Week 11 - Liquidation, Liquidators & Insolvent trading

What is Liquidation (Winding Up)?

Liquidation is the final legal mechanism to address a company's financial failure. A liquidator is appointed to take control of the company, ceasing the powers of its directors.

What is the liquidator’s role?

• finalise outstanding matters

• identify assets

• accumulate and convert assets and

• ensure creditors receive a proportionate return on the amount they are owed.

• controls the company and takes all powers of the board,

• acts as agent of the company, and is subject to fiduciary obligations and statutory duties as an "officer"

Members Voluntary Winding Up

This is available for solvent companies. It requires the members to pass a special resolution (75% majority) under s 491 and the directors to make a written declaration of solvency (s 494), affirming the company can pay its debts in full within 12 months.

Creditors Voluntary Winding Up

This occurs when the company is insolvent. It can be initiated by the company in a general meeting (s 499) or, commonly, by a vote of creditors at the final meeting of a voluntary administration to wind the company up (s 439C). This pathway includes the simplified liquidation process.

Compulsory Winding Up (Insolvency)

This is a court-ordered process that can be initiated on several grounds. This is the most common form of compulsory winding up.(s 459A)

Who can apply to make a company wind up due to being insolvent?

Company, creditor (most common), contributory (member), director, liquidator, or ASIC. Legal basis: s 459P.

What is a statutory demand and how can it be used to claim insolvency?

If the company fails to pay the debt (which must be at least the statutory minimum of $4,000) within 21 days, the court must presume the company is insolvent (s 459C(2)(a)).

How can a company Set Aside a Statutory Demand

Company must apply within 21 days; main grounds are major defect (s 459J(1)) or genuine dispute about debt/amount (s 459H, s 459J). Mere assertion insufficient. Legal basis: s 459G.

What other grounds can a company be wound up on?

• Directors have acted in their own interests or in a manner that is unfair or unjust to members.

• The company's affairs are being conducted in an oppressive manner.

• ASIC reports that it is in the public interest for the company to be wound up.

• The court is of the opinion that it is "just and equitable" that the company be wound up.

What is Simplified Liquidation and its Purpose

This process provides a simpler, less complex, and more cost-effective liquidation for eligible small business s 500A.

Simplified Liquidation Eligibility criteria

• The company's liabilities are less than $1 million.

• The directors declare the company cannot pay its debts in full within 12 months.

• The company and its directors have not undergone restructuring or a simplified liquidation within the last seven years.

• Legal basis: s 500A, reg 5.5.03.

What are the limitations for a liquidator to using a Simplified Liquidation process?

The liquidator must adopt the process within 20 business days of the winding up resolution and provide 10 business days' notice to creditors.

The process cannot be adopted if creditors representing at least 25% of the debt value object (s 500AB).

Reduced Requirements/ Benefits of Simplified Liquidation

Eliminating certain requirements:

• liquidator's detailed report on contraventions (s 533),

• certain creditors' meetings, and committees of inspection.

Streamlines investigations by reducing the "relation-back" period for unfair preferences from six to three months and making them non-voidable if the value is no more than $30,000 (and the creditor is not a related party).

Who gets to claim their security over assets first when a company is liquidated?

Secured creditors are generally entitled to enforce their security over specific assets first. An important exception exists under s 561, where a creditor with a circulating security interest may lose priority to employees if funds are insufficient to cover their entitlements.

Who gets to claim their security over assets second when a company is liquidated and what is the order of distribution?

Priority Creditors:
Distribution order (s 556):

1. Preservation/realisation costs

2. Winding up costs (solicitor/liquidator fees)

3. Wages

4. Injury compensation

5. Holiday/sick entitlements

6. Retrenchment payments

Who gets to claim their security over assets third when a company is liquidated?

Any remaining funds are distributed to all other unsecured creditors. They share proportionately under the pari passu principle, which mandates equal treatment.

Who gets paid last (if at all) when a company is liquidated?

Members/shareholders receive a distribution only in the rare event of a surplus after all creditors have been paid in full.

What can liquidators do in terms of recouping assets?

Corporations Act provides liquidators with powerful tools to "claw back" funds and property that were transferred away from the company prior to its collapse.

Explain s588g

Director fails to prevent company incurring debt when company is/is becoming insolvent; aware or reasonably should suspect insolvency.

Consequences of breaching s588g

• A liquidator can sue the director to recover the amount of the debt for the company (s 588M).

• ASIC can seek civil penalties, including pecuniary orders and disqualification from managing corporations (s 206C).

• If a director's failure to prevent the debt was dishonest, they commit a criminal offence (s 588G(3)), punishable by imprisonment and/or significant fines.

Directors’ Required Actions

Must be actively involved; if aware of impending insolvency, may need to wind up, resign, or initiate restructure (e.g., voluntary administration). Legal basis: N/A.

What are the defences to s588g?

A director has a defence against an insolvent trading claim if they can prove:

1. Reasonable Expectation of Solvency

2. Reliance on a Competent Person

3. Absence from Management

4. Reasonable Steps to Prevent Debt

Defenses: Reasonable Expectation of Solvency

The director had reasonable grounds to expect, and did expect, that the company was and would remain solvent. This requires more than "mere hope or possibility." (s 588H(2))

Defenses: Reliance on Competent Person

Director reasonably believes competent person provides reliable solvency info; expected solvency based on that info. Legal basis: s 588H(3).

Defenses: Absence from Management

Illness or good reason; non-participation reasonable and not breach. Legal basis: s 588H(4).

Defenses: Reasonable Steps Taken

Director proves all reasonable steps to prevent debt/disposition. Legal basis: s 588H(5).

What does s588GA say?

A director is protected from insolvent trading liability for debts incurred in connection with developing and taking a course of action that is "reasonably likely to lead to a better outcome for the company" than the immediate appointment of an administrator or liquidator.

How can directors access the safe harbour defence?

To access the safe harbour, directors should be:

• properly informed

• keep proper records

• prevent misconduct and,

• obtain advice from an "appropriately qualified entity" (e.g., an accountant, lawyer, or insolvency practitioner).

Do directors get protections when a company is undergoing restructuring under Part 5.3B?

Further protections exist for directors when a company is formally undertaking a Part 5.3B restructure (ss 588GAAB and 588GAAC).

Debt incurred during Pt 5.3B restructure doesn’t count with practitioner/court consent.