Insolvency is the inability to pay one’s debts when they fall due.
Insolvent individuals are bankrupted under the Bankruptcy Act 1966 (Cth) whereas insolvent companies are wound up under the Corporations Act 2001 (Cth).
The Bankruptcy Act 1966 applies to all adult individuals or businesses connected with Australia either through their residence or business.
Bankruptcy may be voluntary of involuntary. An application may be made as long as there is a probable debt.
Bankruptcy applications are made (ie filed) with the Insolvency and Trustee Service, which is the office of the Official Trustee in Bankruptcy who delegates its functions to the Official Receivers and/or registered private trustees.
Voluntary and involuntary bankruptcy
Voluntary bankruptcy is sought by completing and filing a Debtor’s Petition and Statement of Affairs. The Official Receiver may reject such an application if the debtor:
- would be able to pay their debts in a reasonable time and that the debtor is unwilling to pay the debts and have previously become bankrupt by debtor’s position three or more times or once in the last 5 years.
- does not reside or carry on business in Australia.
Involuntary bankruptcy is sought by an unpaid creditor or creditors presenting a Creditor’s Petition to the Federal Circuit Court or Federal Court of Australia, subject to their being a judgment and no response to a bankruptcy notice after 21 days since service.
Declaration of bankruptcy
A person is declared bankrupt when a Debtor’s Position is order accepted or a sequestration order is made on a Creditor’s Position.
A declaration of bankruptcy results in the person’s divisible property being put under the control of the Official Trustee or, if requested by the creditor, a private trustee. The divisible property is used to pay the debts.
Divisible property includes: the bankrupt’s interest in land, cash, jewellery, stocks, money owed and most other valuable property.
Divisible property includes property owned as tenants in common with another person, such as a spouse. Property owned separately by a spouse is not included.
If the bankrupt owns property jointly with another person, such as a spouse or business partner, the trustee becomes registered as the tenant-in-common of the bankrupt’s interest in the property.
The trustee cannot take certain property, including:
- ordinary clothing.
- household goods.
- tools of trade up to $3,500.
- certain insurance/assurance/endowment or annuities, or their proceeds.
- amounts paid under rural assistance agreements.
- net equity in motor vehicles up to $7,050.
- monies received by the bankrupt for damages for personal injury or death, defamation, or property purchased with those monies.
- superannuation policies, proceeds, lump sums or property purchased with those monies, except for “out of character payments” designed to avoid creditors.
The trustee may also reclaim property given away or sold to others in the 5 years before bankruptcy for less than full value or at any other time if the intention was to defeat creditors.
A bankrupt must also make payments to the trustee out of 50 percent of their income if it exceeds a certain amount.
Restrictions on credit, travel and court proceedings
A bankrupt may not obtain credit for goods or services over $5,040 without advising the provider that they are bankrupt.
The trustee may impose restrictions on the bankrupt’s overseas travel.
A bankrupt may continue or start proceedings relating to personal injury, family death, wrongs to the person (such as defamation) and employment (such as wrongful dismissal or harassment). Other proceedings commenced cannot continue without the approval of the trustee and creditors.
A bankrupt is discharged automatically from bankruptcy after three years after filing their Statement of Affairs, unless the trustee objects and seeks an extension of 5 or 8 years.
A bankrupt is released from all outstanding or provable debts after discharge. However, a bankrupt cannot be released from certain debts relating to child support, bonds, fines, proceeds of crime, fraud debts, unliquidated claims, post-bankruptcy debts and student loans and HECS charges.
A bankruptcy is annulled when the creditor and trustees have been paid in full or if the creditors accept an offer for less, made through the trustee.
Alternatives to bankruptcy
An insolvent person may avoid bankruptcy if they can satisfy their creditors that they can work their way out of insolvency. Arrangements to effect this include :
- informal arrangements
- Part IX debt agreements for small debts, administered by a trustee
- Part X personal insolvency agreements, administered by a trustee
The Corporations Act 2001 applies to companies registered in Australia.
Winding up is the process of bringing a company to an end. It is sometimes referred to as liquidation or dissolution. Liquidation specifically means the conversion of assets and inventory into cash to pay the debts whereas dissolution means the ending of the business.
Both solvent and insolvent companies may be wound up. Insolvent companies are wound up when they cannot pay their debts whereas solvent companies are wound up when they no longer serve any useful purpose.
Winding up is not to be confused with receivership. Receivership involves the appointment by a secured creditor of a receiver to collect and sell charged assets to pay the outstanding debt owed to the secured creditor.
Voluntary and involuntary winding up
An insolvent company may be wound up voluntarily or involuntarily.
Voluntary winding up is done by way of resolutions of the shareholders and/or creditors. A company goes into voluntary administration by appointing an external administrator to take control of the company to investigate the affairs of the company and report to the creditors as to whether or not the company be wound up, enter into a scheme of arrangement with the creditors or control be returned to the directors.
Involuntary winding up, or court liquidation, is when the court finds a company to be insolvent and orders that it be wound up, usually following a failure to comply with a Statutory Demand for monies owing.
Statutory Demands are a request by a creditor to a company to pay to their satisfaction an outstanding debt within 21 days. Failure to pay the debt within 21 days results in a presumption that the company is insolvent.
Once an application for winding up has been made, court permission is needed for voluntarily winding up or alteration of the shareholding and membership of the company.
Appointment of liquidator
Once an order for winding up is made, the court (Federal Court of Australia or Supreme Court of a State or Territory) appoints a liquidator.
The liquidator takes control of the company and attends a number of matters including:
- investigation the company’s affairs and report to ASIC.
- collection, protect and realise the unencumbered assets and inventory.
- recovery and sale of property transferred improperly when the company was insolvent.
- stay of proceedings against the company.
- implementation of a claims process.
- implementation of an order of priority for distribution.
- apply for deregistration after liquidation is completed.
Priority of payment is to be given to the liquidators (for their costs and expenses), secured creditors, employee entitlements, other unsecured creditors and then shareholders.
At the completion of the liquidation, the liquidator applies for deregistration of the company.
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