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Insolvency Issues

For some years, low interest rates, increasing asset prices and readily available credit have kept business insolvencies at a minimum.  However, now that we are seeing interest rates on the rise, supplies constrained by logistical issues and the ATO announcing its intention to pursue directors for unpaid tax, it’s likely that we will all start to encounter more situations involving insolvency administrations.  This is a quick reminder of a few issues you might face and a few tips to protect your position.

When you are concerned that your customer may be struggling, the following steps should be taken:

  1. Review your contracts – whether you are trading under a formal written agreement or pursuant to terms and conditions printed on the back of your invoice, it’s a good idea to understand the terms on which you are trading. By the time there’s a problem it’s generally too late to avoid the argument about whether you’re trading on the terms printed on the back of your invoice or the terms printed on the back of your customer’s purchase order but you can bet they’ll be very different!
  2. Look for security – are you supplying in circumstances where a retention of title clause might help you? If so, make sure it’s registered on PPSR.  Can you seek other security from the customer or from a third party (like a guarantor)?  Again, don’t forget to register.  Be particularly careful where you have any stock or other assets in someone else’s possession.  This includes supplying to one company in a group where the stock is used by another company in the same group.  If your security interest is not registered against both companies, you can lose it.
  3. Don’t worry about preferential payments – we see a lot of people who get concerned about customers entering into payment plans because they want to avoid the money being “clawed back” by a liquidator. Over the years, we can say that it’s always better to take the money and have the argument later, if it is necessary.
  4. Be cynical – hope springs eternal in the mind of a debtor but the reality is that, when businesses are struggling, more promises are broken than are kept. Act decisively and swiftly.

If your customer enters formal insolvency administration, it’s a good idea to understand the characteristics of each type of insolvency administration as they are different from each other and there may be very different outcomes depending on which form you are dealing with.

  1. Liquidation – This is the process where a liquidator (or two or even three) is appointed to close down the affairs of a company, realise its assets, determine its creditors and then pay them in accordance with the priorities set out in the Corporations Act. In practice, in most cases there is no dividend to unsecured creditors.  A liquidator can only trade on for 4 weeks after his or her appointment, except with leave of the Court.  After the affairs of a company have been fully administered by the liquidator it is struck off.
  2. Voluntary Administration – This is a process where the management of a company is taken over by a Voluntary Administrator for a short time (generally a month or two but sometimes, with the consent of the Courts, for much longer). The Voluntary Administrator will generally continue trading and, in doing so, is personally liable for any debts for goods and services.  There are two meetings of creditors which take place.  The first meeting happens within a few days after the appointment and, at this meeting, the voluntary administrator can be replaced by a vote of creditors.  At the second meeting of creditors, there may be a proposal for a deed of company arrangement.  There are a few other options that the creditors can consider but, generally, the only other viable alternative is to place the company into liquidation.
  3. Deed of Company Arrangement – If a proposal for a deed of company arrangement is supported by a majority of creditors (both in number and value), it will be accepted and implemented. If you are a secured creditor, you will NOT be bound by a deed of company arrangement unless you voted for it or otherwise agree to it.  For this reason, it is often worthwhile taking security over a struggling customer, even if there are secured creditors ahead of you (generally a bank) and there may be no equity value left for you.
  4. Small Business Restructuring – This form of administration was brought in during COVID to enable a company to quickly and cheaply restructure its indebtedness. In order to qualify a business must have total liabilities of $1m or less (excluding employee entitlements), it must have paid all amounts owing to employees at that time and it must have lodged (but not necessarily paid) its BAS Statements.  It appoints a business restructuring practitioner and proposes a restructure proposal.  The creditors vote on the proposal and, if they accept it, the plan is implemented.  During the restructure process, the affairs of the company remain in the hands of the directors.

If you are worried about any of your customers, or you encounter any of these forms of insolvency administration, Partners Legal Solutions can provide you with the advice you need to get the best outcome possible.