australian Taxation Office. There are only a few instances when an employee may also lodge a proof of debt for superannuation: 1. When the employer contributions are payable under a contract of employment rather than an award or pursuant to the Superannuation Guarantee levy. This would e unusual. 2. Employee or member contributions into superannuation (not employer contributions) that have been deducted but not forwarded by the employer to the superannuation fund. 3. where, for whatever reason, the superannuation contributions outstanding will not form part of a superannuation guarantee charge. It is also evident that an employee can lodge a proof of debt for any agreed excess employer contributions over the minimum levy, but only if the ATO does not include these amounts in their claim. None of which is substantiated in any legislation. There does not appear to be any circumstances where a trustee of a superannuation fund can prove a claim in an estate. The rationale for this is the fund trustee s duties are simply to hold the funds received on trust, rather than enforce any level of payment. WHAT PRIORITY IS GIVEN TO THE SUPERANNUATION GUARANTEE SHORTFALL? The rules differ slightly under the Corporations Act and the Bankruptcy Act. Under the Corporations Act, superannuation contributions and the superannuation guarantee charge are included in the same priority as wages. These will be paid in full or on a pro-rata basis with outstanding wages. Excluded employees superannuation (whether under the charge or not) is also included in section 556 and caught by the statutory limitation to their priority. That is, they will only be allocated $2,000 between wages, superannuation and the superannuation charge. 50 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

53 RELATED TOPICS 2 Under the Bankruptcy Act, the superannuation guarantee charge is also included in the same priority for wages, but is limited to the statutory level for all employees. Section 109 of the Bankruptcy Act gives a priority for amounts: due or in respect of any employee of the bankrupt and includes unpaid superannuation due to section 109(1C). The reference in paragraph (1)(e) to amounts due to or in respect of any employee of the bankrupt also includes a reference to amounts due as superannuation guarantee charge (within the meaning of the superannuation guarantee (Administration Act 1992), or general interest charge in respect of nonpayment of the superannuation guarantee charge. That means that the statutory level will be divided between outstanding wages and superannuation, including claims for excess or contract contributions. Amounts above the statutory limit will be able to be claimed as a non-priority creditor. PRIORITY EMPLOYEE ENTITLEMENTS WORRELLS NEVERS... Never run a business unless you truly understand the difference between a Profit and Loss Statement and a Balance Sheet. 51

54 2 DIRECTORS PENALTY NOTICES DIRECTORS PENALTY NOTICES OVERVIEW The Australian Taxation Office (ATO) would be the most common creditor across insolvent estates, whether personal or corporate. The ATO is seen as an easy and cheap source of short-term funding when cash flow tightens and an easy creditor to delay, usually without penalty. Tax debts are commonly the last to be satisfied when cash starts to become available. For these reasons it is very common for the ATO to be a substantial creditor. Directors were previously isolated from company tax debts. Historically the ATO was a priority creditor in liquidations for outstanding Group and PPS taxes. This priority compensated the ATO for the lack of access to the directors personally. However this regime changed in The old 221P priority provisions went out, and the ATO became a non-priority unsecured creditor alongside all other creditors in the liquidation. But they also picked up provisions that allowed collection of some tax debts personally from directors of companies. Since June 1993 the ATO has had the power to collect outstanding deducted taxes (amounts deducted under the PAYG provisions) by making directors liable for a penalty in the same amount as the unpaid taxes. These provisions create a separate parallel liability to the ATO in the name of each director, resulting in a separate and severally liabilities for the full amount of the penalty. These provisions underwent some amendments in These effectively transferred these provisions from the ITAA to the Taxation Administration Act (TAA) and made various, sometimes minor, adjustments to how these provisions work. These provisions all relate back to the Commissioner s right to collect tax that remains unpaid Recovering a tax related liability that is due and payable (1) An amount of a tax related liability that is due and payable: (a) is a debt due to the Commonwealth; and (b) is payable to the Commissioner. (2) The Commissioner, a Second Commissioner or a Deputy Commissioner may sue in his or her official name in a Court of competent jurisdiction to recover an amount of a tax related liability that remains unpaid after it has become due and payable. These new provisions fall into the following five areas: 1. Creation of the obligation for directors to cause the company to pay its tax 2. Creation of a penalty for directors who do not fulfill that obligation 3. The Directors Penalty Notice 4. Defences 5. Discharging the liability CREATION OF THE OBLIGATION FOR DIRECTORS TO CAUSE THE COMPANY TO PAY ITS TAX The mechanisms that create the penalty are pretty straight-forward. Directors are under a positive obligation to cause the company to pay deducted or withheld tax or take other specified remedial action by the time it is due for payment. Section sets out the director s obligation to cause the company to comply with its obligation to pay its tax liability. This section does not create financial liability on the director, more a duty to make the company pay its tax (an obligation). That obligation of the director continues until the company has paid the tax, or the company is wound up or placed into voluntary administration. The obligation continues if the company enters into a repayment agreement. Directors obligations (1) The directors (within the meaning of the Corporations Act 2001) of the company (from time to time) on or after the initial day must cause the company to comply with its obligation. (2) The directors of the company (from time to time) continue to be under their obligation until: (a) the company complies with its obligation; or (b) an administrator of the company is appointed under section 436A, 436B or 436C of the Corporations Act 2001; or (c) the company begins to be wound up (within the meaning of that Act). Under the old regime, one option available to directors was to enter into a repayment agreement under section 222ALA of the ITAA. The provisions regarding instalment agreements have also been moved to the Taxation Administration Act (TAA) and are set out below. Interestingly the option to enter into a repayment agreement does not relieve the directors of the obligation to make the company pay its tax. The director s obligation (and later the penalty) is not removed or remitted just because an installment agreement is entered into. The obligation remains and the commissioner is unable to collect the money or penalty whilst an installment agreement is in place. 52 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

55 RELATED TOPICS 2 If the company does not comply with the instalment agreement, the original penalty can be collected from the directors under the original obligation. Previously the old penalty was remitted, and a new obligation was created if the 222ALA agreement failed. To emphasize this point, the commissioner can still issue a Directors Penalty Notice (DPN) against a director when an instalment agreement is in place. They were unable to do so under the old legislation as entering the old 222ALA agreement removed the director s liability to the penalty. Instalment arrangements (3) The Commissioner must not commence, or take a procedural step as a party to, proceedings to enforce an obligation, or to recover a penalty, of a director under this Division if an arrangement that covers the company s obligation is in force under section (Commissioner s power to permit payments by instalments). Note 1: The arrangement may also cover other obligations of the company. Note 2: Subsection (3) does not prevent the Commissioner from giving a director a notice about a penalty under section One of the reasons these changes came into effect was due to a very interesting case: A director appointed a man-of-straw (actually a homeless person) to replace him as the director of his company just before a director s liability crystallised. He then caused this man-of-straw to enter into a 222ALA agreement, which removed the old director s liability (his), and then caused the company to default on the agreement making the new (homeless) director liable for the debt. Then upon reinstating himself as the director of the company he effectively avoided any personal liability. CREATION OF A PENALTY FOR DIRECTORS WHO DO NOT FULFIL THAT OBLIGATION The new legislation is very similar to the old provisions in regards to creating penalties for directors. A director becomes liable for a penalty if they do not cause the company to pay its liabilities by the due date. The creation of the penalty is automatic. The penalty also applies to directors who were appointed when the obligation for the company to pay tax was incurred (the amount was deducted), but also to those directors who resigned before the due date for payment. This provision captures anyone who was a director at the time when the tax debt becomes was payable. People becoming directors even on the day before the tax is due will be liable for the penalty, even if they were not directors when the tax debt was incurred, accrued or deducted. The pertinent key words are at or before the due date for payment. As long as you were a director for any of the period between when the tax was deducted and when it is due for payment, you are liable for the penalty if the company does not pay the tax. Penalty for director on or before due day (1) You are liable to pay to the Commissioner a penalty if: (a) at the end of the due day, the directors of the company are still under an obligation under section ; and (b) you were under that obligation at or before that time (because you were a director). Note: Paragraph (1)(b) applies even if you stopped being a director before the end of the due day: see subsection (2). (2) The penalty is due and payable at the end of the due day. Note: The Commissioner must not commence proceedings to recover the penalty until the end of 21 days after the Commissioner gives you notice of the penalty under section As with old provisions, the new provisions also make new directors (appointed after the due date) liable for the same penalty. This liability commences 14 days after the appointment of the director, at the end of that 14 days, the company still has not complied with its obligation to pay its outstanding tax. Penalty for new director (3) You are also liable to pay to the Commissioner a penalty if: (a) after the due day, you became a director of the company and began to be under an obligation under section ; and (b) 14 days later, you are still under that obligation. (4) The penalty is due and payable at the end of that 14th day. Note: The Commissioner must not commence proceedings to recover the penalty until the end of 21 days after the Commissioner gives you notice of the penalty under section The amount of the penalty is the amount of the unpaid tax. Amount of penalty (5) The amount of a penalty under this section is equal to the unpaid amount of the company s liability under its obligation. All of this leads to a position where a director is liable if they were a director when; (i) tax was deducted (ii) it was payable, or (iii) remained payable (subject to the 14 day period). DIRECTORS PENALTY NOTICES 53

56 2 DIRECTORS PENALTY NOTICES DIRECTORS PENALTY NOTICES THE DIRECTORS PENALTY NOTICE Similarly to the old provisions, the ATO must follow a specific procedure to make the amount collectable. The word collectable is used intentionally, as makes the director liable for the penalty, but the ATO cannot commence proceedings to recover that debt. This is expressed in the note to (2) stating: The Commissioner must not commence proceedings to recover the penalty until the end of 21 days after the Commissioner gives you notice of the penalty under section The question is; what other actions can the commissioner take to recover the amount from directors (garnishee Orders etc) that do not require him to commence proceedings. The commissioner must give the director a notice of penalty before he is able to commence proceedings to collect that penalty. But there are two major differences to the old legislation. The first is that the director has 21 days to meet the requirements of the notice, which is an increase from the 14 days stipulated under the old provisions. The second is that entering into an instalment agreement is not an option for compliance. It will stop collection action against the director whilst the agreement is in place, but only while the company complies with the agreement. It will not satisfy the debt. Commissioner must give notice of penalty (1) The Commissioner must not commence proceedings to recover from you a penalty payable under this Subdivision until the end of 21 days after the Commissioner gives you a written notice under this section. Content of notice (2) The notice must: (a) set out what the Commissioner thinks is the unpaid amount of the company s liability under its obligation; and (b) state that you are liable to pay to the Commissioner, by way of penalty, an amount equal to that unpaid amount because of an obligation you have or had under this Division; and (c) explain the main circumstances in which the penalty will be remitted. (3) To avoid doubt, a single notice may relate to 2 or more penalties, but must comply with subsection (2) in relation to each of them. One of the new provisions clarifies when the notice is given. Until the Meredith decision in 2007 (DCT v Meredith [2007] NSWCA 354) the argument was regularly tested as to when and if the director received the notice of the penalty and when the period for compliance began. The Meredith ruling stated that the time period commenced when the commissioner posted the notice, regardless of when or if it was received. The new provisions clarify this point by stating that the notice is given when it is posted or left (which would assume personal delivery at the address). When notice is given (4) Despite section 29 of the Acts Interpretation Act 1901, a notice under subsection (1) is taken to be given at the time the Commissioner leaves or posts it. Note 1: Section 28A of the Acts Interpretation Act 1901 may be relevant to giving a notice under subsection (1). Note 2: Section of this Act is also relevant to giving a notice under subsection(1). Another important provision relevant to the notice, sets the address to serve the director. This change is not technically different from the old provisions, it just clarifies the position. The director is still to be served at the address listed in the company records maintained by ASIC. Directors should ensure that their address details are current with ASIC, or potentially they could be validly served with a DPN at an old address. How notice may be given The Commissioner may give you a notice under section by leaving it at, or posting it to, an address that appears, from information held by the Australian Securities and Investments Commission, to be, or to have been within the last 7 days, your place of residence or business. The penalty is then discharged if, within the time period, the company complies with its obligations i.e. pays the tax or appoints either administrators or a liquidator as outlined in the notice. Remission of penalty before end of notice period A penalty of yours under this Division is remitted if the directors of the company stop being under the relevant obligation under section : (a) before the Commissioner gives you notice of the penalty under section ; or (b) within 21 days after the Commissioner gives you notice of the penalty under that section. 54 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

57 RELATED TOPICS 2 DEFENCES The two main defences available to directors remain that they either: 2. could not take part in the management of the company, or 3. that they took all reasonable steps to make the company comply with its obligations. The wording of the illness provision has been altered. This mainly arose from two cases where directors successfully argued: 1. They did not take part in the management of the company because they were slightly ill. The argument was not that they were incapable of acting, just they did not take part in the management (the old wording) due to that illness; and 2. They did not take part in the management of the company because someone else (the director s wife) was ill. The Act did not (and still does not) state that the director has to be the ill person. The provisions now state that the defence will be available if it is unreasonable to expect [the director] to take part due to illness (theirs or someone else s) or some other good reason. The commissioner can see circumstances where a director with an ill spouse or child (or conceivably a pet) may be excused due to the need to care for that person. Illness (2) It is a defence in the proceedings if it is proved that, because of illness or for some other good reason, it would have been unreasonable to expect you to take part, and you did not take part, in the management of the company at any time when: (a) you were a director of the company; and (b) the directors were under the relevant obligations under section The all reasonable steps defence is essentially the same as under the old provisions. All reasonable steps (3) It is a defence in the proceedings if it is proved that: (a) you took all reasonable steps to ensure that the directors complied with their relevant obligations under section ; or (b) there were no such steps that you could have taken. (4) In determining what are reasonable steps for the purposes of subsection (3), have regard to: (a) when, and for how long, you were a director and took part in the management of the company; and (b) all other relevant circumstances. DISCHARGING THE LIABILITY Essentially the same parallel liability provisions apply as they did under the old legislation. If an amount is paid or applied at a particular time towards discharging one of the liabilities, each of the other liabilities in existence at that time is discharged to the extent of the same amount (269-40(2)). The Act outlines the rights of one director who pays a liability against the company and the other directors who were also liable to pay penalties. The same rules apply as if the payments were made under guarantees, not the penalty provisions. Directors rights of indemnity and contribution (1) This section applies if you pay a penalty under this Division in relation to a liability of the company under an obligation referred to in section (2) You have the same rights (whether by way of indemnity, subrogation, contribution or otherwise) against the company or anyone else as if: (a) you made the payment under a guarantee of the liability of the company; and (b) under the guarantee you and every other person who has paid, or from whom the Commissioner is entitled to recover, a penalty under this Division in relation to the company s obligation were jointly and severally liable as guarantors. DIRECTORS PENALTY NOTICES 55

58 2 DIRECTORS PENALTY NOTICES DIRECTORS PENALTY NOTICES REPAYMENT AGREEMENTS WITH THE ATO Under the old legislation, a director could avoid personal liability for a company s tax debt (the director s penalty) by causing the company to enter into a 222ALA Repayment Agreement with the ATO. The director s liability would then be remitted and would only reappear, or more correctly a new liability would arise, if the agreement fell into default. Separate from repayment agreements, taxpayers can seek to have the time to pay taxes varied. This removes a director s obligation to pay by the original due date, because the due date itself is varied. To defer the payment time Deferrals for particular taxpayers (1) The Commissioner may, having regard to the circumstances of your particular case, defer the time at which an amount of a tax related liability is, or would become, due and payable by you (whether or not the liability has already arisen). If the Commissioner does so, that time is varied accordingly. Note: General interest charge or any other relevant penalty, if applicable for any unpaid amount of the liability, will begin to accrue from the time as varied. See, for example, paragraph 5 15(a) of the Income Tax Assessment Act (2) The Commissioner must do so by written notice given to you. The Commissioner can also vary the due date for whole classes of taxpayers, but all variations must be made in writing. The Commissioner may also allow the taxpayer (in this case the company) to enter into a repayment arrangement payments by installments. These provisions resided in the ITAA (section 222ALA and associated sections) until the change in July They now reside in the Taxation Administration Act. The essence of the provisions is retained in the new provisions. The Commissioner may allow the payment of a tax liability over time by installments, albeit that it does not change when the tax is due. Although, how these arrangements relate with the DPN and penalty provisions has changed. To permit payments by instalments (1) The Commissioner may, having regard to the circumstances of your particular case, permit you to pay an amount of a tax related liability by instalments under an arrangement between you and the Commissioner (whether or not the liability has already arisen). (2) The arrangement does not vary the time at which the amount is due and payable. Note: Despite an arrangement under this section, any general interest charge or other relevant penalty, if applicable for any unpaid amount of the liability, begins to accrue when the liability is due and payable under the relevant taxation law, or at that time as varied under section or An arrangement is defined as any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings. This definition is held in the Income Tax Assessment Act It does not state in the definition or in the sections that the arrangement has to be in writing. The first point of difference is that entering into a repayment arrangement is now not something that will cause a director to avoid personal liability for a penalty. The old section 222AOB allowed directors to cause the company to enter into 222ALA agreements as a means of avoiding such liability. The current does not have that provision. This is significant and is described further below. Directors obligations (1) The directors (within the meaning of the Corporations Act 2001) of the company (from time to time) on or after the initial day must cause the company to comply with its obligation. (2) The directors of the company (from time to time) continue to be under their obligation until: (a) the company complies with its obligation; or (b) an administrator of the company is appointed under section 436A, 436B or 436C of the Corporations Act 2001; or (c) the company begins to be wound up (within the meaning of that Act). 56 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

59 RELATED TOPICS 2 The second point is that entering into a repayment arrangement is now not an option to remove personal liability for a penalty under a DPN. The old section 222AOE allowed directors to remit the liability that was about to become collectable by the DPN by causing the company to enter into a 222ALA agreement. The current sets out the provisions for issuing a DPN and the ability to commence proceedings to recover a penalty. Furthermore, section (3) sets a limitation on the Commissioner commencing initial or further proceedings whilst a repayment arrangement is in force. That means that as soon as the arrangement is breached and not in force the Commissioner can proceed for the original penalty, as these provisions do not remit the original penalty. Instalment arrangements (3) The Commissioner must not commence, or take a procedural step as a party to, proceedings to enforce an obligation, or to recover a penalty, of a director under this Division if an arrangement that covers the company s obligation is in force under section (Commissioner s power to permit payments by instalments). Note 1: The arrangement may also cover other obligations of the company. Note 2: Subsection (3) does not prevent the Commissioner from giving a director a notice about a penalty under section This effectively blocks directors from avoiding liability from the initial date when the tax is incurred or deducted, through to when it is due for payment and until it has been paid. The new provisions, whilst still allowing the company to pay its tax debts over time by instalments, do not give directors the same get out of jail free card that the old provisions provided. The debt may be payable over time, but directors are still liable for their penalties until it is paid in full under the arrangements. SUMMARY Most directors are aware that they can become personally liable for some unpaid tax liabilities. The positive obligations set out in the TAA legislation and DPNs provide a range of options to protect directors from that personal liability if they take the required action. But realistically by the time that the notice is issued and advice has been sought, the options can be limited to either entering into voluntary administration or voluntary liquidation. New directors may not be aware that they too may become liable for past tax debts simply by being appointed. Often the ATO provides some breathing space by not issuing DPNs immediately after the tax is due. This may allow a repayment agreement to be explored or the company to be wound up. But section repayment agreements do not remove the liability for the penalty as they once did. They just may end up delaying the inevitable. DIRECTORS PENALTY NOTICES WORRELLS NEVERS... Never skimp on the paper work. When disputes arise paper work is worth gold. 57

60 2 LENDING MONEY LENDING MONEY Everyone considering lending money will want to be reassured that they have the best chance of being repaid, or should the loan go bad, that they can recover the maximum amount possible. If the loan is not properly documented or if adequate security is not taken and/or properly registered, there is a chance that only some of the money lent (if any) will be recovered. Protecting yourself against a loan going bad is not expensive or a time consuming exercise, particularly when compared to the loss of the money lent. However, it is something that must be done properly to be effective. HOW DO I PROTECT MYSELF? First satisfy yourself that the borrower (and the monies) will not disappear once the money has been lent. You should only deal with established people or businesses. Secondly, you will want to assure yourself that the borrower has the capacity to repay the loan. It would be prudent to get your accountant to look over the borrower s records or business plans. There are three steps that should be considered before any money is handed over. Lenders should: 1. prepare proper documentation of the loan; 2. obtain adequate security; and 3. obtain guarantees from third parties. WHY PREPARE DOCUMENTATION? Without proper documentation, you may not be able to substantiate that monies were lent, the conditions of how the money would be repayable, or what interest and other terms were applicable. Without it you are relying on the good faith of the borrower (or their trustee or liquidator) and being able to convince a Court that what you say is correct. Documentation creates certainty. ARE SECURITIES AND GUARANTEES NECESSARY? Necessary? No. Recommended? Yes. Think of securities and guarantees as insurance. You hope that the loan is repaid as expected, and suppose that preparing the documentation and obtaining securities and guarantees is a waste of time and money. But, if the loan goes bad, they may be the only way of getting some money back. You may not always be able to obtain securities and guarantees, but they should be requested. If you do not obtain security, your loan will be unsecured and your rights will be limited if the borrower goes bankrupt or is wound up and in the same position as all other unsecured creditors. Without a guarantee from another party, you will be left solely with your rights in the borrower s estate with no avenue of obtaining payment from anyone else. WHAT DOCUMENTATION SHOULD BE PREPARED? 1. The loan itself should be fully documented. The loan agreement should include the amount lent and the repayment provisions; it should deal with interest and other charges; it should detail what are deemed breaches of the agreement, your rights if a breach occurs and other matters. Most importantly, it should include dispute resolution provisions, who should pay these costs, and provisions addressing your rights to exercise any security or guarantee held. 2. Any security over assets should be documented, as most securities are invalid or unenforceable if not in writing. There are also registration considerations as some securities will be invalid if not registered, particularly securities over assets owned by a company or under a Bill of Sale. The security documentation should detail all of the assets covered by the security, the powers to exercise the security over those assets and the powers of any person appointed over those assets. 3. A guarantee must be in writing to be enforceable. Guarantees should be prepared by lawyers as they need to contain certain clauses and be explained to the guarantor before they are signed. We recommend that a solicitor prepare all of these documents. Most solicitors will have these documents as precedents. WHAT IS A SECURITY? A security is a right over an asset that allows the holder of the security to sell that asset to satisfy an outstanding debt. They are generally known as mortgages, though different forms of security have different names. The common point is that an asset (something of value) is pledged to support the repayment of a loan and the security can be exercised under certain conditions. The asset security does not have to be owned by the borrower. A third party may give a security over one of their assets to support the loan. WHY ARE SOME CHARGES FIXED OR FLOATING OR BOTH? Whether a charge is fixed or floating depends on what type of asset it covers. Charges can be both fixed and floating over different types of assets, but need to be defined in the documentation. A fixed charge covers a specific asset like a house, land, a piece of machinery etc. The asset can be specifically and individually identified and will sometimes be listed in the charge documentation. This mitigates any dispute as to what asset is charged to secure a debt. Usually the asset will not change during the life of the charge, or if it does, the outgoing asset will be released from the charge and will be replaced by the new asset. 58 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

61 RELATED TOPICS 2 A floating charge covers classes of assets that naturally change from time to time. Floating charges secure assets like trade debtors, cash at bank and stock. As a business must retain the ability to deal with these assets to trade, the charge can be not specific to a particular asset. This charge floats above the class of asset while it is constantly changing. When a breach occurs, the charge falls and captures the particular assets (debtors, stock etc.) held at that time - hence a floating charge. After activation, the floating charge can be considered as fixed on those particular assets. WHAT IS A REGISTRABLE SECURITY? This is a security of whatever form or name that is required to be registered with an authority under the provisions of various Acts. An unregistered, registrable security may not be enforceable. Lenders will need to check the asset secured, the type of security and the entity that owns the asset to determine whether it should be registered. SHOULD THE SECURITY BE REGISTERED? If it is a registrable charge, Yes. Some legislation requires that a security be registered to be enforceable in some circumstances. The best known of these are charges over many types of assets owned by a company that require registration with the Australian Securities & Investments Commission (ASIC). Section 262 of the Corporations Act sets out the charges that require registration. Bills of Sale also need to be registered to be enforceable against trustees in bankruptcy or other insolvency practitioners. It is advisable that lenders should seek legal advice on this point. PERSONAL GUARANTEES SHOULD I OBTAIN PERSONAL GUARANTEES? Lenders do not need to get a personal guarantee but it is desirable, particularly if the borrower is a company. If directors are not prepared to guarantee the repayment of the loan, they must not have sufficient expectations that the company will be able to do so. They want the lender to take the financial risk, while they profit from the loan. Guarantees may be obtained from anyone. They do not have to be officers of a company or related to the borrower. The guarantee allows you to seek payment from another party if the borrower defaults. We recommend that a solicitor prepare the guarantee documentation and be present while it is being signed by the guarantor. Guarantees may be challenged if they are not properly executed and/or explained to the guarantors. WILL A GUARANTEE ENSURE REPAYMENT? No. If the guarantor has no assets or means of repaying the loan themselves, the guarantee will be worthless. Some background examination of the guarantor should be undertaken before granting the loan based on such a guarantee. If the guarantor is resistant to this examination, you should become suspicious. You may also seek security over some of the guarantor s assets, as a guarantee will only make you an unsecured creditor of the guarantor in the case they are declared bankrupt. OTHER CONSIDERATIONS WHAT IF A SECURITY OR A GUARANTEE CANNOT BE OBTAINED? If the borrower will not or cannot grant any security, and the people behind the borrower will not give guarantees, think twice about lending money. How much risk you are willing to take is a decision that you alone have to make. Making a loan without security or guarantees is can be very risky. OTHER POINTS Think about these points before granting a loan: (a) ensure that the entire arrangement (loan, guarantees and security) is in writing and executed by all of the relevant parties before any money is handed over. (b) ensure that the lender keeps the complete executed originals. Usually a number of originals will be executed - one for each party. (c) determine whether guarantees from the individuals or other entities behind the borrower should be sought. (d) check that any asset(s) offered as security actually exist. (e) check who actually owns the asset(s) that are being charged. Is it owned by the entity that is offering the charge over the assets? (f) check whether the charge requires registration and who is to register it. (g) check whether there is another charge that has a higher priority over the asset. (h) check whether the assets secured are worth more than the debt - on a forced sale basis as this is how a security holder would have to sell it. Should further security be sought to cover any shortfall? (i) check that the rights for enforcement of any security or guarantee. Are they set out clearly in the documentation and do they make sense. Do they create unnecessary hurdles before rights can be exercised? 59 LENDING MONEY

62 2 LENDING MONEY LENDING MONEY HOW IS THE SECURITY ENFORCEABLE? Details of the enforcement steps are and when they can be taken will need to form part of the security documentation. It is important that the loan documents clearly state what is a breach of the loan, the time periods for notice and rectification of the breach, and the action that may be taken to enforce the security. The action taken will greatly depend on the type of asset that is secured. Recovery may be as simple as having the asset collected and sold at auction. If the security is over a business, the business may have to continue to trade while it is sold. There is also the decision of who can, or should, take that action. The documentation should provide the alternatives. The main options are: (a) to take the action yourself (be a Mortgagee in Possession); or (b) to appoint an agent (commonly called an agent for the Mortgagee in Possession). WHO SHOULD PAY FOR SETTING UP THE LOAN? Both accountants and solicitors will charge a fee for preparing the documents and undertaking any searches that are required prior to loan commencement. The cost should be paid by the borrower, by way of an application fee. If the borrower cannot or will not pay the costs of setting up and documenting the loan properly, you should question whether you should grant the loan. WHY GRANT THE LOAN? One last consideration is why to lend the money. Generally a loan is made for one of two reasons: 1. to help out someone in a time of need; or 2. as a commercial venture to earn interest. SHOULD THESE LOANS BE TREATED DIFFERENTLY? WE BELIEVE NOT. Helping someone out during a time of need may be noble, but their financial position is probably doubtful. If that is the case, you need to protect your money. If the loan is made with a view to earn interest, then all proper documentation and security precautions should be undertaken as a matter of good business practice. All too often, many people grant too many loans to borrowers without considering the possibility that the loan may go bad. If it does go bad, they generally join a long list of other creditors and wonder why they cannot get their money back. You can also appoint Receivers or Receivers and Managers. The security documents should provide for all of these alternatives, as standard. WORRELLS NEVERS... Never underestimate a large builder s ability to find fault in a subcontractor s work. 60 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

63 RELATED TOPICS SUBCONTRACTORS CHARGES 2 WHAT IS A SUBCONTRACTORS CHARGE? A subcontractor s charge is a statutory security granted to certain parties in the building industry under the subcontractors Charges Act. The charge secures payment of monies owed to subcontractors. Only Queensland, ACT and South Australia have these Acts. WHICH PARTIES ARE INVOLVED? There are generally three parties involved in a subcontractor s charge: 1. The developer (the employer) owes money to a builder under a building contract. The Act defines an employer as: a person who contracts with another person for the performance of work by that other person, or at whose request or on whose credit or behalf, with the person s privity and consent, work is done. 2. The builder or contractor was engaged by the developer to complete a building project. The Act defines a contractor as: regards an employer, means a person who contracts directly with the employer to perform work and, as regards a subcontractor, means a person with whom the subcontractor contracts to perform work. 3. The subcontractor is engaged by the builder to conduct part of the work under the main building contract. The subcontractor is owed money by the builder for work performed under this subcontract. The Act defines a subcontractor as a person who contracts with a contractor or with another subcontractor for the performance of work. WHAT IS THE PURPOSE OF THE CHARGE? The charge provides the subcontractor with some protection from an insolvent builder by securing the monies owed by the developer to that builder and therefore directing some of those monies to the subcontractor. This allows a potentially insolvent builder to be bypassed. WHO CAN LODGE A CHARGE? Any subcontractor of a builder as defined by the Act is entitled to charge for monies payable to a builder or another superior contractor. The monies must be owed to the subcontractor for relevant work. Monies owed for work that falls outside relevant work cannot be the subject of a charge. WHAT IS RELEVANT WORK? Relevant work is: work includes work or labour, whether skilled or unskilled, done or commenced upon the land where the contract or subcontract is being performed by a person of any occupation in connection with- (a) the construction, decoration, alteration or repair of a building or other structure upon land; or (b) (c) the development or working of a mine, quarry, sandpit, drain, embankment or other excavation in or upon land; or the placement, fixation or erection of materials, plant or machinery used or intended to be used for a purpose specified in paragraph (a) or (b); or (d) the alteration or improvement of a chattel; and includes also the supply of materials used or brought on premises to be used by a subcontractor in connection with other work the subject of a contract or subcontract but does not include; (e) (f) (i) the mere delivery of goods sold by a vendor under a contract for the sale of goods, to at or upon land; or work or labour done or commenced by a person; under a contract of service; or (ii) in connection with the testing of materials or the taking of measurements or quantities; or (g) the supply under a contract of hire of materials, plant or machinery not intended to be incorporated in the work. SUBCONTRACTORS CHARGES 61

64 2 SUBCONTRACTORS CHARGES SUBCONTRACTORS CHARGES Section 3AA of the Act further elaborates these definitions. Obtaining legal advice is recommended if there is any doubt. WHAT CAN BE SECURED UNDER THE CHARGE? Money. The subcontractor can lodge a charge only on money owed to a contractor. This includes retention monies and any security monies held by the developer. But the developer must still have the money and still owe a debt to the builder. Money cannot be charged after it has been paid to the builder, or if the entire debt to the builder has been paid by the developer. HOW IS A CHARGE LODGED? A notice of the subcontractor s charge must be given to both the builder and developer. The notice must specify the amount and particulars of the claim in relation to the relevant work. It must be certified by a prescribed person and supported by a statutory declaration from the subcontractor. Subcontractors will usually engage solicitors to prepare the charge notice as charges may be overturned if not executed properly, on the prescribed form and within the applicable time periods. WHAT ARE THE APPLICABLE TIME PERIODS? A notice of charge can be given at any stage during the subcontract period, but the following time restrictions apply after the completion of the subcontract: 1. for contract monies - Within (3) three months after the completion of works. 2. for retention monies - Within (3) three months of the expiration of the maintenance period. 3. for security monies - Within (3) three months of the expiration of the release periods. CONSEQUENCES OF A NOTICE OF CHARGE Within fourteen days after the notice of charge is received, the builder must give a contractor s notice to the developer, stating that the builder: (a) Accepts liability to pay the claimed amount; or (b) Disputes the claim; or (c) Accepts liability to the amount stated in the contractor s notice, but otherwise disputes the claim. When a builder provides a notice accepting the liability, the developer will pay the amount direct to the subcontractor. If the builder does not accept the liability, the subcontractor must take the next steps to enforce the charge. WHAT IF MORE THAN ONE CHARGE IS LODGED? Where the money payable under a contract is insufficient to meet the claims of two or more subcontractors, any deficiency shall be borne by subcontractors in proportion to the amounts of each claim. Each subcontractor will share equally in the charged monies. The developer will usually pay the monies into Court and have the Court determine the disbursement of the funds. WHAT SHOULD THE DEVELOPER DO IF THEY RECEIVE A CHARGE? The lodgement of a charge secures the monies for the subcontractor. The developer may be able to withhold all monies that have been charged and use these monies to complete the project (may be using another builder if the original builder is insolvent). The developer may not be obliged to pay out any of the monies under a charge until after the project has been completed and these costs have been paid. The developer will not have to pay any more money than they would have had to pay under the original contract. The charge does not create an extra obligation on the developer, it just directs payment of the monies due under the contract. It is not uncommon for the developer to pay surplus monies (monies due under the contract after it has been completed) into Court. This removes the obligation of disbursing the monies from the developer and places it on the Court. This also applies to parties that hold security in respect of the builder s contract. 62 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

65 RELATED TOPICS SECURITIES OVER ASSETS 2 WHAT IS A SECURITY? A security or charge is a pledge of an asset to a particular creditor to support a debt. A creditor who holds a security is known as a secured creditor and the asset is known as being charged. Securities or charges are over assets, not over companies or people. The best known form of security is a mortgage over real property granted to a bank to support the loan used to buy the property. Securities over other assets have different rules than real property mortgages, particularly with regard to registration, but they have the same general effect and purpose. WHAT ASSETS MAY BE CHARGED? Almost any asset capable of being identified may be charged. The type of asset will generally determine the type of charge and registration requirements. WHO MAY RECEIVE A SECURITY OVER ASSETS? The charge must be given by the debtor. It cannot simply be taken by the creditor. But any creditor may receive a charge over assets. Usually trade creditors or creditors with small debts will not go to the effort, in terms of time and cost of requesting and creating a charge. But creditors with substantial or long term debts may consider it beneficial and commercial to do so. WHAT ARE FIXED AND FLOATING CHARGES? Charges over assets (usually not over land) can be fixed or floating. Charges that contain both fixed and floating elements are known as fixed and floating charges. A fixed charge (or portion of a charge) is a charge over a particular identifiable asset, usually physical plant and equipment. Fixed assets continue with exactly the same identity throughout their life. The charge is fixed on that particular asset. A floating charge (or portion of a charge) covers a class of assets like debtors, cash at bank, stock, etc. These assets do not maintain the exact same identity over time (e.g. stock is continually purchased and sold). A floating charge floats over that class of asset and captures the particular asset that is held at the time when the charge is exercised. The charge is formed this way because businesses need to be able to deal with these classes of assets in the normal course of business. HOW DOES A CHARGE AFFECT AN ASSET? This will depend on whether the charge is fixed or floating. The debtor will generally not be able to deal with assets under fixed charges without the consent of the holder of the charge. The asset may have to be released from the charge to be sold, and the new asset may need to be added to the charge. Assets under floating charges are able to move in and out from under the charge. The debtor will be able to deal with the asset in the normal course of business without the consent of the holder of the charge. As soon as an asset is sold it moves from under the charge. When does a charge have to be registered? Charges over most assets owned by a company must be registered with ASIC. Without registration, the charge will be unenforceable against external administrators. Even without an external administrator being appointed, unregistered charges fall behind other registered charges in priority. Charges over real property do not need to be registered with ASIC, but should be registered on the appropriate land register or they will fall behind other registered charges in priority. Some charges over personally owned assets need to be registered to be enforceable against bankruptcy trustees and some other people. Those requirements are found in the relevant Acts. Legislation is being brought in to simplify the many different Acts that govern securities over personal property. Legal advice should be sought when taking a charge to ensure that all requirements are fulfilled. WHAT SHOULD BE CONSIDERED BEFORE GRANTING CREDIT BASED ON A SECURITY? Certain matters must be considered and some investigation should be done before granting credit based on a security. The process is not as simple as making the decision to obtain a security, the following should be considered: (a) Does the asset being offered as security actually exist? (b) Who owns the asset? Is it the entity that is offering the charge over the asset? (c) Does the owner have the right to charge the asset? (d) Is the charge one that requires registration and who is to register it? (e) Is there another charge over that asset that will have priority? (f) Is the asset worth more than the debt secured over the asset - has it been valued and on what basis (forced sale)? (g) Is the charge properly documented and executed by the right people? (h) Is the charge Fixed or Floating or both? (i) Are enforcement rights clearly set out in the documentation? A VALID SECURITY MAY HAVE NO VALUE! A security is only as good as the attached asset. If the asset is worthless, the security will be worthless. If the security is subordinate to another higher ranking security, it will be worthless unless the value of the asset is sufficient to cover both the debts. SECURITIES OVER ASSETS 63

66 2 SECURITIES OVER ASSETS If the proper procedures have not been followed to register and exercise the security, it may be void once a liquidator or trustee is appointed. REGISTRATION UNDER THE CORPORATIONS ACT A security over assets owned by a company is likely to be void if it requires registration but is not registered at the time that a liquidator or administrator is appointed. Securities registered outside the relevant time period may also be void if they are registered within six months before the appointment. Attempting to replace a security that would be deemed void with a security that complies within the registration requirements may be grounds to also be voided. Creditors obtaining securities should ensure that registration is completed as soon as possible. REGISTRATION UNDER THE BILLS OF SALES ACTS Some securities cannot be enforced against certain persons if not registered. The most common type of security over personally owned assets is a bill of sale. These must be registered under the relevant Acts in each state to be able to be enforced against certain persons. Each state has individual registration requirements. HOW IS A CHARGE EXERCISED? WHAT ARE THE POWERS OF A CONTROLLER? These will be set out in the loan/credit and charge documents. Depending on the security, they may be able to carry on the business, manage a property, terminate or dispose of all or any part of the business and dispose of any of that property as they think fit. Any asset that is not covered under the charge does not fall into the control of the controller, and they should not exercise any power that is not granted under the security. CAN A SECURITY BE OVERTURNED BY AN EXTERNAL ADMINISTRATOR? Yes. In some circumstances a security may be invalid: (a) if the actual granting of the charge was a preference; (b) if there was no current or future consideration for the granting of the charge; (c) if a related party attempted to exercise a charge in a specific period after its creation (Corporations Act only); (d) if the granting of the charge is an attempt to defraud or delay payments to creditors; (e) if the charge is not properly registered; (f) if the charge was created to replace a charge that would have been void. ARE SECURED CREDITORS RESTRICTED UNDER OTHER TYPES OF APPOINTMENTS? In most cases there are no restrictions on secured creditors exercising valid securities. The major exception is under the voluntary administration provisions of the Corporations Act. In these scenarios, a secured creditor has 13 business days to exercise his charge. If they do not, they then are bound by a moratorium for the duration of the administration period. Once the second meeting of creditors is held, the secured creditor regains the right to exercise their security. The charge documentation and credit terms should have provisions dealing with what constitutes a breach of the agreement and the creditor s rights to take possession of assets. It should provide the mechanism for the appointment of a controller over the assets, or for the creditor to take possession of the assets for the purpose of a sale. Creditors need to act strictly within their rights as set out in the documentation, or risk having damages claims made against them. CAN A CHARGE BE A PREFERENCE? Yes. Granting a security over assets can be preferential and may be overturned by a trustee in bankruptcy or liquidator. Charges that secure advances at the time of the charge are usually not preferential, but a new security that covers old debts may be void. 64 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

67 RELATED TOPICS SECURED APPOINTMENTS 2 WHAT ARE SECURED APPOINTMENTS? A creditor who holds a security over an asset is known as a secured creditor. If their debt goes unpaid, they may exercise this security and appoint a controller to take control of that asset and sell it. Appointments of a controller to realise assets under a security are known as secured appointments. The terms of the security and the nature of the assets will determine whether the person is appointed as a Receiver, a Receiver and Manager or an agent for the Mortgagee in Possession. WHY APPOINT A THIRD PARTY CONTROLLER? Secured creditors will appoint a controller when the debtor is in default (they have not been paid) and they wish to take action under their security to get their money back. Secured creditors can take possession of the asset themselves, but many wish to appoint someone experienced and knowledgeable of the statutory issues involved. WHO DOES A CONTROLLER ACT FOR? A controller acts solely for the creditor that appointed them. They do not act for any other party, though the controller may have to deal with other secured creditors who have higher ranking securities over the same assets and at times employees of the debtor. They do not act for the benefit unsecured creditors. WHO PAYS THE CONTROLLER? The secured creditor who has engaged the controller is responsible for payment of their fees. The security documentation will usually allow the secured creditor to recover these costs from the assets under the charge. WHO CAN BE A CONTROLLER? Only registered liquidators can be appointed as controllers to assets owned by a company under the Corporations Act. Anyone can take appointments under securities that are not governed by the Corporations Act. WHICH LAW GOVERNS CONTROLLERS? Currently this depends on whether the assets are owned by a company or a person. 1. If the assets are owned by a company, the appointment will be governed by the Corporations Act. This Act regulates the powers, rights and obligations of the controller and of the directors that owns the assets. If the asset secured is land, they will also be governed by the various Acts dealing with real property. 2. The Bankruptcy Act does not govern secured appointments made over assets owned by individuals. These appointments are governed by various non-insolvency laws in each state, like the Property Law Act and Acts governing Bills of Sale, etc. The government is currently considering one piece of legislation to replace these various Acts, particularly in regards to the registration of securities. HOW DO SECURED CREDITORS APPOINT A CONTROLLER? A controller is usually appointed by a simple deed of appointment. Before making an appointment, the creditor needs to check: (i). that the debtor is in default, (ii). they have made all demands required under their loan agreement and security and (i)ii. taken all steps required under the security documents to allow them to validly appoint a controller. (iv). If not, the appointment may be challenged and overturned. WHAT IS A CONTROLLER APPOINTED OVER? Controllers are only appointed over the specific assets covered by the security and that form part of the appointment. It is possible that they will only be appointed over some of the secured assets if the value of those assets is sufficient to pay the secured debt. They are not appointed over the company structure or the person that owns the assets. Their rights are limited to dealing with the assets listed in the security and covered by the appointment, though this may include a business, in which case the controller may have the right to trade and realise the business as a going concern. But they do not act as liquidators or bankruptcy trustees. WHAT DO CONTROLLERS DO? Controllers have the powers that are set out in the security documentation and the relevant Acts. All controllers will: (a) Realise the assets that are covered under the security and the appointment; (b) pay any employee entitlements that have priority under the Corporations Act (if applicable); and (c) pay money to the secured creditor. They will not conduct any of the investigations carried out by liquidators or bankruptcy trustees and will not take action on issues like unfair preferences, insolvent trading or other void transactions. They comply with all of the necessary reporting requirements under the relevant Acts. SECURED APPOINTMENTS 65

68 Never be afraid to vigorously chase what is due to you. The squeaky wheel gets oiled first, and very 2 SECURED APPOINTMENTS WHAT CAN UNSECURED CREDITORS DO WHEN A CONTROLLER IS APPOINTED? Essentially nothing. There is no requirement for controllers to report to unsecured creditors, and unsecured creditors cannot control the appointment. Controllers regulated by the Corporations Act are required to provide information to unsecured creditors. These are: (a) advertise their appointment; (b) lodge a report under section 421A of the Corporations Act with the ASIC; and (c) lodge receipts and payments every 6 months with the ASIC. Controllers not governed by the Corporations Act are not required to make any information available to the unsecured creditors, and apart from some employee entitlements, controllers do not have the authority to pay money to unsecured creditors. WHAT ABOUT EMPLOYEE ENTITLEMENTS? The Corporations Act provides that some employee entitlements will have priority over the secured creditor. The priority is limited to monies realised from the sale of assets covered by a floating charge. These monies have to be used to pay certain outstanding employee entitlements. Monies that are realised from the fixed assets are not covered by these provisions. There are no such priority provisions outside appointments governed by the Corporations Act. WHAT ARE FLOATING AND FIXED ASSETS? Floating assets are assets that do not maintain the same identity throughout their life. Their exact identity will change with the conduct of the business. An example is stock on hand, that fluctuates as sales and purchases are made. The term floating assets comes from the floating charge, signifying that the charge floats over the top of the class of assets as they change, until such time as it is activated and then falls to capture those exact assets owned by the debtor at that particular time. Fixed assets continue with exactly the same identity throughout their life. Examples of these assets are plant and equipment, land and buildings, motor vehicles, items as plans and patents etc. HOW DOES A SECURED APPOINTMENT END? The appointment is a contractual arrangement and ends by the controller executing a deed of resignation, or by the secured creditor executing a termination notice. There is no requirement for a Court Order or other formal process to end an appointment. But the appointment of the controller may end if a Court Order is brought about and rules that the appointment is not valid for any reason. WORRELLS NEVERS... rarely does granting credit lead to the retention of a good customer. 66 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

69 RELATED TOPICS DETERMINING INSOLVENCY 2 OVERVIEW Proving the date that a company or a person became insolvent is usually one of the most difficult and time consuming tasks in any insolvent estate. Therefore it is one of the most expensive tasks to complete. Moreover it is imperative as most void transactions recovered by external administrators occur when the company or person was insolvent. This is why insolvency practitioners will spend significant time investigating and asking creditors and banks to assist by providing pertinent information. In its most simplistic form the task is mathematical. It is primarily a comparison of what resources were available to the company or person and the debts that were due and payable at a particular point in time. In reality the task is not that easy. The greatest hurdle is gathering sufficient evidence to prove the necessary values at the relevant time in Order to make the comparison because, many times, the records do not provide a clear picture. It is also important to distinguish between insolvency and a temporary lack of liquidity or cash-flow. A lack of liquidity is simply concerned with the available cash for a short period, but over time the situation will naturally rectify itself. This is not insolvency. Insolvency is a lack of resources, not just the liquidity of resources for a time. To give an idea of the process is difficult, as variations to the process occur case by case. The full insolvency investigation process in detail is complex and has many variables that influence, so we summarize the major processes as follows. DEFINITIONS OF INSOLVENCY The definitions of solvency and insolvency are identical in the two Acts and means that the process necessary to prove insolvency is the same. CORPORATIONS ACT - SECTION 95A Solvency and insolvency (1) A person is solvent if, and only if, the person is able to pay all the person s debts, as and when they become due and payable. (2) A person who is not solvent is insolvent. BANKRUPTCY ACT - SECTION 5 (2) A person is solvent if, and only if, the person is able to pay all the person s debts, as and when they become due and payable. (3) A person who is not solvent is insolvent. An investigation into insolvency is centred upon when the company or person (the entity) ceased being able to pay its debts as they needed to be paid. It is the inability to pay the debts that is significant. Just because an entity was not paying its debts does not mean that is was unable to do so and was insolvent. They may have decided not to pay for some other reason. The entity must have been unable to pay the debts from a lack of resources to do so. STEP ONE - CLASSES OF ASSETS AND LIABILITIES Step one is to list all of the classes of assets and liabilities the entity had during the period of examination. This step does not examine the particulars of amounts or dates, just the different types of assets and liabilities. This information is obtained from the financial statements, the business records, searches and any other source available. The task is then to classify which of these classes are resources and relevant to the solvency question. Assets Vs. Resources The next step is to distinguish between assets that can be used for debt repayment (resources) and those that cannot. This is generally a three part process. Once it has been determined which classes of assets are not resources, they will be excluded from the calculation. The first part is to determine whether a particular class of asset will never be a resource as they are not liquid or realising them will disrupt the business. Examples are: (i) Plant and Machinery (ii) Motor Vehicles (iii) Goodwill (iv) Intangible Assets (v) Land and Buildings Part two is determining classes of assets that can be easily classified as resources for their entire value. These are the liquid assets and include: (i) Cash at bank (ii) Available balance of a Bank Overdraft (iii) Cash Investments (iv) Shares in Listed Companies Part three are the assets that are classed as resources, but where the total value of that asset may not be immediately available. Some of that value should become available within a reasonable time as these assets are realised or liquidated in the normal course of business. Only the parts that may be realised or liquidated in that reasonable time may be classified as a resource at a particular time. This group includes assets like: (i) Trade Debtors - what can be collected in a reasonable period? )ii) Stock on Hand - what can be sold for cash in a reasonable period? This information usually has to come from historic trends - what was collected last month, the same month last year, on average over a period, etc. 67 DETERMINING INSOLVENCY

70 2 DETERMINING INSOLVENCY Liabilities Vs. Due and Payable Debts The difference between liabilities and due and payable debts is whether or not they are due for payment at a particular time. This involves two decisions; 1. whether the debt is due and payable as a class, and 2. what amounts are due at any particular time. The first decision to be made is; which liabilities will not be due and payable without a particular event occurring, usually a formal demand for payment or a breach or expiry of an agreement. These will not form part of the calculation, unless that event has occurred. These liabilities include: (i) Bank Overdrafts (ii) Loans from third parties (iii) Lease and finance arrangements (iv) Provisions for payment of liabilities The remainder of the liabilities should become due and payable at some time. The question is how much is payable at different points in time. The major class, and usually the largest class of debts of a trading entity, are the trade creditors. STEP TWO - DETERMINING VALUES Step two is to allocate values to the resources and due and payable debts at the various times covered in the examination. This can be easy or quite difficult depending on the information available. Obtaining values for some of these items can be the most time consuming part of the examination. Each class of resource and due and payable debt must be shown in isolation and at each relevant point in time. A. Resources The highly liquid assets can usually be valued easily, due to their liquidity. Cash at bank can easily be identified from the bank statements. Shares in public companies can usually be valued very easily from market figures. The difficulty lies with the classes that are only partly a resource due to the need to be realised or collected. The result of this examination will be a valuation of the resources that may be used now, or in the near future, to satisfy due and payable debt. (i) Trade Debtors Trade Debtors are usually collectable after some short credit period. After the invoice has been issued, it could be expected that the debt will be collected in one month. Even though credit terms vary between businesses, and there are some significant exceptions to the rule, a 30 day term is the most common. This leads to some questions: (a) What if they are not collected at that stage? (b) What if they have not been collected after 3 months or are disputed? (c) What if there are extended credit terms and they do not become collectable for some time? We must determine two matters: 1. Which trade debtors are not collectable yet due to the fact that the credit terms have not expired; and 2. Which trade debtors are not collectable now or in the immediate future, or may never be collectable, and should be removed from the debtor s ledger. This will then result in having a figure that is considered collectable within a reasonable period and are available for debt repayment. We can also look at this equation historically. This is done by calculating the amounts received from month to month and determining what proportion of these receipts are received from debtors and what percentage from cash sales. This will give us the amount of debtors that should have been collectable at the end of any month, as it is the amount that was actually collected in the period just after the end of the month. This process should illustrate whether the entity was in fact insolvent not what other parties may have thought at the time. These considerations may become relevant in recovery actions. (ii) Stock on Hand Stock is the largest single asset in most retail businesses and being able to use it to pay debts will directly depend upon being able to sell that stock in a timely manner. Therefore, in businesses with stock, careful calculation needs to be undertaken of its value as a resource. We start by asking how much of the stock is available, or will become available to pay debt. If a company holds $1 million in stock at cost, but only sells $200,000 of it on average in a month, what amount of stock is a resource? Strictly speaking none, as you cannot pay debt with stock. Practically though, allowance must be made for the sale of stock in the usual course of business in the reasonable period. There are a number of ways of determining this, but commonly the following factors are considered: (a) Are this year s sales comparable to last year s sales for a direct comparison? (b) What are the average sales per month this year as opposed to the same period last year? (c) How can this be compared to the projected next month s sales? (d) What can be realised in a discount sale? (e) Is the stock being sold for cash or on extended credit terms? That is, when will you be paid for it? Turning stock into debtors will not assist in solvency. Determining these matters will give a figure for the amount of stock that could be reasonably expected to be liquidated in the next month and therefore be available for debt repayment. We also have to consider whether these will be cash or credit sales. Credit sales may be irrelevant to the solvency equation as the sales will be counted through the collection of debtors. 68 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

71 RELATED TOPICS DETERMINING INSOLVENCY 2 B. Due and Payable Debt The question is what amount of debt is due for payment at the different times. Some debts (bank overdraft and loans, director s loans etc.) are usually not due and payable in full in the short-term, unless demands have been made for repayment. Allowances must also be made for that portion of debts that may become payable from time to time, like monthly payments under a loan agreement. Care is taken to determine whether other loans or finance arrangements have expired credit terms. This will require an examination of the balance sheet items and obtaining information on the terms of the credit from the financiers. In many cases, trade creditors are the only significant due and payable debts. Credit is usually given under certain terms and, once those terms have expired, the debt becomes due and payable. The amount of due and payable debt will therefore be the dollar amount of debt that have exceeded its credit terms. Determination of this amount may be easy if there is a reliable aged trade creditor ledger. Simply discounting all debt that has not reached its credit period and creditors that have extended credit terms will give this amount. Rarely this information is available in the records and, even when it is available, it may not be reliable. Therefore this amount may have to be calculated manually. Albeit complex, the actual task is not actually that difficult. Calculation of due and payable debt can be done without any reference to the business records. Creditors are simply asked to provide details of their debts; when they were incurred and when they are payable. In these cases, the banks and creditors records are used and sometimes prove better and more reliable evidence than the records of the company. In reality both procedures are used to verify the information gathered. The result of this process is the calculation of due and payable debt. It is this amount that is to be compared with the resources at the relevant times. STEP THREE - THE CALCULATION The last step is the mathematical calculation done at various points in time to find the earliest date, or the earliest convenient date, that the entity became insolvent, or whether it was insolvent at some point in time. It may that the issue is not to prove the initial date of insolvency, only just that the entity was solvent at or before a certain date - usually the date of a potentially void transaction. Calculation of a shortfall is mathematical. You simply deduct the due and payable debts from the resources and determine whether there is a surplus or a shortfall. The calculation is: Available Resources - Due and Payable Debts = Shortfall or Surplus A surplus means that the entity has sufficient resources to meet its due and payable debts - it is solvent - regardless of whether it is actually paying its debts or not. A shortfall means that the entity does not have sufficient resources to meet all of its due and payable debts - it is insolvent at that particular time. INDICATORS OF INSOLVENCY The Courts looked closely into the question of insolvency and indicators that directors and other parties should notice. In ASIC v Plymin (2003) 46 ACSR 126, the Judge (para 386) referred to a check list of indicators of insolvency as follows: 1. Continuing losses. 2. Liquidity ratios below Overdue Commonwealth and State taxes. 4. Poor relationship with present Bank, including inability to borrow further funds. 5. No access to alternative finance. 6. Inability to raise further equity capital. 7. Suppliers placing [company] on COD, or otherwise demanding special payments before resuming supply. 8. Creditors unpaid outside trading terms. 9. Issuing of post-dated cheques. 10. Dishonoured cheques. 11. Special arrangements with selected creditors. 12. Solicitors letters, summons[es], judgments or warrants issued against the company. 13. Payments to creditors of rounded sums which are not reconcilable to specific invoices. 14. Inability to produce timely and accurate financial information to display the company s trading performance and financial position, and make reliable forecasts. There would be very few cases of insolvencies where all of these indications are present at the one time. Just as there would be few cases of insolvency where none of these indications were present. Overall, they represent a reasonable set of circumstances that, cumulatively, would indicate insolvency. DEEMED INSOLVENCY Section 588E of the Corporations Act provides circumstances where a company may be deemed insolvent without having to prove insolvency through the method used above. There is no parallel provision in the Bankruptcy Act. These circumstances fall into two major categories: 1. Where it has been proven that a company was insolvent within 12 months of the winding up, it may be deemed to be insolvent thereafter. To rely on a previous finding that the company was insolvent, the company will have to have been found to be insolvent by a Court in another action. DETERMINING INSOLVENCY 69

72 2 DETERMINING INSOLVENCY This deeming of insolvency simply avoids the need for the liquidator to re-prove matters already proven to the Court. This is helpful where the liquidator is taking multiple actions for preference and or insolvent trading. CORPORATIONS ACT- SECTION 588E Presumptions to be made in recovery proceedings (3) If: (a) the company is being wound up; and (b) it is proved, or because of subsection (4) or (8) it must be presumed, that the company was insolvent at a particular time during the 12 months ending on the relation-back day; it must be presumed that the company was insolvent throughout the period beginning at that time and ending on that day. 2. Where the company did not keep proper books and records in compliance with section 286 of the Corporations Act, the company may be deemed insolvent for some purposes throughout that entire period. This provision can only be used when prosecuting actions that involve related parties, not third party trade creditors. CORPORATIONS ACT- SECTION 588E Presumptions to be made in recovery proceedings (4) Subject to subsections (5) to (7), if it is proved that the company: (a) has failed to keep financial records in relation to a period as required by subsection 286(1); or (b) has failed to retain financial records in relation to a period for the 7 years required by subsection 286(2); the company is to be presumed to have been insolvent throughout the period. Having a company deemed insolvent due to lack of records is not an easy task. The liquidator must show that the company did not keep records in a manner that complies with the Act. In Forem Freeway Enterprises Pty Ltd the Judge stated at paragraph 16:.. the requirements are that the financial records should both correctly record and explain a company s transactions, financial position and performance and also enable true and fair financial statements to be prepared and audited Though the deeming provisions are available, they are not commonly used. It is usually beneficial and more reliable to prove insolvency from the information from the records and third parties. WORRELLS NEVERS... Never ask your parents or children to guarantee your debts or allow you to borrow against their assets. You have no right to ask them to take such a risk. 70 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

73 RELATED TOPICS LANDLORD RIGHTS 2 Landlords and insolvency practitioners have different rights when a tenant becomes insolvent. The type of insolvency administration will determine the immediate rights between the parties, and the terms of the tenancy will determine what claims the landlord has against the insolvent tenant. Most administrations result in: (a) the tenant will vacate the premises and the landlord will lodge a claim in the insolvent estate; or (b) the tenant s financial affairs will be rectified through some formal arrangement and the tenancy will continue. Either way, it is likely that some of the outstanding rental will remain unpaid. What are the common issues between the landlords and insolvency practitioners? The most common issues are: (i) who is liable for the rent during the period (ii) the landlord s right to re-enter the premises (iii) what will be included in the landlord s provable debt (iv) the insolvency practitioner disclaiming the lease (v) any liabilities of the practitioner (as opposed to the insolvent tenant) WHAT HAPPENS TO A LEASE WHEN A TENANT ENTERS AN INSOLVENCY ADMINISTRATION? A lease is a contract that generally survives the initial appointment of an insolvency practitioner. Regardless of whether the tenant is a company or an individual, the tenant will be liable under that contract and the estate of the tenant will deal with the liability for unpaid rent as a provable debt. The terms of the contract may also include some provision for dealing with insolvency, usually an automatic breach upon liquidation, bankruptcy etc. If not, the rights of the landlord are firstly based in a breach of the contract for unpaid rent. WILL AN INSOLVENCY PRACTITIONER BE LIABLE TO PAY RENT? Sometimes. The lease contract is with the insolvent tenant, not the insolvency practitioner, so will only be liable in limited circumstances. An insolvent tenant will remain liable for rent after the appointment of a practitioner, at least until the tenant vacates the premises but usually only for the remainder of the rental period. Any liability to pay the rent during this period rests with the insolvent tenant albeit that it will probably not be paid. The landlord can prove in the estate for post-appointment rent (as well as unpaid current rent) as a claim based on the original contract. The insolvency practitioner is not a party to the lease and, in the normal course, does not become personally liable for rent accrued during the period that the tenant continues to occupy the property. But the relevant insolvency Act may specifically provide for that liability. WHAT TYPES OF INSOLVENCY PRACTITIONERS MAY BE LIABLE TO PAY RENT? 1. A voluntary administrator under section 443B; or 2. A receiver under section 419A. These practitioners will be liable for the rent accrued where the insolvent tenant uses, occupies or is in possession of the leased premises. This liability starts seven days after the appointment and ends when the practitioner: (a) gives notice that the tenant is vacating the premises; (b) vacates the premises - whether notice is given or not; or (c) ceases to be the voluntary administrator or receiver regardless of whether the tenant continues to occupy the premises thereafter or not. Sometimes the insolvent tenant (through the practitioner) will vacate the premises but another party will remain, usually negotiating new arrangements with the landlord. The liability of the practitioner ends when the tenant vacates the premises. Notice will usually be served on the landlord at that time and it then is at the discretion of the landlord to deal with the other party as it sees fit. WHY ARE ADMINISTRATORS AND RECEIVERS LIABLE FOR RENT? The Corporations Act specifically makes voluntary administrators and receivers personally liable for rental after the seven day period to force the practitioner to decide whether they need to continue occupying the premises, or if they can hand it back to the landlord. The seven day rent-free period gives the practitioners the time to make this decision and if needed to vacate the premises. In both cases the company is not being wound up. The administration is a control period to allow the company to form and propose a Deed of Company Arrangement (DOCA) to creditors, at which point the administration of the company could conclude. The receivership is purely an appointment to benefit a secured creditor and the landlord should not have to contribute to that process. Without these provisions practitioners would not be personally liable for rental and could continue to occupy the premises indefinitely. This would be both unfair and damaging to landlords financially. ARE PRACTITIONERS LIABLE FOR ANY BREACH OF THE LEASE? No. The appointment of a practitioner usually breaches the terms of a lease, and by this time the lease is usually already in breach for non-payment of rent. LANDLORD RIGHTS 71

74 2 LANDLORD RIGHTS 72 The practitioner will not be liable for these or any other breach of the lease, including any costs for removal of rubbish or to make good on the fit-out etc. Again, the contractual arrangement is between the landlord and the tenant, not the practitioner. CAN A PRACTITIONER REMAIN IN THE PREMISES? The insolvent entity remains the tenant and the practitioner (acting through the entity) can remain in possession of the premises as long as the process of eviction isn t underway. The Corporations Act provides that voluntary administrators can retain possession of the premises during the period of the administration (section 440C), but the administrator will become liable for the rent for that period (section 443B). Receivers do not have the power to remain in possession if the landlord wants them out. However, legally the landlord must follow the normal eviction process. They usually cannot demand the immediate removal of the tenant. Even though the tenant is insolvent, and subject to the above, the landlord can still rely on the terms of the lease to evict the tenant. WHAT DO LANDLORDS HAVE TO DO TO TAKE POSSESSION? In most cases the landlord will undertake due process under the lease to evict a tenant. These will be of no effect if a voluntary administrator invokes the powers under section 440C. The landlord should consult a solicitor about the preparation and service of appropriate notices. The notice should be directed to the practitioner, but be in the name of the tenant. Usually the practitioner will be able to advise the landlord of when they expect to vacate the premises. WHAT IF THE LANDLORD NEEDS TO GO TO COURT TO TAKE POSSESSION? When a corporate tenant is placed into administration or liquidation, all proceedings against the company are stayed and no new actions can be commenced. A landlord will have to seek the leave of the Court in Order to obtain the necessary Order to evict the tenant. In normal circumstances, the Court will grant leave for this purpose but it is an extra step in the process. In most cases, the practitioner will deal fairly with the landlord and will try to vacate as soon as possible. Nothing stops the landlord from commencing eviction proceedings or suing the tenant for rent owed when a receiver is privately appointed. A receiver is not protected by any legislation to limit the rights of the landlord. In the case of a Court appointed Receiver, a landlord must apply to the Court to exercise its rights. WHAT IF THE PRACTITIONER DOES NOT COMPLY WITH THE NOTICES? If an insolvency practitioner does not provide possession of the premises to the landlord after all relevant notices have been issued, that practitioner may be held liable for damages and trespassing. Once the appropriate notices have been issued, a practitioner must vacate the premises. It is rare that a practitioner will ignore a properly delivered eviction notice and risk personal liability. WHEN CAN A LANDLORD LODGE A PROOF OF DEBT? The landlord can lodge a proof in any liquidation, administration, Deed of Company Arrangement (DOCA), agreement under Part X or bankruptcy of a tenant. WHAT CAN LANDLORDS PROVE FOR? A landlord is entitled to prove for any rent outstanding at the time of the appointment and for any rent that becomes due for payment after the appointment and that cannot be collected from the practitioner. Future rent that would have been paid under the lease is a provable debt; however, the amount may have to be discounted at a rate which is prescribed by the various regulations. The landlord can also prove for any other amounts that are owed under the provisions of or breach of the lease. WHAT ABOUT MITIGATION OF THE LOSS? A landlord must attempt to mitigate their loss by taking reasonable steps to find a new tenant - and will generally be eager to do so. The claim will have to be adjusted to allow for the amount paid by any subsequent lessee. At times, these amounts will have to be estimated as the landlord will not be able to determine the exact figure at the time of lodging a proof of debt. CAN THE LANDLORD COMMENCE LEGAL ACTION FOR THIS DEBT? No. When the landlord has a right to prove for a debt, there is no need to commence any legal action to recover rent. Actions against the insolvent entity will be stayed. Insolvency practitioners will process any claims made by landlords and adjudicate further to relevant provisions of the Act. These rental claims will then rank alongside the other non-priority creditors for dividend purposes. WHAT IS DISCLAIMING A LEASE? Disclaiming a lease is different from the notices given by administrators and receivers when they vacate any premises. Disclaiming a lease terminates the lease. This allows the landlord to re-enter possession (if they have not already done so) and re-let the premises. It also removes the registration of the lease from the title of the property. Liquidators (section 568) and Trustees in Bankruptcy (section 133) have powers to disclaim lease contracts. This does not affect the rights of the landlord to prove for any amount in the estate, but allows the landlord to deal freely with the property. WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

75 RELATED TOPICS 2 LANDLORD RIGHTS WORRELLS NEVERS... Never keep bad news about your business from your marriage /partner. He or she won t appreciate being kept in the dark and it will be all the harder if losses continue. 73

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77 3 WORRELLS ARTICLES SET-OFFS: WHEN ARE THEY AVAILABLE? 76 NEVER NEVER SAY NEVER 77 SUPERANNUATION CLAIMS IN INSOLVENCY 78 RECEIVERS, LIQUIDATORS AND EMPLOYEE ENTITLEMENTS 80 ATO GARNISHEE NOTICES 82 VOLUNTARY DEREGISTRATION OF COMPANIES AND DIRECTOR PENALTY NOTICES BEWARE!!!! 83 AM I LIABLE FOR THE COMPANY TAX? 84 75

78 3 SET-OFFS: WHEN ARE THEY AVAILABLE? SET-OFFS: WHEN ARE THEY AVAILABLE? A Worrells partner was recently appointed as liquidator of two companies that traded in the same industry. Each company had a common director and a range of clients which they each serviced from time to time. A number of their clients were also creditors of one or other of the companies. Thus at the date of the liquidation of the companies, these clients were both owed money by and owed money to one of the companies. Where the party is both a debtor and a creditor of the liquidated company, the debtor/creditor is entitled to offset the debts owed to and from the liquidated company and either receive from (i.e. make a claim for) or pay to the company the balance of the debts. This set-off essentially takes place at the time of liquidation, see section 553C of the Corporations Act. The Bankruptcy Act has very similar provisions at section 86. For set off to occur there must be mutuality in regard to the debts owed to and from the insolvent entity. CORPORATIONS ACT SECTION 553C Insolvent companies--mutual credit and set-off (1) Subject to subsection (2), where there have been mutual credits, mutual debts or other mutual dealings between an insolvent company that is being wound up and a person who wants to have a debt or claim admitted against the company: (a) an account is to be taken of what is due from the one party to the other in respect of those mutual dealings; and (b) the sum due from the one party is to be set off against any sum due from the other party; and (c) only the balance of the account is admissible to proof against the company, or is payable to the company, as the case may be. There are two circumstances which will affect the right of set off. A set off is not allowed where the company was insolvent at the time that either side of the transaction was performed and the obligation forming part of the mutual and off-setting debts was created, and the party claiming set off had notice of the insolvency. This limitation is imposed to preclude circumstances where a creditor, having knowledge of the debtor s insolvency, contracts to buy goods or services from the insolvent company with the intention of claiming a set off. Such an approach is contrary to the policy of the Act as it would provide an unfair advantage to that creditor. The other circumstance where set off is not allowed is where there is a lack of mutuality. In the recent liquidations referred to above, a number of clients were a debtor of one company and a creditor of the related company. In these circumstances there is no mutuality, so no set-off, and this is true despite the common director and the close trading relationship which existed between the two liquidated companies. Accordingly the liquidator was unable to allow any set off. The effect of this was that debts due to the one company had to be paid in full and a claim lodged for amount due in the other company. By Ivor Worrell Partner, Worrells Brisbane Plain Talk e-update August WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

79 WORRELLS ARTICLES NEVER NEVER SAY NEVER 3 At the start of a new financial year and after thirty-eight years in practice I feel qualified to offer a range of Never maxims drawn from my experiences as an insolvency practitioner over that time. These fifteen Never maxims reflect some of the recurring problems that we see contributing to insolvency. 1. Never start a new year, or a new business, without a realistic budget. If the expected outcome cannot be expressed in a budget it s a gamble not a business. 2. Never rely on one customer, one product or a single employee for any more than 15% of your turnover. 3. Never deal in cash. It will ruin your judgment, your reputation and your balance sheet. More than what you save in tax is lost in personal and business capital. 4. Never overlook getting accurate and up to date accounts. If your accountant cannot get them done, get an accountant who can. 5. Never sink your money into a business that you don t fully understand. There is no better recipe for disaster. 6. Never advance funds to your own company, or guarantee your company s debts, without taking a security from the company at the same time. 7. Never fool yourself into thinking that all of the items in your inventory have value. Probably much of it is obsolete or unsalable. Clear it out and write it off. 8. Never make an investment based on a perceived tax benefit. A tax benefit can make a good decision better but it can never make a bad decision good. 9. Never confuse cash flow with profits. 10. Never skimp on the paper work. When disputes arise paper work is worth gold. 11. Never run a business unless you truly understand the difference between a Profit and Loss Statement and a Balance Sheet. 12. Never underestimate a large builder s ability to find fault in a subcontractor s work. 13. Never keep bad news about your business from your marriage/partner. He or she won t appreciate being kept in the dark and it will be all the harder if losses continue. 14. Never be afraid to vigorously chase what is due to you. The squeaky wheel gets oiled first, and very rarely does granting credit lead to the retention of a good customer. 15. Never ask your parents or children to guarantee your debts or allow you to borrow against their assets. You have no right to ask them to take such a risk. If readers would care to pass on their own Never maxims to Ivor Worrell we would be pleased to publish them. By Ivor Worrell Partner, Worrells Brisbane NEVER NEVER SAY NEVER Plain Talk e-update July

80 3 SUPERANNUATION CLAIMS IN INSOLVENCY SUPERANNUATION CLAIMS IN INSOLVENCY Superannuation and the claims that may be made for outstanding superannuation in an insolvent estate have been discussed recently in light of the pending changes to legislation that will allow directors to become personally liable for outstanding superannuation amounts under the DPN provisions (as they are commonly known). In the past all outstanding superannuation had to be paid to employee s funds by 28 July each year. If that did not happen, notice had to be given to the Australian Taxation Office under the Superannuation Guarantee Charges Act by 14 August. The provisions currently state that employers have to pay superannuation contributions for each employee by the quarterly cut-off dates, being 28 days after the end of each quarter. If they do not or cannot make those payments, employers have to lodge a Superannuation Guarantee Charge Statement - Quarterly within that 28 day period. The Australian Taxation Office website says that employers have to do this if they: don t pay enough super contributions (at least 9% of ordinary time earnings) for your employee - this is called a super guarantee shortfall don t pay super contributions by the quarterly cut-off date for payment don t pay super to your employee s chosen super fund - this is called a choice liability. According to the website: you ll have to: complete a Superannuation guarantee charge statement - quarterly work out the amount of super guarantee charge to pay pay the super guarantee charge to us by the due date for the relevant quarter. One would think that that if you had the money to pay the superannuation guarantee charge (which includes the amount of the shortfall) to the Australian Taxation Office by the end of the quarter, you had enough money to pay the superannuation to the fund by that date and there would be no shortfall. At times the employer is insolvent and enters into a form of insolvency administration before the required amount is paid to the Australian Taxation Office under the superannuation guarantee charge leaving a debt that may be proved in the estate. If there is a superannuation guarantee shortfall and the Australian Taxation Office makes an assessment of the amount from the statements forwarded to the Australian Taxation Office or by default or otherwise, they may lodge a proof of debt with the liquidator or trustee for the Superannuation Guarantee Shortfall. Superannuation is an amount that the employer must deduct and pay to the superannuation fund on behalf of the employee. This statutory amount is not technically a debt to the employee though other amounts deducted to be paid to the fund may be. It not provable by them in an insolvent estate if it falls under a claim made by the Australian Taxation Office under the Superannuation Guarantee provisions. It is also not technically a debt due to the trustee of the superannuation fund even though it should have been paid to them. The Corporations Act contains section 553AB that in effect provides the priority to the Australian Taxation Office s proof of debt for their superannuation guarantee charge. The Australian Taxation Office s claim has priority over one lodged by the employee or their fund manager. 78 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

81 WORRELLS ARTICLES 3 CORPORATIONS ACT- SECTION 553AB Superannuation contribution debts not admissible to proof Whole of superannuation contribution debt (1) In a winding up, the liquidator must determine that the whole of a debt by way of a superannuation contribution is not admissible to proof against the company if: (a) a debt by way of superannuation guarantee charge: (i) has been paid; or (ii) is, or is to be, admissible to proof against the company; and (b) the liquidator is satisfied that the superannuation guarantee charge is attributable to the whole of the first-mentioned debt. According to the Corporations Act, only the Australian Taxation Office can lodge a proof of debt for unpaid superannuation if it falls under the Superannuation Guarantee Charge, whether a claim has currently be made or not. It appears that as long as the Australian Taxation Office has the right to make a claim for the Superannuation Guarantee Shortfall, no one else can make that claim. The Bankruptcy Act does not clarify this position to the same degree. As to priority, under the Corporations Act any superannuation not remitted (whether amounts claimable by the employee or fund or under the superannuation guarantee charge) has a priority under section 556(1)(e), superannuation being specifically mentioned as a priority entitlement. It must be paid alongside wages and before other entitlements. 556(1)(e) subject to subsection (1A) -- next, wages and superannuation contributions and superannuation guarantee charge payable by the company in respect of services rendered to the company by employees before the relevant date; The Bankruptcy Act is different and gives a priority limited by a dollar amount for entitlements due to employees of the bankrupt. Section 109 includes (at subsection 1C) any outstanding superannuation guarantee charge (which includes interest and penalties) as part of that priority amount. Therefore any amount of superannuation claimed and proved by the Australian Taxation Office is subject to the upper priority limit imposed by the Bankruptcy Act currently $4,000. The balance of superannuation guarantee charge would then be a non-priority debt along with the balance of the wages amount. BANKRUPTCY ACT SECTION 109 Priority payments (1C) The reference in paragraph (1)(e) to amounts due to or in respect of any employee of the bankrupt also includes a reference to amounts due as superannuation guarantee charge (within the meaning of the Superannuation Guarantee (Administration) Act 1992), or general interest charge in respect of non-payment of the superannuation guarantee charge. Claims by employees for excess contributions or contract contributions would have section 109 priority, as they are due in respect of an employee and for services rendered, but also subject to that limited priority. SUPERANNUATION CLAIMS IN INSOLVENCY By Michael Griffin Partner, Worrells Brisbane Plain Talk e-update July

82 3 RECEIVERS, LIQUIDATORS AND EMPLOYEE ENTITLEMENTS RECEIVERS, LIQUIDATORS AND EMPLOYEE ENTITLEMENTS It is not uncommon for a recently decided case to have some impact or application on one or more of our files, and the Challenge Australian Diary Pty Ltd case is no exception. Challenge dealt with the application of certain sections of the Corporations Act and how they relate to receivers and employee entitlements. Our cases have a similar background to Challenge. In one we are the liquidators of a company that has outstanding employee entitlements. A controller was also appointed. There are assets that fall under the floating portion of the charge and these will have to be used to some extent to pay employee entitlements. The dispute is to what extent that is required by the controller and what rights and obligations the liquidator has to floating assets. Not that this point is disputed in our case, the Challenge case looked at what entitlements are due to employees when the controller is appointed. Our case was easy, the liquidator was appointed first and trading had ceased and employment contracts had been terminated at that time. Section 558 of the Corporations Act provides that all entitlement (including all leave and redundancy entitlements) are deemed to be payable when a liquidator is appointed. One of the questions decided in the Challenge case was whether leave and related entitlements to continuing employees that had not become due for payment were caught under the priority provisions that relate to controllers. It was confirmed that section 558 does not apply to controllers, so if a liquidator is not appointed before them, controllers are liable for only those entitlements that had become due for payment at the time of their appointment, not afterwards. Employees who do not have leave entitlements owing at that time will not be paid as part of that priority. Section 558 only has application to liquidations. Again, these provisions relate to liquidators only, not to controllers who have their own priority provisions. CORPORATIONS ACT SECTION 561 Priority of employees claims over floating charges So far as the property of a company available for payment of creditors other than secured creditors is insufficient to meet payment of: (a) any debt referred to in paragraph 556(1)(e), (g) or (h); and (b) any amount that pursuant to subsection 558(3) or (4) is a cost of the winding up, being an amount that, if it had been payable on or before the relevant date, would have been a debt referred to in paragraph 556(1)(e), (g) or (h); and (c) any amount in respect of which a right of priority is given by section 560; payment of that debt or amount must be made in priority over the claims of a chargee in relation to a floating charge created by the company and may be made accordingly out of any property comprised in or subject to that charge. Controllers have a more limited priority regime to consider. Because section 558 does not apply to them, the amount of leave entitlements that they have to pay under the priority provisions in that Part of the Act is limited to what was outstanding and due for payment at the time of the appointment. The qualification given by the Court is that this applies to employees who continue in employment after the appointment of the controller, not those terminated at that time or indeed just before and who have not been paid. Amounts to those employees will be due for payment and hence have priority. As it applies to employee entitlements, section 433 provides that assets under the floating charge must be used to pay those certain entitlements before payments to the secured creditor. CORPORATIONS ACT SECTION 558 Debts due to employees (1) Where a contract of employment with a company being wound up was subsisting immediately before the relevant date, the employee under the contract is, whether or not he or she is a person referred to in subsection (2), entitled to payment under section 556 as if his or her services with the company had been terminated by the company on the relevant date. In cases where there are no controllers appointed but there is a secured creditor with a charge over floating assets, the liquidator who has control of the assets can take precedent over that charge to pay employees some of their entitlements (including to third parties who have provided money for the company to pay entitlements). Because of section 558, these will include all of the relevant entitlements to all employees. The qualification given by statute is that this provision only applies when the controller is appointed before the appointment of a liquidator. If a liquidator is appointed before them, the liquidator will have the obligations for employee entitlements and will be able to utilize section 561 to use assets for that purpose. CORPORATIONS ACT SECTION 433 Payment of certain debts, out of property subject to floating charge, in priority to claims under charge (2) This section applies where: (a) a receiver is appointed on behalf of the holders of any debentures of a company or registered body that are secured by a floating charge, or possession is taken or control is assumed, by or on behalf of the holders of any debentures of a company or registered body, of any property comprised in or subject to a floating charge; and 80 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

83 WORRELLS ARTICLES 3 (b) at the date of the appointment or of the taking of possession or assumption of control (in this section called the relevant date): (i) the company or registered body has not commenced to be wound up voluntarily; and (ii) the company or registered body has not been Ordered to be wound up by the Court. (3) In the case of a company, the receiver or other person taking possession or assuming control of property of the company must pay, out of the property coming into his, her or its hands, the following debts or amounts in priority to any claim for principal or interest in respect of the debentures: (c) subject to subsections (6) and (7), next, any debt or amount that in a winding up is payable in priority to other unsecured debts pursuant to paragraph 556(1)(e), (g) or (h) or section 560. (5) The receiver or other person taking possession or assuming control of property must pay debts and amounts payable pursuant to paragraph (3)(c) or (4)(b) in the same Order of priority as is prescribed by Division 6 of Part 5.6 in respect of those debts and amounts. This of course leaves a position where secured creditors will have more of their floating asset money used to pay employee entitlements if a liquidator is appointed before they exercise their security and take control of those assets. Generally most employees will not have leave entitlements etc due at any one point in time, so if the first appointment is a controller, those entitlements will not be a priority. Our second case has almost the exact opposite circumstances. We are receivers and were appointed before the liquidator, a position very similar to Challenge. However all of our employee entitlements had come due before our appointment, so deciding what entitlements are priorities is not a difficult question. Employees of course have the fall back position of GEERS should the controller not pay their entitlements and the company not being able to in the future as long as the company goes into liquidation and the employees are terminated because of that insolvency. Realistically, if the company is left in a position where it cannot make payments to employees at the end of a controllership, it is likely to be wound up if it has not happened already. By Raj Khatri Partner, Worrells Brisbane Plain Talk e-update June 2011 RECEIVERS, LIQUIDATORS AND EMPLOYEE ENTITLEMENTS 81

84 3 ATO GARNISHEE NOTICES ATO GARNISHEE NOTICES We often see that when individuals or corporations are in financial difficulty they start to default in the payment of their tax obligations such as GST and PAYG withholding tax. If a debtor fails to address payment of its taxes and does not enter into a payment arrangement with the ATO, the ATO will inevitably seek to recover the outstanding tax debt. The ATO are like any other creditor in that, if the debt remains outstanding, they can pursue recovery through legal action and as a final sanction may seek the bankruptcy of an individual debtor or the liquidation of a corporate debtor. However, the ATO has additional statutory powers for the recovery of debts which it can (and does) use prior to bankruptcy or liquidation proceedings. One of these recovery powers is the issuing of Statutory Garnishees. Where a person (third party) owes money to or holds money for a tax debtor, section of Schedule 1 to the Taxation Administration Act 1953 (TAA) empowers the ATO to require the third party to pay that money to the ATO rather than paying it to, or continuing to hold it for, the tax debtor. This power is commonly referred to as a Garnishee power and a written notice issued by the ATO under subsection 260-5(2) of Schedule 1 to the TAA is referred to as a Garnishee Notice. When a Garnishee Notice is issued by the ATO, a copy of the Notice is sent to the tax debtor. Any third party who receives a Garnishee Notice and pays money to the ATO as required by the Notice is taken to have been authorised by the debtor or any other person who is entitled to all or part of that amount. The third party is indemnified for any money paid to the ATO. Whilst it is legally possible for the ATO to issue a Garnishee Notice to any third party that owes money to or holds money for a tax debtor, the ATO must be in a position to identify parties upon which to issue such a Notice. Accordingly, it is not surprising that the majority of Garnishee Notices that we see are issued to banks and financial institutions as these entities are more readily identifiable as potentially holding funds on behalf of a tax debtor. Unfortunately for the ATO, a Notice issued to a bank or financial institution will have little or no success if there are no funds or minimal funds available in the debtor s bank account or there is an overdraft account in place. It is however interesting to note that the ATO s garnishee powers can be used to require a financial institution to pay amounts to the ATO which are transacted through a business s merchant card facility before the amounts are deposited into the business s bank account. Other examples of third parties upon which the ATO may also issue Garnishee Notices are: An employer or contractor (for an individual debtor) in respect of salary or wages. The ATO s policy is that they will usually seek to garnishee no more than 30 cents in the dollar of the amount of salary and wages payable to a tax debtor. A purchaser of land or property from a tax debtor. Where such land or property is mortgaged, the Garnishee Notice will also attach to the amount required to pay out the mortgage. As a sale would be unlikely to proceed if a vendor is unable to payout the mortgage and provide a purchaser with clear title to the property, the ATO s policy is that they may require that the notice only applies to the part of the purchase price to be paid to the vendor after the mortgage has been discharged. Solicitors holding trust funds. A Garnishee Notice may be served on a solicitor (or solicitors) holding trust funds on behalf of a client however, the Notice may not be effective if all such funds have become charged by a lien in respect of costs due from the tax debtor to such solicitors. Superannuation funds. A Garnishee Notice may be served on a superannuation fund however it would not be effective until the tax debtor s (member s) benefits are payable under the rules of the fund (usually when the member retires or dies). A company in which a tax debtor holds shares. This would entitle the ATO to receive any dividends payable to the debtor in respect of such shares. Trade debtors. A Garnishee Notice may be served on a trade debtor or debtors of an individual or company. If a Garnishee Notice is issued in respect of a tax debtor and the tax debtor subsequently enters some form of insolvency, the ATO will not ordinarily withdraw the Notice and it will continue to be effective against an insolvency practitioner. With the introduction of the Personal Property Securities Act, 2009 in October this year, it will be interesting to see whether Garnishee Notices may require registration on the PPS register in Order to be enforceable (they probably will) and how the ATO will chieve this. By Stephen Hundy Partner, Worrells Canberra Plain Talk e-update June WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

85 WORRELLS ARTICLES VOLUNTARY DEREGISTRATION OF COMPANIES AND DIRECTOR PENALTY NOTICES BEWARE!!!! 3 Two matters have recently come across my desk involving companies that have been voluntarily deregistered under Section 601AA of the Corporations Act. Section 601AA allows a solvent company to be de-registered by the ASIC under certain circumstances. Those include: all members of the company agree to deregister the company is not carrying on business the company s assets are worth less than $1,000 the company has no outstanding liabilities the company is not a party to any legal proceedings, and the company has paid all fees and penalties payable under the Corporations Act Without going into the specifics of each case, they involved the following basic circumstances: 1. The companies in question had reached the end of their useful lives. 2. Creditors had been paid and the companies tax affairs finalised (or so the directors believed). 3. The companies were subsequently de-registered pursuant to Section 601AA of the Corporations Act. 4. After the companies were de-registered the Australian Taxation Office (ATO) audited the companies. 5. Revised liabilities for PAYG, GST and Income tax were issued; and 6. The ATO then issued Director Penalty Notices (DPNs) against the directors for the outstanding PAYG. As covered in our previous newsletter articles, DPNs are issued by the ATO in an attempt to recover outstanding PAYG from directors personally. In short, the notice prescribes that unless a director undertakes one of three options within 21 days of the notice they will become personally liable for the company s debt as set out under the notice. The three options are: 1. Pay the tax debt in full; or 2. Appoint a Voluntary Administrator; or 3. Appoint a Liquidator. We have previous article on this matter in October Director Penalty Notices Revisited. The problem for both companies was they were de-registered, so apart from paying the tax (which was disputed) the directors were unable to place the companies in liquidation or voluntary administration to comply with the notices and avoid personal liability. This left two options to have the companies reinstated and then place them into liquidation or voluntary administration to comply with the notice. 1. An application to the ASIC to reinstate the company; or 2. An application to the Court to reinstate the company. The problem with the ASIC application is that it generally take longer than the 21 day period provided under the DPN and there is no guarantee the ASIC will approve the reinstatement. For the ASIC to reinstate a company you will need to provide valid proof that will demonstrate that there was a procedural defect or oversight in the procedure leading to the deregistration. As indicated on the ASIC website it is not enough just for the reinstatement to be convenient for you to form a valid reason. Likewise the application to the Court could take longer than the 21 day period and making an application in a short period of time such as 21 day is very expensive and not an easy task. In one of the cases in question the directors decided to pay the tax as the costs to make the application to Court was greater than the debt. In the other case the directors left the matter until the afternoon of the 21st day of the DPN to seek advice, so there was nothing that could be done to help them. Both directors of the later company became personally liable for the ATO debt (as per the DPN) as they were unable to comply with the notice. These cases should serve as a warning that voluntary deregistration will not banish a company s past sins in respect of TAX debts and should only be used in circumstances where the company s affairs have truly been finalised. If there is any doubt about the past sins of a company, other options involving members or creditors voluntary liquidations maybe a better option to finalise a company s affairs and avoid any DPN surprises. If you have any questions regarding this type of situation, please contact your local Worrells office. By Paul Nogueira Partner, Worrells Sunshine Coast Plain Talk e-update April 2011 VOLUNTARY DEREGISTRATION OF COMPANIES AND DIRECTOR PENALTY NOTICES BEWARE!!!! 83

86 3 AM I LIABLE FOR THE COMPANY TAX? AM I LIABLE FOR THE COMPANY TAX? I had one of those conversations with a few directors of a company recently where you just knew that everything you were going to say was the opposite of what they wanted to hear, and what they thought the legal position was. I was talking to directors of a company that was about to be wound up, and who were concerned about their personal positions as they related to outstanding tax. The conversation started with: Q: Have you received any Director Penalty Notices yet? A: Yes, I did about a month ago. The conversation went downhill from there. Most directors are aware that they can become personally liable for unpaid tax liabilities. The TAA (Tax Administration Act - in Schedule One) sets out a director s obligation to cause the company to comply with its obligation to pay its tax liability. This does not create financial liability just an obligation to make the company pay its tax. A director becomes liable for a penalty if they do not cause the company to pay its liabilities by the due date. The directors I was talking to knew that the company had not paid its tax, amongst other debts. They had taken some action to limit their exposure by having a few of them resign before the company would be wound up. In fact some resigned before the DPN was issued, but not the one who received it. They had just been told that this did not matter, that they could still be liable for the tax debts. They spoke to me to get some clarification. The financial strain had also greatly strained relations between these directors all until now friends. I was not making matters better. The general position is understood to be that directors of companies have an obligation to cause the company to pay its tax and any person who is a director at the time that the company does not pay its tax is liable for a penalty. But the position is wider than that. Penalty for director on or before due day (1) You are liable to pay to the Commissioner a penalty if: (a) at the end of the due day, the directors of the company are still under an obligation under section ; and (b) you were under that obligation at or before that time (because you were a director). The relevant words in the section mean that you are liable for the penalty if you were under the director s obligation (to make the company pay tax) at or before the due date for payment. The obligation is created when the tax is deducted. So as long as you were a director for any of the period between when the tax was deducted (before the due date) and when it is due for payment (at the due date), you are liable for the penalty if the company does not pay the tax, even if you resigned during that period. Not that it was relevant to my conversation, but new directors appointed after the due date may become liable for the company s past tax debts simply by virtue of being appointed. Directors appointed after the due date are liable for the same penalty. That liability commences 14 days after the appointment if the company still has not complied with its obligation to pay its outstanding tax. The wording in the section could read at or before or anytime afterwards. All of this leads to a position where a director is liable if they were a director when (i) tax was deducted (ii) it was payable, or (iii) the tax remained payable (subject to the 14 day period). 84 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

87 WORRELLS ARTICLES 3 The TAA does not allow collection of the penalty without a DPN being issued. Actually, that is not entirely correct. The TAA does not allow the ATO to commence proceedings to recover the penalty without issuing a DPN. Even though some of the directors had resigned before DPNs were issued, they could still be issued with DPNs as they are still liable for the penalty. Also the ATO has other collection techniques that do not require the commencement of proceedings and therefore the issuing of DPNs. It appears then that the director with the expired DPN is both personally liable for the penalty and the ATO can collect it by commencing proceedings. The others are not free from liability as they had thought, but if the company is placed into liquidation before the DPNs are issued or within the 21 days, they would be safer. Luckily (I suppose) the director who received the DPN has assets to satisfy that claim. It also appears that the other directors are safe from liability because this director will pay the debt. Maybe, but not necessarily. The directors (now ex-directors) who did not receive DPNs are still liable for the penalty and the ATO can collect it using other means, as long as they do not commence proceedings. Given that one director is likely to pay the ATO, it is not likely that the ATO will take any action at all. They can only collect the debt once. But the director who pays the penalty has some rights against his other directors. The Act sets out rights where one director pays a liability and the other directors were also liable to pay penalties related to their obligation. The section gives the paying director a right of contribution from directors (or ex-directors). The question that I have not seen answered is whether the other directors need to have been issued DPNs before they fall into this section. I think not. The section appears to give rights to the director who pays the ATO to recover from anyone else whom the Commissioner is entitled to recover, a penalty under this Division. The ATO must not commence proceedings to recover until it has issued a DPN, but technically has a right of recovery without commencing proceedings. That is, they are entitled to recover, just not commence proceedings to do so. I will be interested to see what the Courts make of this in due course. I cannot find any decision on this point yet. Directors rights of indemnity and contribution (1) This section applies if you pay a penalty under this Division in relation to a liability of the company under an obligation referred to in section (2) You have the same rights (whether by way of indemnity, subrogation, contribution or otherwise) against the company or anyone else as if: (a) you made the payment under a guarantee of the liability of the company; and (b) under the guarantee you and every other person who has paid, or from whom the Commissioner is entitled to recover, a penalty under this Division in relation to the company s obligation were jointly and severally liable as guarantors. Given the directors had a strained relationship at the start of the conversation, I cannot imagine I have made it any better. By Michael Peldan Partner, Worrells Brisbane AM I LIABLE FOR THE COMPANY TAX? Plain Talk e-update May

88 GLOSSARY GLOSSARY A Advance Fee Fraud A fraud premised on the victim paying for a product, service or benefit is advance of receipt. The product, service or benefit is then not provided. Annual Meeting & Annual Report Liquidators of Voluntary Windings Up (whether Members or Creditors Voluntary Wings Up) are required under section 508 of the Corporations Act to either (i) hold an annual meeting of members and creditors of the company; or (ii) lodge an annual report with ASIC detailing the position of the winding up. ASIC The Australian Securities and Investments Commission Associated Entity In relation to a person, means: (a) an entity (other than a company) that is, or has been, associated with the person; or (b) a company that is, or has been, associated with the person at a time when the company is, or was, as the case may be, a private company. Asset Shifting The fraudulent moving of assets onto or off an entity s financial statements in Order to manipulate the appearance of the financial health of the entity. B Bankrupt A person: (a) against whose estate a sequestration Order has been made; or (b) who has become bankrupt by virtue of the presentation of a debtor s petition and remains undischarged (an undischarged bankrupt). A discharged bankrupt is a bankrupt who has been discharged from bankruptcy under Section 149 of the Bankruptcy Act. Bankruptcy Notice A notice issued by the Official Receiver to a debtor under section 41 of the Bankruptcy Act requiring the debtor to satisfy a Judgment debt with a specific time period. Blackmail The offence of making an unwarranted demand with a threat of financial or person loss or harm to the person threatened, or for a personal gain to oneself. Bribery The offence relating to the improper influencing of a person in a position of trust. C Caveat A notice, usually on a register, to place the public on notice that no action of a certain kind may be taken without first informing the person who gave notice. The most common use is placing a notice on the title of Real Property to protect an interest in that property. Certified Fraud Examiner A full member of the Association of Certified Fraud Examiners. The Association is based in Huston, Texas in the United States and was formed to create an education and support base for professional fraud examiners. Close Associate (Corporations Act) of a director means: (a) a relative or de facto spouse of the director; or (b) a relative of a spouse, or of a de facto spouse of the director. Committee of Creditors or Inspection A smaller body of creditors or its representatives (usually 3 to 7) that have been elected by the main body of creditors to represent them at meetings with the appointee to the insolvency estate. The committee has the same powers as the general body of creditors in making resolutions at meetings. Composition One of the two types of agreements that can be made between a bankrupt and their creditors (under section 73 of the Bankruptcy Act) during bankruptcy. Acceptance of a proposal for a Composition will annul the bankruptcy. Conflict of Interest A position where an employee has an undisclosed interest in a transaction that adversely affects their employer (whether financial or otherwise). Controller In relation to property of a corporation: (a) a receiver, or receiver & manager, of that property; or (b) anyone else who (whether or not as agent for the corporation) is in possession, or has control, of that property for the purpose of enforcing a charge (Mortgagee in Possession or their agents). Creditor An entity that is owed money by another. Creditor s Petition An application (a petition) to the Courts to place a debtor into an insolvent estate (bankruptcy for a person or liquidation for a company) under an Order of the Court. The application is usually made by a creditor, or more than one creditor jointly, that has an unsatisfied Bankruptcy Notice or Statutory Demand. The application must be heard by the Courts. Creditors Voluntary Winding Up Is the winding up of an insolvent company under Part 5.5 of the Corporations Act. This type of winding up may be commenced through the Voluntary Administration provisions of the Corporations Act, or through a meeting of the company s members through the voluntary winding up provisions. 86 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

89 CORPORATE INSOLVENCY D Debt Agreement Means an agreement under section 185H of the Bankruptcy Act resulting from the acceptance of a debt agreement proposal under Part IX of the Bankruptcy Act. Debt for Equity Swap Where a company agrees to capitalize a debt, by setting off the amount payable by the company under the debt against an amount due by the creditor for an issue of shares. Debtor An entity that owes money to another (a creditor). Director A person who: (a) is appointed to the position of director; or (b) is appointed to the position of an alternate director and is acting in that capacity regardless of the name that is given to their position. Unless the contrary intention appears, it also includes a person who is not validly appointed as a director, if: (a) they act in the position of a director; or (b) the director of the company or body are accustomed to act in accordance with the person s instructions or wishes. E Embezzlement A dishonest appropriation by an employee of money or property given to him on behalf of his employer. The offence is classified as a form of theft. Employee Entitlements Amounts owing the employees of the insolvent, usually made up of outstanding wages, commissions etc; outstanding leave entitlements and redundancy payments. These entitlements are generally priority claims in insolvent estates, but the level of that priority and the amount of the entitlement that is priority varies in certain circumstances. GLOSSARY Debtor s Petition Means a petition presented by a debtor against himself or herself and includes a petition presented against a partnership in pursuance of section 56 of the Bankruptcy Act and a petition presented by joint debtors against themselves in pursuance of section 57 of the Bankruptcy Act. Deed of Company Arrangement Means a Deed of Company Arrangement executed under Part 5.3A of the Corporations Act or such a deed as varied and in force from time to time. It is a formal arrangement entered into between an insolvent company and its creditors to resolve it outstanding debt without going into liquidation. Dependant In relation to a bankrupt means a person who: (1) resides with the bankrupt; and (2) does not receive any income from a person other than the bankrupt or a spouse or former spouse of the bankrupt and: (3) is wholly dependant on the bankrupt for economic support or partially dependant on the bankrupt and partially on the spouse or former spouse. Director Penalty Notice A notice served by the Commissioner of Taxation on a director regarding a remittable amount, under the Prompt Recovery Regime. Disclaiming a Lease The process where a liquidator of bankruptcy trustee formally terminates an ongoing lease (or other financial obligation), thereby activating the right of the financier to deal with the financed asset. Doctrine of Exoneration A principle in equity law that deals with the rights of co owners of property where one co owner has used that property as security for a loan that solely benefited that person. The Doctrine makes assumptions about the roles of principle and surety over the loan and the security. Dividend A payment from an insolvent estate on a proved claim in that estate. Dividends are paid under the provisions of the Corporations Act or Bankruptcy Act in the set priorities for different classes of creditors and pro-rata to the creditors within the class. Entity Means a natural person, company, partnership or trust. Externally Administered Means a company: (a) that is being wound up; or (b) in respect of property of which a receiver, or a receiver and manager, has been appointed (whether or not by a Court) and is acting; or (c) that is under administration; or (d) that has executed a Deed of Company Arrangement that has not yet terminated; or (e) that has entered into a compromise or arrangement with another person the administration of which has not been concluded. Extortion The offence of using ones position to take money or other benefit that is not due for the purpose of exercising that position. 87

90 GLOSSARY GLOSSARY F Final Meeting of Creditors Liquidators of Voluntary Windings Up (whether Members or Creditors Voluntary Wings Up) are required under section 509 of the Corporations Act to hold a final meeting of members and creditors of the company to advise of the finalisation of the winding up and present a the final accounts of the winding up. Floating Charge Includes a charge that conferred a floating security at the time of its creation but has since become a fixed or specific charge. Forensic Conducted with the scientific examination of evidence when a crime is being investigated. Forensic Accounting The application of accounting and business knowledge to the purposes of law. e.g. detecting fraud, analysing or reconstructing books and records. Forgery The offence of making a false instrument or document so that it may be passed off as the original. Fraud A false representation (a deception) by means of a false statement or conduct in order to gain an advantage (usually commercial) over another. G GEERS The General Employee Entitlements & Redundancy Scheme that provides funding for the payment of employee entitlements. It is part of the Australian Government s Department of Employment and Workplace Relations. This scheme provides funding for the payment of certain entitlements left outstanding in liquidations and bankruptcies. H Holding Company In relation to a body corporate, means a body corporate of which the first body corporate is a subsidiary. I Incapacitated Entity An entity that is in liquidation or receivership, or which has a representative appointed; and a person that in bankrupt or who has entered into some arrangement under the Bankruptcy Act. Income Contribution Assessment The assessment of a bankrupt s income by their Trustee to determine whether the bankrupt is liable under the Bankruptcy Act to pay a contribution to their estate. Indemnity An enforceable agreement by one person to pay another person sums of money that are owed, or may become owed, due to a costs, loss or damage, especially in the form of financial compensation. Incorporeal Herediment An intangible interest that is inheritable, issuing out of land. Examples are rent, easements and profits à prendre. At common law, a deed is necessary to convey an incorporeal hereditament inter vivos. Insolvent A state of not being able to satisfy ones debts as and when they become due and payable. Insolvency can also be deemed for non-satisfaction of a Bankruptcy Notice or a Statutory Demand. Insolvent Trading A claim that a Liquidator of a company may make against a Director of that company for compensation. The amount of compensation is calculated on the amounts of debts incurred by the company, that remains unpaid at the time liquidation and that were incurred when the director knew or should have known, that the company was insolvent. Insolvent under Administration Means a person who: (a) under the Bankruptcy Act 1966 or the law of an external Territory, is a bankrupt in respect of a bankruptcy from which the person has not been discharged; or (b) under the law of an external Territory or the law of a foreign country, has the status of an undischarged bankrupt; and includes: (c) a person any of whose property is subject to control under: (i) section 50 or Division 2 of Part X of the Bankruptcy Act 1966 ; or (ii) a corresponding provision of the law of an external Territory or the law of a foreign country; or (d) a person who has executed a personal insolvency agreement under: (i) Part X of the Bankruptcy Act 1966 ; or (ii) the corresponding provisions of the law of an external Territory or the law of a foreign country; where the terms of the agreement have not been fully complied with. ITSA Insolvency and Trustee Service Australia J Joint Tenancy Ownership of land by two or more persons who have identical interests in the whole of the land. Joint Tenancy can arise only when 4 conditions are satisfied: 1. Each joint tenant is entitled to possession at the same time; 2. The interests must be identical 3. Each must have the same title 4. The interests must exist at the same time. Judgment Means a judgment, decree or Order, whether final or interlocutory, obtained by way of a decision of a Court, made pursuant to an application to the Court to make that decision. 88 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

91 CORPORATE INSOLVENCY L Lease A contract under which the lessor grants the lessee exclusive possession of the property for an agreed period, usually in return for rental and, sometimes, a capital sum called the premium. These are to be distinguished from Chattel Mortgages that are a security over assets owned by the entity or person Liquidation The process of winding up a company s affairs, having a liquidator appointed to the company, whether it is solvent (members voluntary winding up) or insolvent (creditors voluntary winding up or Official Liquidation by the Courts). Liquidator A personal able to be appointed to oversee the winding up of a company. See Registered Liquidator and Official Liquidator. M Maintenance Agreement Under the Bankruptcy Act means a maintenance agreement, within the meaning of the Family Law Act 1975, that has been registered in or approved by a Court in Australia or an external territory or any other agreement with respect to the maintenance of a person that has been so registered or approved. Members Voluntary Winding Up This is the process of winding up a solvent company, done when the members no longer wish to retain the company structure. There can be a number of reasons for the members wanting to do this, but usually it is because the company has reached the end of its useful life. This is the only process for fully winding up the affairs a solvent company. It ensures that outstanding creditors are paid in full and protects the members interests while the company structure is dismantled. Mutual credit and setoff (in relation to proving a claim) Where there have been mutual credits, mutual debts or other mutual dealings between an insolvent company that is being wound up and a person who wants to have a debt or claim admitted against the company: (a) an account is to be taken of what is due from the one party to the other in respect of those mutual dealings; and (b) the sum due from the one party is to be set off against any sum due from the other party; and (c) only the balance of the account is admissible to proof against the company, or is payable to the company, as the case may be. N National Personal Insolvency Index (NPII) In Bankruptcy, means the Index of that name established under the Bankruptcy regulations Net Value In relation to property, means: (a) if the property is unencumbered: the value of the property; (b) if the property is encumbered and the unencumbered value of the property exceeds the amount or value of the encumbrances: the amount of the excess; or (c) in any other case: a nil amount. Net Worth (in Bankruptcy) In relation to an entity, in relation to a time, means: (a) if the entity is a trust and the total value of the trust property as at that time exceeds the total of the amounts of the trustee s liabilities as at that time (other than liabilities constituted by the rights of persons as beneficiaries under the trust): the amount of the excess; (b) if the entity is not a trust and the total value of the entity s assets as at that time exceeds the total of the amounts of the entity s liabilities as at that time: the amount of the excess; or (c) in any other case: a nil amount. O Objections to Discharge A process where a Trustee in Bankruptcy may apply for the extension of the term of a bankruptcy (effectively keeping someone bankrupt for an extended period). Objections to Discharge must be based on some Ground and - depending on that Ground - the extension may be for 2 or 5 years. This process is possible under Division 2 of Part VII of the Bankruptcy Act. Officer of a Company Means: (a) a director or secretary of the corporation; or (b) a person: (i) who makes, or participates in making, decisions that affect the whole, or a substantial part, of the business of the corporation; or (ii) who has the capacity to affect significantly the corporation s financial standing; or (iii) in accordance with whose instructions or wishes the directors of the corporation are accustomed to act (excluding advice given by the person in the proper performance of functions attaching to the person s professional capacity or their business relationship with the directors or the corporation); or (c) a receiver, or receiver and manager, of the property of the corporation; or (d) an administrator of the corporation; or (e) an administrator of a Deed of Company Arrangement executed by the corporation; or (f) a liquidator of the corporation; or (g) a trustee or other person administering a compromise or arrangement made between the corporation and someone else. GLOSSARY 89

92 GLOSSARY GLOSSARY 90 Official Liquidator Means a person registered as an official liquidator under section 1283 of the Corporations Act. (Also see Liquidator and Registered Liquidator ) P Part IX Part IX (Nine) of the Bankruptcy Act, dealing with the administration of smaller insolvent estates outside bankruptcy. Part X Part X (Ten) of the Bankruptcy Act, dealing with administration of insolvent estates outside of bankruptcy leading to a proposal by a debtor to their creditors to enter into a Personal Insolvency Agreement. Personal Insolvency Agreement The name of the agreement that can be made between a debtor (being a real person) and their creditors under Part X of the Bankruptcy Act. Ponzi Scheme A system of investment fraud (named after Charles Ponzi) whereby victims are encouraged to invest monies based on fictitious returns and where the monies, or substantially all of the monies, are not invested in any investment. A common tread is that the monies paid by later investors are available to be used to satisfy earlier investors. Preferential Payment A payment(s) to a creditor made under certain circumstances whilst the payer is insolvent, where that payment is recoverable from the recipient by a Liquidator of a company or a Trustee of a Bankrupt Estate. Proof of Debt Specific forms under the Corporations Act and Bankruptcy Act for a creditor to prove the existence and quantum of their claim against the insolvent estate in the estate for voting and dividend purposes. The forms have to be in accordance with form 535 (or form 536 for employee claims) under the Corporations Act and Form 8 under the Bankruptcy Act. Proxy The agency, function, or office of a deputy who acts as a substitute for another. Authority or power to act for another by a document giving such authority. In Insolvent estates, the appointment of a proxy is performed by the creditor for attendance at meetings of creditors under the appropriate forms Public Examination In relation to a company: a common name given to the process of examining parties that are connected to the company about the affairs of the company. These examinations are conducted by the Courts under section 596A and section 596B of the Corporations Act. In relation to a bankrupt: a common name given to the process of examining parties that are connected to the bankrupt about the affairs of the bankrupt. These examinations are conducted by the Courts under section 81 of the Bankruptcy Act. Q Quorum Corporations Act In relation to the Corporations Act, a quorum consists of: (a) if the number of persons entitled to vote exceeds 2: at least 2 of those persons; or (b) if only one person is, or 2 persons are, entitled to vote: that person or those persons; present in person or by proxy or attorney. Quorum Bankruptcy Act In relation to the Bankruptcy Act, a quorum is constituted by: (a) the presence in person of the trustee (or the trustee s representative); and (b) a creditor, or a proxy or attorney of a creditor, participating in person or by telephone. Note: A meeting requires at least 2 persons. Therefore the person covered by paragraph (2)(a) cannot also be the proxy or attorney of the creditor covered by paragraph (2)(b). R Receivers and Managers A receiver of property of a body corporate is also a manager if the receiver manages, or has under the terms of the receiver s appointment power to manage, affairs of the body. Registered Liquidator Means a person registered as a liquidator under subsection 1282(2) of the Corporations Act. Registered Trustee Means a person that has been registered to act as a Trustee under Division 1 of Part VIII in appointments under the Bankruptcy Act. Related Company Where a company is: (a) a holding company of another company; or (b) a subsidiary of another company; or (c) a subsidiary of a holding company of another company; the first-mentioned company and the other company are related to each other. Related Entity In relation to a company, means any of the following: (a) a promoter of the body; (b) a relative, or de facto spouse, of such a promoter; (c) a relative of a spouse, or of a de facto spouse, of such a promoter; (d) a director or member of the body or of a related body corporate; (e) a relative, or de facto spouse, of such a director or member; (f) a relative of a spouse, or of a de facto spouse, of such a director or member; (g) a body corporate that is related to the first-mentioned body; (h) a beneficiary under a trust of which the first-mentioned body is or has at any time been a trustee; (i) a relative, or de facto spouse, of such a beneficiary; (j) a relative of a spouse, or of a de facto spouse, of such a beneficiary; WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

93 CORPORATE INSOLVENCY (k) a body corporate one of whose directors is also a director of the firstmentioned body; (l) a trustee of a trust under which a person is a beneficiary, where the person is a related entity of the firstmentioned body because of any other application or applications of this definition. Relation-Back Day In relation to a winding up of a company means: (a) if, because of Division 1A of Part 5.6, the winding up is taken to have begun on the day when an Order that the company or body be wound up was made-the day on which the application for the Order was filed; or (b) otherwise-the day on which the winding up is taken because of Division 1A of Part 5.6 to have begun. Resolution A motion moved at a meeting of creditors (or a committee) that is approved by the required majority of creditors (more than 50% in number and 50% in value) voting for the motion. For a Special Resolution under the Bankruptcy Act a majority of 50% in number and 75% in value is required. The Corporations Act has no special resolutions. Retrenchment payment In relation to an employee of a company, means an amount payable by the company to the employee, by virtue of an industrial instrument, in respect of the termination of the employee s employment by the company, whether the amount becomes payable before, on or after the relevant date. S Scheme of Arrangement One of the two types of agreements that can be made between a bankrupt and their creditors (under section 73 of the Bankruptcy Act) during bankruptcy. Acceptance of a proposal for a scheme of arrangement will annul the bankruptcy. Section 73 Arrangements Arrangements that are made by bankrupts with their creditors to provide for the annulment of the bankruptcy and the creation of a formal obligation for the ex-bankrupt to satisfy their creditors (wholly or in part) over time. Sequestration Order An Order made by the Federal Court at the hearing of a creditor s petition against a personal debtor (a real person as opposed to a company) that makes that person an undischarged bankrupt. Solvent Means being able to pay all ones debts as and when they fall due. Special Resolution Under the Bankruptcy Act, means a resolution passed by a majority in number and at least three-fourths in value of the creditors present at a meeting of creditors and voting on the resolution. Statutory Demand A demand in the appropriate form (Form 509H) served by a creditor on a debtor company requiring the company to satisfy or otherwise secure or compound the debt to the creditors satisfaction within a 21 day period from service of the notice. Non-satisfaction of the debt under the notice is used to deem that the company is insolvent is winding up proceedings. Statutory Trustee An appointment under a state s property law legislation (for example: section 38 of the Qld Property Law Act) of Trustees to be held by them on the statutory trust for sale or on the statutory trust for partition. Subordinate To treat as less important. In relation to a claim in an insolvent estate: to place it behind other claims in priority. Subrogation The substitution of one person for another so that the person substituted succeeds to the rights of the other. Subsidiary In relation to a body corporate, means a body corporate that is a subsidiary of the first-mentioned body by virtue of Division 6. A body corporate is a subsidiary of another body corporate if, and only if: (a) the other body: (i) controls the composition of the first body s board; or (ii) is in a position to cast, or control the casting of, more than one-half of the maximum number of votes that might be cast at a general meeting of the first body; or (iii) holds more than one-half of the issued share capital of the first body (excluding any part of that issued share capital that carries no right to participate beyond a specified amount in a distribution of either profits or capital); or (b) the first body is a subsidiary of a subsidiary of the other body. Superannuation contribution In relation to a company, means a contribution by the company to a fund for the purposes of making provision for, or obtaining, superannuation benefits for an employee of the company, or for dependants of such an employee. T Tenants in Common Equitable ownership of land by two or more persons in equal or unequal undivided shares. The share does not automatically pass to the other owners under a right of survivorship (as with joint tenancy). GLOSSARY 91

94 GLOSSARY GLOSSARY Trustee (in Bankruptcy) Means: (a) in relation to a bankruptcy: the trustee of the estate of the bankrupt; (b) in relation to a Personal Insolvency Agreement under Division 6 of Part IV: the trustee of the Personal Insolvency Agreement; (c) in relation to the estate of a deceased person in respect of which an Order has been made under Part XI: the trustee of the estate; or (e) in relation to a trust: (i) if only one person is a trustee of the trust: that person; or (ii) if 2 or more persons are trustees of the trust: any one or more of those persons; in his, her or its capacity as a trustee, or in their respective capacities as trustees, as the case may be, of the trust. Undervalued Transaction A transfer of property from a person who later becomes bankrupt where the transferee gave no consideration for the transfer or gave consideration of less value than the market value of the property. Undervalued transaction may be voided under section 120 and associated sections of the Bankruptcy Act. V Vexatious Action An action brought for the purpose of annoying the opponent and with no reasonable prospects of success. The actions may be struck out and the Court may Order that no legal proceedings may be begun or continued without the leave of the Court. Vexatious Litigant A person who regularly brings vexatious actions. U Ultimate Holding Company In relation to a body corporate, means a body corporate that: (a) is a holding company of the firstmentioned body; and (b) is itself a subsidiary of no body corporate. Ultra Vires Beyond the powers. Describes an act that goes beyond the limits of the powers conferred upon the entity or person. Ultra Vires acts are usually invalid. Uncommercial Transaction A transaction undertaken by a company that is later wound up where the benefits to the company are not commercial when considered against the cost or the detriment to the company. Uncommercial transaction may be voided under section 588FB and associated sections of the Corporations Act. Virtual Meetings The common name given to the process of trustees passing a single Creditors Resolution without calling a physical meeting of creditors - done under section 64ZBA of the Bankruptcy Act. W Wholly-Owned Subsidiary In relation to a body corporate, means a body corporate none of whose members is a person other than: (a) the first-mentioned body; or (b) a nominee of the first-mentioned body; or (c) a subsidiary of the first-mentioned body, being a subsidiary none of whose members is a person other than (i) the first-mentioned body; or (ii) a nominee of the first-mentioned body; or (d) a nominee of such a subsidiary. 92 WORRELLS SOLVENCY & FORENSIC ACCOUNTANTS WORRELLS.NET.AU

95 PLAIN TALK. STRAIGHT ANSWERS. FAST RESULTS.

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