Author: Levi Smouha

by Levi Smouha

Insolvency

Personal and Corporate Insolvency

Insolvency is one of our key areas of practice. Our insolvency lawyers are experienced in all aspects of personal and corporate insolvency.

We have a close working relationship with a number of insolvency firms throughout Australia, and as such, are able to provide our clients with a ‘complete package’ of both legal and financial insolvency-related assistance.
We understand that personal or corporate insolvency financial issues are complex, and insist that all possible insolvency options are explored to ensure the best outcomes for our clients. When debt is closing in, the chance to consider multiple possible resolutions can provide peace of mind and a renewed opportunity for financial stability and avert current insolvency, or future insolvency.

We can assist with the following pre-insolvency and post-insolvency related matters:

• Administrations and Deeds of Company Arrangement;
• Liquidations;
• Receiverships;
• ASIC Investigations;
• Recovery of debts via corporate insolvency and bankruptcy mechanisms;
• Reconstruction and personal insolvency arrangements; and
• Bankruptcies.

Frequently asked questions on insolvency:

• Liquidations;
• Administrations;
• Bankruptcy;
• Statutory Demands.

Liquidations

What is liquidation?

Liquidation refers to the insolvency process by which a company is brought to an end or ‘wound up’. It involves redistributing the assets and property of the company, usually to its creditors. It usually occurs when the company has become insolvent, meaning it can no longer pay its debts as they fall due. An independent person known as a ‘liquidator’ will be appointed to oversee this process to ensure that the interest of the creditors, directors and members are treated fairly. Liquidation can be either a voluntary or compulsory insolvency process. Liquidation ends when the company is dissolved by court order on the application of the liquidator or the company is struck off the register of companies by ASIC.

What is voluntary liquidation?

Voluntary liquidation is an insolvency process which occurs when the company, through a resolution of its directors and sometimes its members, chooses to enter into liquidation. This may be because it has become insolvent and the members of the company wish to bring the company to an end. In a voluntary liquidation, a liquidator is usually chosen by the company; however, the creditors have the right to change the liquidator in the course of the insolvency process. Voluntary liquidation can occur in one of two ways, being either through a creditors’ voluntary winding up or a voluntary administration.

A voluntary winding up is a type of insolvency which occurs where the directors and members decide to place the company in liquidation and a liquidator oversees the process of redistributing the assets and property of the company in order to bring it to an end.

A voluntary administration is a type of insolvency which occurs where the directors resolve to appoint a voluntary administrator to the company. The voluntary administrator will take control of the company,conduct investigations into the company’s affairs, and comment as to the solvency (or insolvency) of the company. They will then provide options for the company’s future. These options may include:

1. Entering a deed of company arrangement;
2. Placing the company in liquidation;
3. Ending the administration and handing the company back to the directors.

A deed of company arrangement is an agreement between the company and its creditors to satisfy the company’s debts.

Voluntary administration allows the company time to consider its future and options for moving forward whereas voluntary liquidation is purely aimed at bringing the company to an end.

What is a compulsory liquidation or court appointed liquidation?

Compulsory liquidation or court appointed liquidation occurs when the court orders that the company be wound up in insolvency. In this instance, one or more of the company’s creditors applies to the court for the company to be wound up. This is because the company has become insolvent. In this instance, the court usually appoints the liquidator nominated by the creditor/s.

What is the legal definition insolvency?

Pursuant to section 95A of the Corporations Act 2001 “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.” When a person is not solvent, they are insolvent. Insolvency occurs when a company can’t pay all of its debts as and when they fall due. A company will be considered insolvent even if they have an asset surplus (an ‘asset rich, cash poor’ scenario), if they are unable to quickly liquidate those assets. A company will be deemed to be insolvent when it fails to comply with certain requirements set down in legislation, the most common of these being the failure to comply with a statutory demand from a creditor. A statutory demand is a demand in the appropriate form (Form 509H) served by a creditor on a debtor company requiring the company to satisfy the debt within 21 days.

What is insolvent trading?

Insolvent trading occurs when a director allows the company to incur debts when the company is insolvent. Directors have a duty to prevent insolvent trading and therefore can be held personally liable in certain circumstances for debts that were incurred from the date of insolvency to the date of liquidation of the company.

What does it mean to file for insolvency?

A person can file for personal insolvency (i.e. bankruptcy) by filing the following documents with the Official Receiver of the Australian Financial Security Authority (AFSA) (the regulatory body for personal insolvency in Australia):

• Statement of Affairs; and
• Debtor’s Petition.

AFSA will review the documents ensuring that all relevant sections are completed. If all the documents are in order, the insolvency process of bankruptcy begins. This is explored further below.

A company can file for insolvency through the voluntary liquidation or voluntary administration process. For a voluntary liquidation, this usually involves a meeting with its directors and members to determine that the company is to be placed into voluntary liquidation, and that a liquidator should be appointed to the company. The liquidator will then lodge the appropriate forms with the Australian Securities and Investments Commission (ASIC) (the regulatory body for corporate insolvency in Australia).

For a voluntary administration, this usually involves the directors of the company signing an instrument to appoint a voluntary administrator to the company.

How do you declare insolvency?

For corporate insolvency, a director can declare insolvency of their company through the voluntary liquidation or voluntary administration process.

For personal insolvency, a person can declare insolvency by filing their Statement of Affairs and Debtor’s Petition with the Official Receiver of the Australian Financial Security Authority.

How do you prove insolvency?

For corporate insolvency, there are two common methods to prove insolvency of a company.

The first method is the presumption of insolvency found in section 588E(4) of the Corporations Act 2001 (Cth) (Act), Directors have an obligation under section 286 of the Act to keep adequate accounting records that at the very least could “enable true and fair financial statements to be prepared and audited:” In the event that directors have not kept sufficient books and records, a liquidator is able to rely on section 588E(4) of the Act, which enables a liquidator to presume that the company was insolvent through the period in which section 286 of the Act remained breached. The burden is on the directors or creditors to prove that the company was solvent at the relevant time.

The second method is establishing the indicators of insolvency as set out in the case of ASIC v Plymin, Elliott & Harrison [2003] VSC 123. The indicates of insolvency are:

1. The company is experiencing continuing losses;
2. The company’s liquidity ratio is below 1;
3. The company is subject to overdue Commonwealth and State taxes;
4. The company has evidence of poor relationship with its Bank, including the inability to borrow further funds from it;
5. The company does not have access to alternative finance;
6. The company has an inability to be able to raise further equity capital;
7. The company’s suppliers place the company on cancellation of debt, or otherwise demanding special payments before resuming supply;
8. The company’s creditors are unpaid outside of the trading terms;
9. Issuing of post-dated cheques by the company;
10. Issuing of dishonoured cheques by the company;
11. The company is required to enter into special arrangements with selected creditors;
12. The company becomes the recipient of solicitors’ letters, summons, judgments or warrants issued against it;
13. Payments to creditors of rounded sums which are not reconcilable to specific invoices; and
14. The company has an inability to produce timely and accurate financial information to display the company’s trading performance and financial position, and make reliable forecasts.

See article here for more details.

What are the consequences of insolvency?

The consequences of corporate insolvency can be summarised as below:

1. The directors ceased their role in the company;
2. The liquidator realises any assets of the company for the benefit of creditors;
3. The liquidator investigates the affairs of the company, and reports any breaches of duties by the directors to ASIC;
4. The liquidator makes a dividend distribution to creditors if sufficient funds have been realized in the liquidation; and
5. The liquidator deregisters the company once their duties and obligations are fulfilled.

There are also consequences for a director as a result of insolvency. This is explored further below.

The consequences of personal insolvency can be summarised as below:

1. A trustee is appointed to manage bankrupt’s estate;
2. If the bankrupt earns over a set amount, they are required to make compulsory payments to the trustee in bankruptcy;
3. Not all debts are released from bankruptcy (e.g. court imposed penalties and fines, child support & maintenance, HECS and etc);
4. A bankrupt is required to ask permission from the trustee in bankruptcy to travel overseas;
5. The bankrupt’s name will appear on the National Personal Insolvency Index;
6. If applying for credit, the bankrupt must inform the credit provider if the amount sought is over a certain limit;
7. The trustee may sell the bankrupt’s assets; and
8. The bankrupt loses the right to take or continue legal action (with some exceptions).

Is liquidation the same as insolvency?

Liquidation is a type of corporate insolvency. See the section on Court Liquidation.

What is administration in insolvency?

Administration is a type of corporate insolvency. See the section on Voluntary Administration.

How does a liquidation end?

A liquidation can end by:

1. The company being de-registered;
2. The liquidator appointing an administrator who then arranges a Deed of Company Arrangement;
3. The Court ordering the stay or termination of the winding up.

An administrator might be appointed in circumstances where the liquidator believes that creditors may be given a greater return. This means that the company may be able to continue trading where the liquidator believes the company has prospects of carrying on its business successfully.

What powers do liquidators have?

The liquidator’s powers include:
1. Investigating the affairs of the company;
2. Identifying transactions that are considered void;
3. Examine the directors and others under oath in a public examination;
4. Realizing the assets of the company;
5. Conducting and selling any business of the company;
6. Admitting debts and paying dividends.

What are my rights and options as a creditor?

Creditors are able to apply to the court for an order in relation to a court appointed liquidation in the event that the company is insolvent.

In all types of voluntary liquidation, creditors are able to appoint alternative liquidators or administrators. The creditors are able to vote to appoint an alternative at the first creditor’s meeting which is held within 8 business days of the appointment of the voluntary administrator. If a creditor is seeking to appoint an alternative liquidator, they should secure the alternative liquidator’s consent prior to the meeting. The resolution will be passed if a majority of creditor present at the meeting vote in favour of the resolution.

Where the company’s assets are realized and they are insufficient to pay creditors, creditors will be paid a dividend or percentage of the amount due and owing. Debts of the company are generally paid in order of priority as follows:

1. The costs and expenses of the liquidation (including the liquidators’ fees);
2. The costs of the petitioning creditor;
3. Outstanding employee entitlements;
4. Unsecured creditors; and
5. Members.

Each ‘class’ of creditors must be paid in full before the next class can receive a payment or dividend.

What rights do I have if I am a secured creditor?

A secured creditor’s rights include:

1. appointing a receiver to realize some or all of the secured assets (even after liquidation commences);
2. requesting that the liquidator deal with the secured assets and account for the proceeds;
3. voting at creditors’ meetings for the amount of the debt which exceeds the value of their secured assets;
4. receiving dividends for the amount of the debt which exceeds the value of their secured assets.

A secured creditor will generally need to submit a proof of debt form to the liquidator for the amount of the debt which exceeds the value of their secured assets. This will allow them to receive dividends in a similar way to unsecured creditors.

What rights do I have if I am an unsecured creditor?

An unsecured creditor’s rights include:

1. receiving dividends;
2. attending creditors’ meetings
3. receiving written reports from the liquidator;
4. inspecting certain books of the liquidator;
5. informing the liquidator of matters about the company within the unsecured creditor’s knowledge; and
6. complaining to ASIC or the court about the liquidator’s conduct.

An unsecured creditor must submit a proof of debt form to the liquidator proving their debt in order to be paid a dividend. The proof of debt form should be accompanied by supporting documentation such as invoices. The proof of debt will either be admitted by the liquidator or it will be rejected and the unsecured creditor notified within a period of 7 days. If you cannot reach a resolution with the liquidator in relation to your proof of debt, you may be able to appeal to the court. You should seek legal advice as soon as possible as an unsecured creditor will only have 14 days to appeal to the court.

What are my options as a director?

In the event that the company becomes insolvent, the director should immediately arrange for the company to enter voluntary liquidation or voluntary administration. Voluntary administration may allow for the company to get back on its feet.
Directors should be aware that there are a number of ways that directors can be held personally liable for company debts including where there was insolvent trading, unreasonable director related transactions and personal guarantees. These are the pitfalls of a company entering into insolvency.

What are my rights and options as a member?

Members have a right to receive any surplus after the company’s assets have been realized and creditors and the expenses of liquidation have been paid. This does not occur frequently in insolvency.

Voluntary Administration

What is a voluntary administration and how does it work?

A voluntary administration generally occurs where the directors resolve to appoint a voluntary administrator to the company. A voluntary administrator can also be appointed by secured creditors or a liquidator in some circumstances.

The first creditors’ meeting is called by the administrator within 8 business days of appointment. At this meeting, two issues are decided. Firstly, whether the creditors wish to appoint a different administrator. Secondly, whether they wish to form a committee of creditors and who will make up the committee.

The administrator will take control of the company, conduct investigations and report to the creditors and the Australian Securities and Investment Commission. After the investigations take place, the second meeting of creditors’ will take place. The administrator will provide a report with options for the company’s future. These options may include:

1. Entering a deed of company arrangement;
2. Placing the company in liquidation;
3. Ending the administration and handing the company back to the directors.

Once the company enters voluntary administration, a moratorium comes into effect which prevents the company from being sued by creditors without the written consent of the administrator or the leave of the court, with some exceptions. During this period, guarantees given by a director of the company are unenforceable.

What is a deed of company arrangement and how does it work?

A deed of company arrangement (“DOCA’) is an agreement between the company and its creditors to satisfy the company’s debts. The terms of the DOCA are as agreed, however, generally it allows the company to continue operating and may maximize the return for creditors.

Creditors are able to vote on a DOCA at the second meeting of creditors, generally held 15 to 25 days after the appointment of the administrator. The company must execute the DOCA within 15 days of the creditors’ voting for the proposal to enter a DOCA. Failure to comply within the time period would automatically put the company into liquidation.

It is important to note that all unsecured creditors are bound by the DOCA, even in the event that they did not vote for it. Secured creditors are not bound if they did not vote for the DOCA, unless the court orders that they be bound. The deed administrator appointed under the DOCA is responsible for monitoring the company and compliance with the DOCA

What are the benefits of entering voluntary administration?

Entering voluntary administration can provide a solution for companies to:
1. avoid insolvent trading;
2. come to an arrangement with creditors in relation to the company’s debts;
3. give the company ‘breathing room’ which may allow it to get back on its feet;
4. maximize the returns to creditors.

What are my rights as an unsecured creditor?

An unsecured creditor’s rights include:

1. lodging a proof of debt;
2. attending creditors’ meetings; and
3. voting at creditors’ meetings (if a proof of debt form has been lodged).

What are my rights as a secured creditor?

A secured creditor’s rights include:

1. lodging a proof of debt;
2. attending creditor’s meetings;
3. exercising their rights over their security within 13 business days; and
4. voting at creditor’s meetings (for the full amount of the debt).

Bankruptcy

What is bankruptcy?

Bankruptcy is an insolvency process where a trustee is appointed to administer an insolvent person’s estate. A person is insolvent if they are unable to pay their debts as and when they fall due.

How long does bankruptcy last?

Generally bankruptcy lasts three years from the date that the bankrupt files their Statement of Affairs, unless the trustee objects. A Statement of Affairs is a document completed by the bankrupt which discloses the bankrupt’s personal and financial information including their assets and debts. At the end of the bankruptcy the bankrupt is ‘discharged’.

Is bankruptcy the right option for me?

Bankruptcy can provide a solution to debt problems for both the debtor and the creditors. The debtor is released from their debts at the end of the bankruptcy and can start afresh. Creditors have the benefit of an independent person (the trustee) administering the debtor’s estate and receiving some payment for the unpaid debts.

How does someone become bankrupt?

A person may make themselves bankrupt by filing a debtor’s petition and Statement of Affairs with the Official Receiver. The Official Receiver will then issue an estate number to the bankrupt.

A creditor may apply to the Federal Circuit Court to make a person bankrupt. Generally, the creditor must have obtained a judgment on their debt and have served a bankruptcy notice on the debtor. The debtor then must pay the debt before the expiry of the bankruptcy notice. If the debtor fails to pay the debt before the expiry of the bankruptcy notice the creditor may file a creditor’s petition with the Court seeking a sequestration order, which will bankrupt the debtor. It is important to note that the Statement of Affairs must be completed by the bankrupt before the three years will begin to ‘run’ so it is essential that the bankrupt files this as quickly as possible.

What are the consequences of being made bankrupt?

There are a number of restrictions and obligations placed on a bankrupt person including:

1. The bankrupt must surrender their passport and seek permission for any overseas travel;
2. The bankrupt must make all financial records available;
3. The bankrupt must make all their divisible assets available to the trustee;
4. The bankrupt can’t act as a company officer;
5. The bankrupt can’t trade under a registered business name without disclosing that they are a bankrupt;
6. The bankrupt can’t incur credit over a set amount without disclosing to the lender that they are bankrupt.

A bankrupt’s assets will be realized by the trustee. Any asset that is able to be realized and divided among creditors is referred to as divisible assets. Divisible assets include:

1. All property owned a the time of bankruptcy or acquired during the bankruptcy;
2. Any rights or powers over property that existed at the date of bankruptcy or during the bankruptcy;
3. Any rights to exercise powers over property.

Examples of divisible assets may include:

1. Real estate including the family home;
2. Contents of bank accounts;

The bankrupt’s assets which cannot be realized may include:

1. Necessary clothing and household items;
2. Tools of trade up to an indexed amount;
3. Motor vehicle up to an indexed amount;
4. Sentimental property;
5. Superannuation payments;
6. Life assurance or endowment policies;
7. Certain damages and compensation payments.

Sentimental property must have sentimental value and be an award for sporting, cultural, military or academic achievement. This does not include monetary awards. The creditors must also resolve that the property is sentimental. Engagement and wedding rings are not considered sentimental property.

A bankrupt is still able to earn an income up to a certain amount. Any income in excess of this amount must be paid into the estate.

What are the duties of the trustee?

The trustee will:
1. Find and realize the assets of the bankrupt;
2. Conduct investigations into the financial affairs of the bankrupt;
3. Make any recovery of assets necessary;
4. Report to creditors;
5. Report offences; and
6. Distribute surplus funds to creditors, usually by way of dividends.
The assets and property of the bankrupt immediately ‘vest’ in the trustee once bankruptcy occurs. This means that the trustee automatically gains rights and control over the assets and property and does not have to take any special action.

How are creditors affected when a person becomes bankrupt?

Secured and unsecured creditors of the bankrupt are affected in different ways. If a creditor is ‘secured’ it means that they have a charge over a debtor’s asset; a common example of a secured creditor is a bank with a mortgage over the family home. A creditor is ‘unsecured’ if they do not hold a right to or charge over any of the debtor’s assets; a common example of an unsecured creditor is a bank who has issued a credit card to a customer.
Unsecured creditors exchange their right to bring a claim for a right to prove their debt in the bankrupt estate in return for a dividend. This means that the unsecured creditor gives up their right to bring a claim for the full amount of the debt owed by the bankrupt for the right to be paid a dividend by the trustee once all assets of the bankrupt have been realized.
Secured creditor’s rights generally remain the same. They can enforce their rights by having their secured asset sold or realized. They are then able to prove in the estate for the shortfall or difference between the amount recovered from the security and the original amount of their debt.

Creditors are able to vote to change the trustee.

What are void transactions and preferential payments?

Void transactions include undervalued transactions, transfers which were intended to defeat the debtor’s creditors and transfers where the consideration was paid to a third party within five years of the commencement of the bankruptcy. There are some exemptions including maintenance agreements or orders made in the Family Court or payment of tax pursuant to Commonwealth or State law. The trustee is able to void these transactions and recover the asset. It will then be available for distribution among the creditors.
Preferential payments are when a creditor of the bankrupt received an advantage over other creditors when compared to what they would have received in the bankruptcy. The payment has to have occurred when the bankrupt was insolvent and within a certain timeframe of the bankruptcy. The trustee is able to void these preferential payments and recover the payment in order to make a more fair and equitable distribution among the creditors.

Is there an alternative to bankruptcy?

Yes. A personal insolvency agreement (also known as a Part X agreement) allows a debtor to come to an agreement with their creditors in relation to their debts without being made bankrupt. In this process, a trustee is appointed by the debtor signing an authority under section 188, a Statement of Affairs is prepared by the debtor and a draft personal insolvency agreement must be provided to the trustee. A meeting of creditors is then held to decide whether the creditors will accept the proposal. Debtors should be aware that signing a section 188 authority is an act of bankruptcy and creditors may choose not to accept the proposal and bankrupt the debtor instead.

What is a section 73 proposal?

A section 73 proposal can be used to annul a bankruptcy. The bankrupt proposes an alternative arrangement for paying the debts to creditors.
An annulment has the effect of voiding the bankruptcy from the beginning. It is as if it never occurred.

What is a Part IX debt agreement?

A Part IX debt agreement is an agreement between the debtor and their creditor’s which provides for a sustainable plan for the debtor to pay off their debts.
Creditor’s Statutory Demands

What is a statutory demand?

A statutory demand is a demand in the appropriate form served by a creditor on a debtor requiring the debtor to satisfy or secure the debt within 21 days.

How do I issue a statutory demand?

A statutory demand must be made in the correct form pursuant to section 459C of the Corporations Act.

A statutory demand must:

1. Be in the prescribed form (Form 509H);
2. Be for a debt that is due and payable;
3. Be for an amount which is no less than $2,000.00 (the current statutory minimum);
4. State the debtor company name and its registered office; and
5. Specify where the debt can be paid.

A statutory demand must be accompanied by an affidavit in support of the debt or a judgment of the Court.

What should I do if I am served with a statutory demand?

It is important to note that the debt is required to be paid within 21 days of being served with the statutory demand; otherwise the creditor gains the presumption that the company is insolvent and can apply for a winding up order. Accordingly, the debt should be paid immediately in accordance with the statutory demand.

There is also the option to resist the statutory demand. This involves filing an application with a supporting affidavit to the court within the 21 day period.

A statutory demand may be set aside on the basis that:

1. The amount owed is less than the statutory minimum;
2. Where there is a defect in the statutory demand that would cause substantial injustice to the debtor;
3. Some other reason which may include the debt being for an inflated or incorrect amount.

What happens if the debtor doesn’t comply with a statutory demand?

The creditor can apply to the court for a winding up order on the presumption that the company is insolvent. However, this presumption of insolvency applies only where the winding up order is made within 3 months.

If you would like further information regarding the voluntary liquidation insolvency process, please contact the Insolvency Lawyers at Rostron Carlyle Rojas Lawyers on (07) 3009 8444 or email us at mail@rcrlaw.com.au.

by Levi Smouha

Personal liability of a director for failure to keep financial records

In the matter of Substance Technologies Pty Ltd [2019] NSWSC 612, the Court considered a liquidator’s application with respect to whether a director is personally liable to pay the sum of $170,000 for debts incurred whilst the company was insolvent, largely on the basis that the director failed to keep / produce financial records.

If a company fails to keep, and retain for 7 years, suitable financial records, it can be assumed to be insolvent for the purposes of an insolvent trading claim.

Director Personal liability case study- Facts

• Since its incorporation until late 2013, Substance Technologies Pty Ltd (In Liquidation) (Company) traded a scrap metal yard.

• From at least 2009, the Company rarely made a profit. By 30 June 2013, the Company had accumulated losses of $374,373 and taxation debt in the sum of $13,929.36.

• In early 2014, the Company purchased scrap metal from Ausgrid for the sum of $78,463, to which the Company failed to pay.

• On 2 January 2015, Christopher Thaler resigned as sole director of the Company, and Andrew Thaler (his son), replaced him as sole director.

• During Andrew’s directorship of the Company, Ausgrid entered judgment for the debt and the Company was subsequently placed into liquidation on 27 June 2016.

• The liquidator issued 3 demands to Andrew for the Company’s books and records, to which he did not comply.

Defendant’s arguments concerning personal liability case

The Court considered a number of arguments put forward by the Defendant, summarised as follows:

Defendant’s argument The Court’s findings
1. The debts no longer exist as they were written off If a bad debt proves to be recoverable, in whole or in part, then the creditor remains entitled to payment and to adjust its accounts to reverse the write-off and recognise the income. This is consistent with accounting standards.
2. Taxes are not debts incurred Taxes are debts incurred by the taxpayer for the purposes of insolvent trading.
3. The obligation to keep financial records was satisfied The obligation to keep financial records…is twofold: firstly, to keep records which record the company’s transactions and financial performance sufficient to enable financial statements to be prepared; and, secondly, to retain those records for seven years.
4. The financial records were not produced relying on the privilege against self-incrimination The directors’ privilege against self-incrimination has been abrogated by section 530A of the Corporations Act, requiring officers to help a liquidator carrying out their duties.
5. The company was not insolvent – the ATO debt could be paid and tax losses were an asset Christopher alleged that funds could have been loaned from his spouse – no such loan was made. Further, it was held that accumulated tax losses were not an asset of the Company as it could not be sold to pay off liabilities of the Company.
6. Both directors said they did not suspect insolvency Upon review the Company’s bank statements, the outstanding tax liabilities and financial statements, a “a director would have been left in no doubt that the company was insolvent
7. The company would pay the Ausgrid debt from profits on sale of the scrap metal There is no evidence that the company expected to earn such profits before the invoices were due for payment, nor that the company had other means of paying the invoices.

Outcome- Director personal liability

Both the former director (Christopher Thaler) and the current director (Andrew Thaler) were liable for the debts incurred by the Company, whilst it was trading insolvent, during the times they held directorship of the Company.

It is an important lesson for all directors of a company that you are required to keep financial records of a company for 7 years to comply with section 286(2) of the Corporations Act 2001 (Cth) (Act). A director may be held personally liable for failure to produce financial records to a liquidator, as section 588E(4) of the Act makes clear that the presumption of insolvency arises from the failure to keep records.

If you are a director of a company, or know someone who is, and want to know more, please contact the Insolvency Lawyers at Rostron Carlyle Rojas Lawyers on (07) 3009 8444 or email us at mail@rcrlaw.com.au.

by Levi Smouha

Case Study: Proof of debt claims for Subrogated Claims

Can a creditor vote and prove for a debt in an external administration, for a debt that it bought from another creditor?

This question frequently arises in an administrator’s or liquidator’s adjudication of claims for voting or dividend purposes. Often this happens where the business of the company in administration was continuing to trade and a related party has paid debts owed by the company to maintain a working relationship with suppliers. However, the admissibility of such a claim will depend on the circumstances under which the payment was made.

Assignments, Guarantor, Security and Subrogated claims

If a legal or equitable assignment of the debt took place, then the creditor can claim as an assignee of the debt. If no assignment took place, then it is possible that a right of subrogation will apply, but this will not apply in all circumstances.

If a guarantor pays a debt of a company in administration or liquidation, the guarantor can usually make a subrogated claim for the amount paid under the guarantee (but this may be subject to certain limitations in the terms of the guarantee). In this regard, a ‘subrogated’ claim puts the guarantor in the shoes of the creditor they had to pay and the guarantor can seek reimbursement from the company, as the company was primarily liable for that debt.

Where the debt paid on behalf of the company was secured, the payor may have a subrogation claim in the place of the secured creditor they paid out.

However, where a third party has spontaneously paid an unsecured debt of the company without any request by the company for that payment to be made, then that third party may not be able to claim reimbursement from the company by way of a subrogated claim in the liquidation or administration.

Case study Subrogated Claims

We recently had to consider this issue, where a company went into voluntary administration and then was subject to a deed of company arrangement, and certain trading debts of the company were paid by a related party (to maintain a working relationship with suppliers for that related party). There was no evidence that the company had requested the related party to pay those debts.

In that matter, the claim of the related party for the amount of the company debts it paid were not admitted for voting purposes at a meeting of creditors.

This was also the outcome in the case of re Dalma No 1 Pty Limited (In Liquidation) and Anor [2013] NSWSC 1335. In that case, a related party paid wages directly to the staff and sought the Liquidators consent to subrogate them into the priority position of the employees’ claims for unpaid wages (which have priority above other certain other claims in a liquidation). As the related party paid the employees directly (rather than funding the company to pay the employees), section 560 of the Corporations Act 2001 allowing a priority claim to the related party did not apply. Relevantly in respect of subrogation, Justice Brereton in that case held that:

At [33]: While the common law restitutionary claim for moneys paid might avail a third party who discharges a debt at the express or implied request of the debtor, its availability is contingent on an express or implied request; there is no such remedy for a third party who spontaneously pays off a debtor’s unsecured liability.

At [37]: In my view, the only context in which a spontaneous voluntary payment by a third party may found a claim for subrogation is in the exceptional category of the payment off of existing securities. There is no authority for extending that exceptional case to unsecured debts.

Takeaways for creditors and related parties

If you intend to make a payment on behalf of another party (in particular if it is, or may soon be, in administration or liquidation), it is important to consider whether security, subrogation or assignment may be available to maintain rights for making such payment. This may require a request by the debtor for you to make such payment, or for security or assignment documentation to be prepared and signed before making such payment.

Rostron Carlyle Rojas Lawyers are available to advise you and to prepare documentation to maintain your rights when funding or making payments for another party’s debts. Contact our Insolvency Lawyers for assistance on subrogated claims or any matters to do with insolvency or commercial litigation.

by Levi Smouha

Illegal Phoenix Activity Reforms

Announcements in the Federal Budget for 2018-2019 saw the Turnbull government continue their crackdown on illegal phoenix activity. Their reform package aims to transform corporations and tax laws in order to provide regulators with additional tools to disrupt “phoenixing”.

What is illegal phoenix activity?

There is no legal or statutory definition of phoenix activity. The Australian government notes that phoenixing can encompass both legitimate business rescue as well as the use of serial insolvency to avoid paying creditors.[1]

Fraudulent or unlawful phoenix activity usually involves the transfer of assets of a company to another company in circumstances where the company that made the transfer was unable to pay its debts when due. The transfer is done in order to deprive unsecured creditors equal access to its assets. There is usually a link between the management and shareholding of the old and new company.

Illegal phoenixing is orchestrated to leave behind a shell company, whereby the liquidation of that company will occur resulting in limited to no returns to creditors. This in turn forces employees to recover their entitlements through the Fair Entitlements Guarantee scheme at the expense of the Commonwealth government.

Accordingly, it is important to seek professional advice before any business restructure.

Costs to the Australian economy

Whilst the impact of illegal phoenix activity is difficult to quantify, in 2012 the cost of illegal phoenix activity was estimated to be in the range of $1.8 to $3.2 billion per year.[2] Such activity has widespread impact through the avoidance of debts to creditors, avoidance of paying employee entitlements and a loss of market integrity which comes at an increased cost to regulators.[3]

Planned reforms

In his announcement, Treasurer Scott Morrison said that the Federal Government plans to introduce a number of measures to protect Australian business from those companies that choose to “deliberately go bust to avoid paying their bills” including:

• The introduction of new phoenix offences in the Corporations Act 2001 (Cth) to target those that conduct or facilitate illegal phoenixing. This will include offences for directors that fail to produce adequate books and records to a liquidator;
• Prevent company directors from improperly backdating resignations to avoid liability or prosecution. In particular, where directors lodge a change in director notice more than 28 days after the director’s resignation, they may be liable for misconduct up until the date of lodgement;
• Limit the ability of directors to resign where it would leave a company with no directors;
• Restrict the ability of related creditors to vote on appointment, removal or replacement of an external administrator;
• Extend the Director Penalty Regime to GST, luxury car tax and wine equalisation tax, in turn making directors personally liable for such tax debts of a company; and
• Expand the ATO’s powers to retain refunds where there are outstanding tax lodgements.

These proposed measures build on reforms that already saw the introduction of the government’s Phoenix, Serious Financial Crime and Black Economy taskforces. Other announced reforms include a combined black economy and illegal phoenixing hotline, as well as reforms to address the corporate misuse of the Fair Entitlements Guarantee and non-payment of the Superannuation Guarantee Charge. At the centre of the reforms is the introduction of a Director Identification Number (DIN). The long awaited and much-discussed DIN will give every director in Australia a unique number. DINs will be used by government agencies and regulators to track the activity of directors in relation to alleged phoenix activity, including their interaction with accountants and lawyers.

The government is now tasked with rolling out the reforms and ensuring they are appropriately targeted in order to avoid legitimate and honest directors getting caught in the crackdown.

Levi Smouha, Partner of Rostron Carlyle Rojas Lawyers, is an expert in restructuring and corporate insolvency. Contact Rostron Carlyle Rojas Lawyers on (07) 3009 8444 or email our office at l.smouha@rcrlaw.com.au.