FAQ: the real difference between insolvency, bankruptcy, liquidation, etc.

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COVID-19 has had an undeniable and significant impact on many businesses in Australia. With every lockdown and tough restrictions implemented, business owners and managers are forced to scramble to keep their businesses afloat. No doubt liquidators will soon be inundated with companies desperately trying to weigh their options.

Insolvency, voluntary administration, bankruptcy and liquidation are terms that keep coming up. But what do they mean? Is there a difference?

Insolvency

Insolvency applies to businesses. Your business is insolvent if it cannot pay its debts when they come due.

Insolvency tests are more nuanced, however, including a “cash flow” test, which takes into account the sources of income available to the business and the spending obligations it must meet. This contrasts with the “balance sheet” test, which focuses on the value of the company’s assets and liabilities reflected in the company’s books.

Whether or not a business is insolvent at any given time is a question of fact that must be established from a review of the position of the business as a whole. The court’s task is to decide whether the business suffers from an ‘endemic’ shortage of working capital, which means that, from a cash flow perspective, it cannot pay its debts as they go. of their due date.

Bankruptcy

Bankruptcy occurs when a natural person (as opposed to a business) is unable to pay their debts.

The official trustee or a registered trustee is then authorized on behalf of the state to take possession of the bankrupt’s property. Think of an “administrator” as someone who can step into someone else’s shoes to make decisions. If you file for bankruptcy, the “trustee” will effectively step in to manage your remaining assets in order to pay off your debts and manage related affairs. It generally lasts three years and, in most cases, involves the bankrupt paying his trustee the income he earned during this period.

Liquidation / liquidation

Liquidation is the process of liquidating a business.

Usually, a creditor who has not been paid will ask the court for an order declaring that the company is “liquidated”. After a company is wound up, it still exists until it is written off.

An insolvent business should not be put into liquidation. This insolvency can be temporary or a plan can be drawn up (called a deed of arrangement of the company). Early intervention can be applied to a business to prevent it from going into liquidation. The most common of the processes used is voluntary administration.

Voluntary administration

When a company becomes insolvent (or its creditworthiness is in doubt), the directors, or the main person responsible, can put the company under voluntary administration. Voluntary administration is a process in which an administrator is appointed in the company to investigate the affairs and financial difficulties of the company and make recommendations to ultimately resolve the situation.

While the business is under administration, the administrator takes full control of the business. With full control of the business, the manager or the third party and the volunteer administrator have time to find a way to save the business to the extent possible. This can involve charging debts at reduced amounts, selling an unprofitable part of the business, reducing staff and other similar actions.

Voluntary administration provides a respite to assess whether value can be preserved.

What is a deed of company arrangement

A director can propose the implementation of a deed of company arrangement. A corporate arrangement deed (‘DOCA’) is a binding agreement between a business and its creditors that governs how the business of the business will be handled in order to pay off all or part of its debts. Creditors will need to complete proof of debt and attach all unpaid invoices in order to have their say.

For example, a business may have 5 major creditors, to whom it owes $ 50,000 each. If the company goes into liquidation, the creditors will each receive $ 5,000 of the total amount owed to them. The administrator can negotiate with the creditors so that each creditor receives $ 25,000 to settle the debt. Creditors will be in a position where they will have more than if the company were liquidated. The company’s debt is reduced and it can continue to trade and stabilize.

Sequestration

Similar to bankruptcy, receivership is the legal process in which a receiver is appointed to a business to collect or sell enough property or secured assets to pay off debts.

A company in voluntary administration can also be in receivership. The difference between voluntary administration and receivership is that a receiver is appointed by a secured creditor to collect its debts or by a court to perform specific functions.

Small business restructuring

Currently, when the insolvency process begins, an external administrator (eg liquidator or voluntary administrator) will take control of the business. From January 1, 2021, eligible businesses can resolve to appoint a Small Business Restructuring Professional (SBRP) to help them restructure their business. The SBRP will assist the company in formulating a restructuring plan and will make a statement to creditors on this matter.

Once the proposed restructuring plan is finalized:

  1. Creditors will have 15 working days to vote on the plan and the disbursements that would be paid to the SBRP (in addition to the lump sum);
  2. More than 50% of creditors by value must approve it to proceed; and
  3. Employee rights must be paid in full before the plan can be voted on, and related creditors cannot vote.

Only companies with liabilities less than $ 1 million can take advantage of the proposed changes, although it is said that this threshold will cover 76 percent of companies subject to insolvency today.

If the restructuring plan is approved by the creditors, the company can continue its activities under the control of the SBRP with regard to the distribution of funds to the creditors.

Conclusion

If you are a director and think your business is headed in the wrong direction, now is the time to face reality and seek timely advice on a possible restructuring or liquidation. There are many options available to a business that has a chance for turnaround and renewal.

Insolvency does not mean the end of a business. Not all insolvent businesses have to end up in liquidation. The key to economy a business must act early.


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