The insolvency of a company may lead to its liquidation whether instigated voluntarily or by a court order.
When is a company insolvent?
Under the Corporations Act 2001 (Cth), solvency is defined as the ability to pay debts when they are due and payable. Consequently, insolvency might be defined as the inability of a company to pay its debts when payable.
The primary test of insolvency is the cash flow test which determines a company’s capacity to generate sufficient income to meet its due debts. There are also a range of precursors that may indicate a company is insolvent or facing insolvency. These include:
- the company sustaining continuing losses with insufficient working capital;
- a poor liquidity ratio;
- the inability for the company to source finance to cover cashflow shortages;
- creditors offering less favourable payment terms than previously (for example, COD rather than 30-day terms);
- failure by the company to meet its tax and reporting obligations;
- the issue of proceedings against the company such as a statutory demand.
What happens when a company is placed into liquidation?
A liquidator is appointed to act as an agent of the company, to ascertain its assets (if any) and convert these into cash for distribution amongst creditors in the order of priorities provided by the Corporations Act 2001. Any surplus after payment of debts, liabilities and expenses incidental to the winding up process, may be distributed amongst the company members in accordance with their respective rights.
The liquidator also investigates the company’s affairs and the conduct of its officers leading to the company’s failure.
The liquidator has broad powers and can enter deeds of arrangements, bring or defend court proceedings on behalf of the company. Once a liquidator is appointed the directors generally no longer have control over the company’s operations.
How is a company placed into liquidation?
An insolvent company may be placed into liquidation pursuant to:
- A creditor’s application seeking a court to make a winding up order (compulsory liquidation) – this often follows a presumption of insolvency after a company’s failure to respond to a statutory demand for payment of a debt;
- A resolution by the company members to wind up the company (creditors’ voluntary liquidation);
- A resolution by the creditors of a company that is in voluntary administration (which is conducted as a creditors’ winding up).
The effects of winding up a company
- A liquidator is appointed, who becomes the company’s agent and takes control and ownership of its assets. The directors have certain preserved rights but generally no longer take part in the company’s operations.
- The company ceases to trade unless the liquidator decides that the continuance of operations will assist in a sale of the business.
- Notification of the liquidation will appear in Australian Securities and Investments Commission (ASIC) records and the words ‘in liquidation’ must appear on all company documentation.
- Legal proceedings against the company are generally stayed and creditors lodge a proof of debt with the liquidator.
- Employees are usually automatically dismissed and may claim unpaid entitlements through the Commonwealth Fair Entitlements Guarantee. Employees may be retained or re-employed if the liquidator decides that the business should continue to operate pending a sale.
- The effect of any contract will depend on its terms and be considered in light of any ipso facto clauses and recent prohibitions against the general operation of such clauses.
Directors and officers of companies facing solvency issues should seek appropriate legal and financial advice to ensure their conduct does not breach their fiduciary and statutory obligations and that any risk of personal liability is mitigated.
Our lawyers have assisted many companies and their directors to navigate insolvency laws and implement strategies to achieve the best possible outcome in difficult financial circumstances.
If you need any assistance contact one of our lawyers at [email protected] or call 07 4046 1111 for a no-obligation discussion and for expert legal advice.