Australian insolvency law regulates the position of companies which are in financial distress and are unable to pay or provide for all of their debts or other obligations, and matters ancillary to and arising from financial distress. The law in this area is principally governed by the Corporations Act 2001. Under Australian law, the term insolvency is usually used with reference to companies, and bankruptcy is used in relation to individuals. Insolvency law in Australia tries to seek an equitable balance between the competing interests of debtors, creditors and the wider community when debtors are unable to meet their financial obligations. The aim of the legislative provisions is to provide: an orderly and fair procedure to handle the affairs of insolvent companies; to ensure a pari passu equal distribution of the assets amongst creditors; to ensure claims against the insolvent company are resolved with the minimum of delay and expense; to rehabilitate financially distressed companies and businesses where viable; to engage with key stakeholders in the resolution of insolvency issues; and providing for the examination of insolvent companies and their representatives, and the reasons for their failure.
Insolvency
A company, partnership, or trust with multiple trustees, is legally insolvent if it is not able to pay its their debts, as and when they become due and payable.. Solvency and insolvency are defined so as to be mutually exclusive.
The common law has also established various indicators of insolvency. These indicators include amongst others:. Continuing losses; Liquidity ratios below 1; Overdue commonwealth and state taxes; Poor relationship with bank or other financial institution culminating in an inability to borrow further funds; An inability to raise further equity capital; and Suppliers placing the company on COD or otherwise demanding ransom payments for continual supply.
Presumptions of insolvency
In certain circumstances a debtor may be presumed to be insolvent without the need to actually prove financial insolvency. A company will be presumed to be insolvent if, during or after the three months preceding the day on which an application was made for the winding-up of the company, any one of the following six situations occurs.. the company failed to comply with a statutory demand; execution process issued on a judgment in favour of a creditor was returned wholly or partly unsatisfied; in relation to a floating charge: a receiver was appointed; an order was made for the appointment of a receiver; a person assumed control of company property; or a person was appointed to enter into possession or assume control of company property.
Statutory demands
A popular way for a creditor to prove that a company is insolvent is to serve a statutory demand pursuant to section 459E of the Corporations Act. Issuing and serving a statutory demand is a relatively simple and inexpensive process when compared against proving actual financial insolvency. Statutory demands are regulated by Part 5.4, Divisions 2 and 3 of the Corporations Act, and the Courts require that the regime be strictly adhered to. Because a company will irrefutably be presumed to insolvent where a statutory demand is not complied with, the Court requires creditors to ensure that demands are expressed in clear, accurate and unambiguous terms. Even a small error may result in the statutory demand being set aside by the Court. The statute specifies the form of the demand, and requires that the demand must:. state the debt claimed, or if the demand relates to two or more debts it must specify the total amount of the debts; require the debtor company to pay the debt within 21 days (or 6 months during COVID-19 as part of temporary measures); must be in writing in the prescribed form (Form 509H); and must be signed by or on behalf of the creditor.
Requirements
In relation to the debt to which the demand relates: the debt must be due and payable - it cannot be contingent, prospective or unliquidated; a creditor may not serve a demand at the same time as taking proceedings against the debtors company's directors in relation to the same alleged debt as this would constitute an abuse of process; The demand must be served on the company by leaving it at its registered office, sending it by post to that office, or delivering a copy of the demand personally to the director of the company.
Upon being served with a valid demand, the debtor may either pay the debt, or secure or compound the debt to the creditor's reasonable satisfaction. Failure to do so within 21 days (unless an extension is granted) will mean that insolvency of the debtor is presumed and the creditor may use that presumption in order to make a winding-up application to the Court.
Setting aside a statutory demand
A debtor company can also apply to set aside a statutory demand on various grounds. These include: where there is a genuine dispute about the existence of the debt;(1)(a). where the company has an offsetting claim;(1)(b). where there is a defect in the demand and substantial injustice will be caused;(1)(a). and/or where there is some other reason why the demand should be set aside.(1)(b).
Genuine Dispute Various cases in Australia have decided what a genuine dispute is, and is not. A genuine dispute should:
Show a plausible contention requiring investigation;Eyota Pty Ltd v Hanave Pty Ltd (1994) 12 ACSR 785 Be bona fide, genuine and real; Be in good faith and show a prima facie plausibility; Truly exist in fact, and contain a serious question to be tried;. Be something more than mere bluster or mere assertion;Re Morris Catering (Australia) Pty Ltd (1993) 11 ACSR 601 Be a claim that may have some substance;Chadwick Industries (South Coast) Pty Ltd v Condensing Vaporisers Pty Ltd (1994) 13 ACSR 37. Have a sufficient degree of cogency to be arguable; Have objective existence; and Have sufficient factual particularity.
A genuine dispute should not:
Be spurious, hypothetical, illusory or misconceived; Be plainly vexatious or frivolous; Be so devoid of substance that no further investigation is warranted; Be merely spurious claim, bluster or assertion; and Be merely fanciful or futile.
Offsetting Claim You may also set aside a statutory demand if you have an offsetting claim.
Section 459H(1)(b) of the Corporations Act 2001 (Cth) Determination of application where there is a dispute or offsetting claim. says:
Then goes on to define an offsetting claim to mean:
“offsetting claim” means a genuine claim that the company has against the respondent by way of counterclaim, set-off or cross-demand (even if it does not arise out of the same transaction or circumstances as a debt to which the demand relates).
This means that any claim that you have against the person/company issuing the demand, can be used to set aside the demand. Especially if the offsetting claim means that the offset total of the demand drops below the statutory minimum.
Defect in the Demand Causing Substantial Injustice A statutory demand can also be set aside pursuant to section 459J(1)(a)Setting aside demand on other grounds. if because of a defect in the demand, substantial injustice will be caused unless the demand is set aside.
Section 9 of the Corporations Act Dictionary. defines the word "defect" to mean:
However, a simple defect is not enough to allow the demand to be set aside, it must cause substantial injustice.
There are a number of cases in Australia which have decided what a defect in a demand which will cause substantial injustice is. Some examples of this are:
Misstatement of a Debt, Amount, or Total;.. Incorrect Interest Calculation;. Defect in the Names of the Parties;Re Macro Constructions Pty Ltd 2 Qd R 31Scandon Pty Ltd v Dome Supplies Pty Ltd (1995) 17 ACSR 662
There are also cases in Australia which have decided that certain defects in the demand do not cause substantial injustice. Some examples are:
Where the notes and warning have been deleted;... Whether the demand is so defective it becomes a nullity;. The omission of an address for service for interstate demands;Re Ad-a-Cab Holdings Pty Ltd 2 Qd R 115.. The omission of a signature from a statutory demand..
Effect If a company fails to satisfy a statutory demand, or have it set aside, then it is presumed to be insolvent. The company requires leave of the court to before it can challenge the debt in opposing an application to wind up the company.. The effect of the presumption is that the company has to prove that it is solvent..
Bankruptcy term
On 19 October 2017 The Australian Federal Parliament proposed a bill is to reduce the period of bankruptcy from three years to one year. According to this bill, after one year, a person will not be required to disclose his status as bankrupt. Furthermore, it states that after one year, a bankrupt would be able to travel without prior permission.
Liquidation
Liquidation is the process whereby the assets of a company are collected and realised by a liquidator, and the proceeds are subsequently applied to discharge all relevant debts and liabilities in accordance with the priorities set by law. Any balance which may remain after paying the costs and expenses of winding-up is then distributed among the members according to their respective rights and interests.
A company may be wound up on either a voluntary basis or on a compulsory basis.
Types of liquidation
There are three different types of winding-up: members' voluntary winding-up creditors' voluntary winding-up compulsory winding-up
Members' voluntary winding-up
A members' voluntary winding-up is not technically an insolvency process. It is a voluntary liquidation entered into by the members where the company is not insolvent. The process is initiated by a special resolution of the company,. and the creditors have no direct involvement and are repaid in full. The directors are required to give a declaration as to the solvency of the company which must be filed with the Australian Securities & Investments Commission (ASIC).
Where a liquidator who is appointed pursuant to a members' voluntary winding-up subsequently determines that the company is in fact insolvent in his opinion (contrary to the solvency declaration made by the board of directors), then the liquidator must either (a) apply to the Court for the company to be wound-up on an insolvent basis, (b) appoint an administrator to the company, or (c) convene a meeting of creditors. If a meeting of the creditors is convened, then from the time of the meeting the winding-up will be treated as a creditors' voluntary winding-up.
Creditors' voluntary winding-up
A creditors' voluntary winding-up is also initiated by the members but (in contrast to a members' voluntary winding-up) where it has been determined that the company is insolvent. The process normally occurs where the board of directors has determined that the company is insolvent and then recommended to the members that it be wound up. However, as noted above, it may also be initiated by a liquidator was originally appointed pursuant to members voluntary winding-up where the liquidator has subsequently formed the opinion that the company is actually insolvent.
Compulsory winding-up