As of October 2019, the Australian Taxation Office (ATO) had an outstanding debt amounting to $45 billion.
If government agencies can carry that much debt, of course, it can happen to businesses too. Other than entering into liquidation, what else can businesses do if they reach the point of not being able to pay back creditors?
Under the Corporations Act 2001 (Cth), companies that are facing severe financial problems can finalise their affairs through external administration. Under external administration, the company can enter into administration, receivership, or liquidation.
All external administration processes typically involve creditors, which could be those that have provided goods or services to the company, employees that are owed wages and other employment benefits, or statutory agencies that are owed money such as the Australian Taxation Office.
In this article, we’ll take a closer look at administration, particularly voluntary administration.
What Is Voluntary Administration?
When a business becomes unable to meet its financial obligations as its debts are due, they are considered insolvent. Rather than an actual legal process, this term describes a state of financial distress in which a business can’t find a way to pay its creditors.
Insolvency can happen for any number of reasons. The most common being poor cash management, an increase in expenses, or reduced cash flow.
In ASIC v Plymin (2003) 46 ACSR 126; VSC 123 [paragraph 386]– (Water Wheel case), Mandie J listed relevant factors that are indicias 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 the 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
When a company finds itself insolvent, they have a few options. If they can’t increase income, owners might think about borrowing money or negotiating with creditors. If none of these options is possible, entering into voluntary administration might be a solution for the distress.
Voluntary administration is a process where basically the director(s) gives up control of the company. Control is then placed in the hands of a voluntary administrator.
A voluntary administrator is an independent and qualified third party. Their job is to complete an investigation into the reasons for insolvency and assess the options of the business. They’ll look for the best possible outcome for the creditors.
What Businesses Should Consider Voluntary Administration?
Companies that should consider voluntary administration include those that:
- are insolvent and require a way to deal with creditors
- had a bad trading period or a large, one-time loss that caused a lack of cash flow
- require a freeze on creditors’ legal rights to take action while taking measures to increase cash flow (such as reducing costs and staff)
Voluntary administration has two main purposes–first is to maximise the insolvent company’s chances of maintaining operations; second is to generate the best possible returns for the creditors.
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Appointing an Administrator
The first step of voluntary administration is having an administrator take control of the company from the directors. Generally, an administrator may be appointed by:
- majority of the company board;
- the company’s liquidator or provisional liquidator; or
- a person who holds a security interest or charge in the whole, or substantially the whole, of a company’s property.
As soon as practicable after the appointment, the administrator is required to make to a declaration of the company’s indemnities and relevant relationships and to give written notice of the first meeting with the creditors.
In addition, the administrator also:
- has control of the company’s business, property, and affairs;
- may carry on that business and manage that property and those affairs;
- may terminate or dispose of any of the property, or all or part of the business; and
- acts as the company’s agent and may perform any function and exercise any power that the directors or any of the company officers could perform.
While the company is under voluntary administration, only the administrator can deal with the company’s property.
With the help of the company directors, the administrator will also conduct an investigation and report on such things as:
- When the company became unable to pay their debts (insolvency date)
- If the company traded whilst insolvent
- If a past or present officer, employee, or member of the company committed any offences (e.g. negligence, breach of duty)
- Whether there is a possibility of recovering payments for creditors (preferential payment)
- If there are any secured creditors
- If there are assets being hidden or uncommercial transactions
- If there are any legal actions to consider
The purpose of the investigation is to report to the creditors regarding the property, affairs, and financial circumstances of the business in the most transparent way.
Potential Outcomes of Voluntary Administration
Generally, there are 3 common outcomes of voluntary administration:
- return the company to the control of the director and end voluntary administration
- pursue actions in which the liquidators determine are appropriate and begin the process of liquidating or winding up the company
- approve a deed of company arrangement (DOCA) wherein all or partial debts are paid
Help With Voluntary Administration in Australia
The process of voluntary administration is complex and often long. An administrator may sue you for an uncommercial transaction, unreasonable director-related transaction, insolvent trading or a breach of director’s duties – we can help you. Contact TNS Lawyers to find out more.
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