Restructuring & Insolvency
Liquidation
What and why?
Liquidation is a procedure used to bring a company’s existence to an end where:
• it has insufficient assets to satisfy all of its liabilities; or
• though solvent, it serves no further useful purpose.
There are several reasons why liquidation is commonly chosen as a procedure to
end the life of a company. It:
• ensures that the assets of a company are distributed equitably among creditors
• reduces the cost borne by the community in having insolvent companies
continue to trade
• enables a dormant company to be deregistered
• facilitates an independent investigation into the affairs of the company and
increases the potential for redress for creditors against those who breached their
obligations or the law.
The process
The procedures available to wind up a company are set out in the Corporations Act
2001. A company can be wound up whether it is solvent or insolvent. A company
is “solvent” if it is able to pay its debts as they fall due. A company which is not
solvent, is “insolvent”.
Winding up a solvent company
A solvent company can be liquidated, or wound up, by resolution of its shareholders if
the company is able to pay its debts in full within 12 months after the commencement
of the winding-up. This is known as a members’ voluntary winding-up. The liquidator,
once appointed, is responsible to the members of the company.
Winding up an insolvent company
Insolvent companies can also be wound up voluntarily, by a resolution of shareholders
followed by a resolution of creditors. This is known as a creditors’ voluntary
winding-up. The liquidator is, in this case, responsible to the creditors of the company.
Insolvent companies are more commonly wound up by order of the court. The Federal
Court of Australia and the Supreme Courts of each State and Territory have power
to order the winding up of a company where the company is insolvent or it is just and
equitable to do so.
Most applications to wind up a company in insolvency are based upon a failure to
comply with a statutory demand. A statutory demand can only be served where the debt
is in excess of $2000.
Such a demand, when served, requires a company to pay or compromise the debt to
the creditor’s reasonable satisfaction within 21 days. The failure to do so will result
in a presumption that the company is unable to pay its debts as they fall due. This
presumption will arise even where the debt alleged in the demand is paid, if payment is
made after the 21 day period for compliance.
While an application to a court to wind up a company in insolvency is most commonly
made by a creditor relying on an unsatisfied statutory demand, an application can
be brought by the company itself, a secured, contingent or prospective creditor, a
shareholder, a director, a liquidator, a provisional liquidator or ASIC.
In considering an application to wind up a company in insolvency, the court usually
relies on the rebuttable presumption that a company is insolvent if, during or after the
three months ending on the day when the application was made:
• the company failed to comply with a statutory demand; or
• execution or other process was returned wholly or partially unsatisfied; or
• a receiver or receiver and manager of the property of the company was appointed
pursuant to a power contained in a floating charge or court order; or
• a person was appointed or entered into possession or assumed control of such
property for the purpose of enforcing a floating charge.
The effect of filing an application to wind up a company
The filing of an application to wind up a company has several immediate consequences:
• any disposition of property made by the company or any transfer of shares
or alteration in the status of the members of the company made after the
commencement of the winding-up is, unless the court otherwise orders, void
• the company cannot, without the leave of the court, resolve that it be wound up
voluntarily although it can apply for the appointment of a provisional liquidator or a
stay of the winding up order in order to propound a scheme of arrangement under
section 411 or a deed of company arrangement.
The effect of an application to wind up on a
voluntary administration
There are a few examples of where an application to wind up may affect a company
in voluntary administration:
• where an application to wind up is made but not yet determined before the
appointment of a voluntary administrator, the filing of the application does not in
any way restrict or prohibit the appointment of an administrator to a company by the
directors or a secured creditor with a charge over all, or substantially all,
of the assets of the company
• where proceedings to wind up a company have been commenced prior to
the appointment of an administrator, there is no stay on the continuation of
those proceedings
• where an administrator is already appointed and the winding up application comes
on for hearing before the conclusion of the voluntary administration process, the
Corporations Act 2001 requires the application to be adjourned where the court is
satisfied that it is in the interests of creditors for the company to continue to be
under administration
• where an administrator is appointed, winding up proceedings can only be
commenced against the company with the leave of the court. Likewise, where an
administrator has been appointed to a company, the Corporations Act 2001 provides
that the company cannot be wound up voluntarily.
Where voluntary administration is sought after liquidation
Where a liquidator has formed the view that there is a prospect of a greater return
to creditors by converting the winding up to a voluntary administration, a liquidator is
entitled, pursuant to the Corporations Act 2001, to appoint an administrator or appoint
himself, with the leave of the court or approval by a resolution passed at a meeting of
the company’s creditors, as the administrator. Where such an application is made to the
court there are a number of factors the court will take into account including:
• the person’s independence
• the term of the proposed appointment
• whether it is necessary that the conduct of the administration be subject to
independent scrutiny
• whether there are any investigations which need to be carried out arising
out of the liquidation.
The court needs to be satisfied that there were, or would ultimately be, sufficient
grounds for the termination of the winding up and will scrutinise very carefully the
terms of any proposed deed of company arrangement in order to form a view as to
whether the company, as a result of the arrangement, would be in a position where it
can be allowed to carry on business as before.
The effect of winding up
On the company
Liquidation primarily affects the status of a company. It transfers the power of
management from the directors and members to the liquidator and creditors in general
meeting and necessarily involves the discharge of all employees, subject to any
decision of the liquidator to trade on briefly in order to maximise asset realisation.
Once a resolution has been passed or an order made for the winding up of a company,
the company and its creditors can expect the following to occur:
• the liquidator will collect company property not claimable by secured creditors
• the liquidator will seek to recover property improperly transferred when the company
was insolvent
• proceedings against the company in liquidation are stayed
• a process by which claims against the company may be asserted and
quantified operates
• an order of priorities for distribution of the company’s property applies.
On creditors
The primary effect of a liquidation on the unsecured creditors of a company is that
they are no longer able to pursue ordinary courses of action to recover their debts.
To do so would be inconsistent with the object of liquidation, being the equal
satisfaction of liabilities among classes of creditors. Creditors need to consider how
their claim would rank as against other claimants if a company were wound up in
insolvency. In a liquidation, the property available for distribution among unsecured
creditors of a company includes:
• the company’s own property
• if the company has share capital, any unpaid calls on shares
• rights of actions for damages
• compensation recoverable by the liquidator from directors or a holding company
for insolvent trading
• any property previously disposed of by the company and voidable transactions that
can be clawed back by the liquidator including:
- unfair preferences
- uncommercial transactions.
The liquidator’s functions and duties
The principal function of the liquidator is to collect and realise the company’s assets.
This requires the liquidator to determine what claims exist against the assets of the
company, to apply the assets to meet those claims and distribute the surplus initially
among unsecured creditors and then shareholders. In fulfilling this primary function, the
liquidator may engage in the following specific tasks:
• lodge relevant notices and reports with ASIC
• obtain from the directors a report as to the affairs of the company showing
the company’s assets and liabilities, the company’s creditors and any securities
held by them
• carry out an investigation into the company’s affairs
• investigate breaches of the Corporations Act 2001 and any conduct which falls
short of the standards of commercial morality
• collect the company’s assets and keep proper books.
The role of the committee of inspection
In order to assist and supervise a liquidator, a committee of inspection is
sometimes appointed. That committee consists of representatives of creditors and
contributories. Its task is to superintend and assist the liquidator in the performance
of his duties.
The committee has a number of administrative duties in a compulsory winding up such
as setting the remuneration of the liquidator. It can also act as a supervisory body in
respect of a liquidator’s actions and provide advice and guidance on questions of policy.
The liquidator, in exercising his powers, must have regard to any directions given by the
committee in the administration and distribution of property of the company.
Priorities
Secured creditors are those with proprietary claims over particular assets of a company,
e.g. a charge or mortgage. Their claims will have priority over those of unsecured
creditors and will be satisfied to the extent that the particular asset over which there is
a claim is valuable. To the extent there is a shortfall, secured creditors will rank equally
for that shortfall with unsecured creditors.
A liquidator’s costs, charges and expenses of the winding up are given first priority,
generally followed by employee entitlements and then by the claims of unsecured
creditors. Where assets are insufficient to meet the claims of unsecured creditors in
full, debts are to rank equally and be paid accordingly.
Shareholders will only receive a return after all creditors are paid in full.
Restructuring & Insolvency group publications
The Restructuring & Insolvency group of Clayton Utz has prepared a series of brochures
that provide an outline of the operation of relevant areas of law.
The complete set of brochures in the series comprises:
• Deed of company arrangement
• Company receivers and managers
• Third party guarantees
• Retention of title clauses
• Voluntary administration
• Liquidation
• Provisional liquidation
• Enforcing security rights
Treatment of the topic addressed in each brochure though comprehensive is not
exhaustive. Moreover, a proper understanding of any particular situation demands
an integrated approach. Clayton Utz is available to give advice over the whole range
of issues relating to corporate restructuring and insolvency, including the position of
secured and unsecured creditors, and the practical issues relating to enforcement of
securities and debt recovery, structuring and restructuring transactions and litigation.
Copies of this brochure and the others referred to can be obtained free of charge from
the Restructuring & Insolvency group of Clayton Utz.
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© Clayton Utz 2008