The definition of when a company goes insolvent is when it is unable to pay its debts as they fall due. The Corporations Act 2001 has an ambiguous definition of insolvency. Under the Corporations Act, it does not include all the examples of what it means when you are unable to pay your debt as and when they fall due.

Consequently, we need to turn to case law to get examples. Some of these examples are continuing losses, overdue taxes, dishonoured cheques, or payments to creditors of rounded sums irreconcilable to specific invoices. In ASIC v Plymin (2003) 46 ACSR 126; VSC 123 [paragraph 386] [Walter Wheel case], Mandie J listed relevant factors that are indicia of insolvency:

  1. Continuing losses
  2. Liquidity ratio below 1
  3. Overdue taxes
  4. Poor relationship with bank
  5. No access to alternative finance
  6. Inability to raise further equity capital
  7. Suppliers placing company on cash on delivery (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, judgments or warrants issued against the company
  13. Payments to creditors of rounded sums that 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

Consequently, it is difficult to often determine when a company is insolvent and in particular, the precise date of when a company was insolvent.

Who is a creditor?

You are considered a creditor if a company owes you money for reasons such as:
  • extension of credit or loans to the company
  • supply of goods or services to the company
  • purchase of goods or services that you have not received
  • unpaid wages, salary, or commission (for employees)

What are the types of creditors?

Creditors are commonly divided into two categories based on security interests: secured and unsecured.

Secured creditors

Secured creditors have a security interest over a person’s property or a company’s assets. Basically, they are first in line when the company is liquidated and its assets are distributed. You can find out if anyone holds a security interest over property by checking the Personal Property Securities Register (PPSR). Under the Personal Property Securities Act (PPSA), a security interest is an interest in personal property provided for by a transaction that secures payment or performance of an obligation. Examples of these transactions are fixed charge, mortgage, hire purchase agreement, lease of goods, transfer of title, and consignment.

Unsecured creditors

Unsecured creditors do not have security interests over a property. They are generally only paid on a pari passu basis (or on equal footing) if the company has any money left.

What are the rights and obligations of creditors?

When a company becomes insolvent, it’s important to act cautiously and decisively if you want to turn things around or just close down the affairs of the company. Generally, an insolvent business can enter into external administration–administration, receivership, or liquidation.

Voluntary administration

When going through voluntary administration, the voluntary administrator takes control of the insolvent company and its affairs. The voluntary administrator will manage the company’s affairs to work out payments to the creditors. Creditors have limited rights under voluntary administration but they can still: (a) influence the appointment or take part in appointing a voluntary administrator (b) limited, but potentially take action (i.e. most often priority of security and perfecting security) (c) receive a report on the voluntary administrator’s investigation of the company’s affairs (d) convene creditors’ meetings where they can:

i. vote to replace the administrator or form a committee of inspection; and

ii. decide on the company’s future i.e. return the control of the company to the directors, accept a deed of company arrangement (DOCA), or put the company into liquidation

Receivership

The primary purpose of a receivership is to repay debts owed to secured creditors, generally through the sale of the company assets. Under receivership, a secured creditor can: (a) appoint a receiver under an agreement (b) enter into possession and take control of the property or assets of the insolvent business (through the receiver) (c) lease, let on hire or dispose of said business assets (also through the receiver)

Liquidation or winding up

There are generally two types of winding up insolvent liquidation: court liquidation and creditor’s voluntary liquidation (following a resolution to liquidate by company shareholders or creditors). Unlike a receiver, a liquidator has a duty to all the company creditors whether secured or unsecured. In a liquidation,  the fundamental purpose is to terminate the company’s business, distribute the company’s assets, and ultimately, deregister the company.

Which creditor gets paid first in insolvency?

Creditors can ensure that their security interest is prioritised in insolvency by registering it on the Personal Property Securities Register (PPSR) and/or mortgages etc.  For businesses going through external administration, the general rules for determining priority are:
  1. perfected interests have priority over unperfected interests; and
  2. priority between perfected interests amongst themselves, and unperfected interests amongst themselves, is determined on a first-in-time basis (i.e. who has perfected the security and registered first)
  3. unsecured creditors

What does perfection of interest mean?

When we say perfection of interest, it means giving your security interest the best priority and effectiveness to enforce it against liquidators and third parties. This is mainly done through registration on the PPSR and/or registering a mortgage over real property.

Get timely legal advice on all aspects of insolvency

Insolvency does not necessarily mean that you lose all chances of recovering what you’re owed. Whether you’re a secured creditor or unsecured creditor, our insolvency lawyers can advise you on debt recovery, security enforcement, external administration processes, and other aspects of insolvency and bankruptcy. Let us help you make tough but smart choices and overcome any legal hurdles. Call us on 03 9052 3214 or fill in the contact form below.
Protect your rights as creditor in the event of insolvency. Get expert advice on debt recovery, security enforcement, external administration processes, and other aspects of insolvency. Arrange a free, no-commitment callback from us!
Louis Shivarev of TNS Lawyers
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