Insolvency and Bankruptcy Laws in Australia.

Introduction

Insolvency is a term for an organization or individual, who fails to meet its financial obligation to its lenders as debts become due. It is simply a state of being unable to pay the money owed, by a person or a company on time; those in a state of insolvency are said to insolvent. Insolvency can be classified into two forms: – (1) CASH-FLOW INSOLVENCY & (2) BALANCE-SHEET INSOLVENCY        

CASH-FLOW INSOLVENCY

1. Introduction: It is when a person or a company has enough assets to pay what is owed, however, does not have the appropriate form of payment. For example, when a person may own a large house and valuable car, but does not have enough liquid assets to pay a debt when it falls due. In short, the company might have assets to cover the liabilities, however, deprived of the cash flow or liquid asset.
2. Reasons & Methods to recover: Cash flow insolvency could occur. For example, if a company had account payables (it is an account within the general ledger; that represents a company’s obligation to pay off a short term debt to its creditors or suppliers. Basically a business department or division that is responsible for making payments owed by the company or individual. It is to suppliers or other creditors). Money owed to suppliers coming due in the short term (company’s financial obligations that are expected to be paid off within a year). However, the accounts receivables- money owed by customers-are not being paid in time to pay the company’s payables. In some cases, cash flow insolvency can be corrected by opening a short-term borrowing facility from a bank. Also, the companies or individuals can negotiate better terms with suppliers, so they accept later payments on their account receivables.

BALANCE-SHEET INSOLVENCY

1. Introduction: This situation arises when the value of a company’s liabilities exceeds the value of its assets. It is so-called because, the insolvency appears on the firm’s balance sheet, deeming a company “insolvent on the books”. When its net worth appears negative. Also known as technical insolvency, a company can have the value of its liabilities rise at a faster rate. Than its assets due to increased debts or borrowings.
2. Explanation: This category of insolvency is declared exclusively on the examination of the Balance-sheet; regardless of the company’s ability to continue its operations. An increased amount of debts or borrowing while revenue has declined could lead to technical insolvency. Also, companies with assets falling in value while the value of liabilities remaining unchanged or increasing can experience accounting insolvency.
3. Factors leading to this type of insolvency: Companies facing possible or impending lawsuits can cause an increasing amount of liabilities in the future that will ultimately exceed the assets. These contingent liabilities can prevent the company from functioning properly and can lead to both accounting and cash-flow insolvency. Companies with a significant amount of their assents on their balance sheet tied in fixed assets can run into problems. Fixed assets are typically long- term assets such a property, buildings, and equipment. If the assets become obsolete due to technological innovation, the value of the assets technically declines, causing accounting insolvency. 

Etymology and Objectives of the term, “Bankruptcy”: Filing Bankruptcy

Although Insolvency and Bankruptcy are used interchangeably, but legally they have different meanings. The term bankruptcy is derived from the Italian word ‘banca rotta’, of which the literal meaning is ‘broken bench’, however idiomatically it is “broken bank”. It was so because traditionally the bankers in Italy dealt from wooden benches Bankruptcy can be described as a legal proceeding involving a person or a business organization that is unable to repay outstanding debts. Bankruptcy can be described as a legal process involving a person or business organization that is unable to pay outstanding debts to creditors or creditors. Bankruptcy procedure employs filing which is a legal course undertaken by debtors or insolvent entities to free itself from debt obligations.

The bankruptcy process initiates with the filing of a petition by the debtor, which has been regarded as common, or on behalf of creditors, which is less common. The procedure is disciplinary in nature which ensures that the person or organization who is unable to carry out their financial obligations is disqualified from business, decision making position, and working as professionals. However, people working as employees are not included in the same. The major objectives of Bankruptcy laws are as follows: –

1.  An equal distribution of the borrower’s assets among creditors of the equal rank. 
2.  A process through which a borrower is free from all his debts, it gives him a new chance of making a start again.  
3.  To enquire into the situation accountable for the insolvency and thereby provide information that may prevent others from accumulate debts which they are not capable to liquidate.

Introduction on Australian Laws for Bankruptcy & Insolvency

Every country around the globe has its own set of legislation for Bankruptcy and Insolvency. In this article, we shall be discussing the Bankruptcy laws of Australia. In Australia, the insolvency laws regulate the positions of the business organization, individuals, or companies that are in financial distress and further are unable to repay their debts or carry out their other financial obligations and also matters ancillary to financial distress.

The Corporation Act, 2001 governs the insolvency-related issues in Australia. Furthermore, the comprehensive aim of insolvency laws under the same act is to balance the interests of debtors, creditors, and the general community in the case of insolvency matters. In particular, the insolvency laws sought to provide: – an orderly, and fair procedure to strike a balance between the competing interests of creditors, debtors, and also a wider community in the case of debtors unable to meet the financial obligations. The target of the legislative provision is to provide:

• a fair procedure to ensure debts are satisfied both expeditiously and economically, and furthermore an orderly manner is employed to handle the affairs of financially distress organization or companies;
• proper mechanism treatment of the affairs of insolvents before the same;
• to engage with both debtors and creditors in the resolution of the insolvency problem; and
• mechanisms which allow for the examination of all the representative of insolvent companies, their directors, officers and associates, for the purpose of investigating the affairs of the company and even for ascertaining the reasons for insolvency.

However, in Australia, the term bankruptcy is used for individuals as companies do not go bankrupt but rather go into liquidation. On one hand, the former is governed by the federal Bankruptcy Act 1966, while the latter is governed by the Corporation Act, 2001. Thus, in the case of an individual committing act of bankruptcy, the creditor can apply to the Federal Court to make sequestration orders under Section 43 of the Bankruptcy Act, 1966.

Indicators of Insolvency& Presumptions to made in Insolvency

Any company, or partnership will be declared legally insolvent if their debts become due and payable. In ASIC v. Plymin, Elliott & Harrison[1], the Supreme Court of Australia put forth an extensive list which shall indicate insolvency. This list reworded as follows: “1. Continuing losses. 2. Liquidity ratios below 1. 3. Overdue Commonwealth and State taxes. 4. Poor relationship with present Bank, including an inability to borrow further funds. 5. No access to alternative finance. 6. Inability to raise further equity capital. 7. Suppliers placing [company] on COD, or otherwise demanding special payments before resuming supply. 8. Creditors unpaid outside trading terms. 9. Issuing of post-dated cheques. 10. Dishonored cheques. 11. Special arrangements with selected creditors. 12. Solicitors’ letters, summons[es], judgments, or warrants issued against the company. 13. Payments to creditors of rounded sums that are not reconcilable to specific invoices. 14. Inability to produce timely and accurate financial information to display the company’s trading performance and financial position, and make reliable forecasts.” Section 459C of the Corporation Act, 2001 is titled, “Presumption to be made in certain proceedings”. It reads, “(1)  This section has effect for the purpose of:  (a) an application under section 234, 459P, 462, (b) an application for leave to make under section 459P. (2)  The Court must presume that the company is insolvent if, during or after the 3 months ending on the day when the application was made:

1. the company failed (as defined by section 459F) to comply with a statutory demand; or
2. execution or other process issued on a judgment, decree or order of an Australian court in favor of a creditor of the company was returned wholly or partly unsatisfied; or
3. a receiver, or receiver and manager, of the property of the company was appointed under a power contained in an instrument relating to a circulating security interest in such property; or
4. an order was made for the appointment of such a receiver, or receiver and manager, for the purpose of enforcing such a security interest; or
5. a person entered into possession, or assumed control, of such property for such a purpose; or
6. a person was appointed so to enter into possession or assume control (whether as agent for the secured party or for the company).

(3)  A presumption for which this section provides operates except so far as the contrary is proved for the purposes of the application.”

Restructuring or Reorganization under Australian Insolvency & Bankruptcy Law

A company or business organization with a pragmatic prospect of surviving financial difficulties and which is potentially salvageable may seek to enter into a non-liquidation arrangement. Now, a scheme for restructuring or reorganization is a form of contract between the company or business organization (debtor) and some or all of its creditors and stakeholders. In the case of an agreement with creditors, the same is called a ‘creditors’ scheme of arrangement.

On the other hand, a compromise with shareholders is known as a member’s scheme of arrangement. It may be noted that for the restructuring process, a creditor’s scheme is often applied. This scheme may be proposed by any of the following, namely the company, a creditor, a member, or the liquidator appointed by the company. Interestingly, there are three principal types of reorganization procedures namely, Voluntary administration, Deeds of Company Arrangement, and Receivership.  

Voluntary administration: It is the corporate rehabilitation under which an independent insolvency procedure is appointed to control the company’s management with a view to maximizing the chances of its survival or at least ensuring better returns for creditors and other members.

This procedure may be initiated by either of the following, namely directors of the company, a secured creditor, or a liquidator. Now, as soon as the administrator investigates the company’s affairs, he then reports to the creditors and further must also summon a meeting of the creditors who decide the prospects of the company based upon the report. At this point, the creditors may resolve to do either of the following, namely, execute a deed related to the company’s arrangement; ending up the administration (administrator’s control) and returning the company’s management to the directors; or wind up the business.

Deeds of Company arrangement: It is another type of administration where there is an agreement between a company and its creditors. Under this, a deed of company arrangement is implemented by the resolution of creditors at the watershed meeting. In this case, the administrator of the company becomes the deed administrator. Although, there are terms in the contract that secured creditors and owners or lessors of the property who did not vote in favor of the deed, but the same is binding on all creditors.

Receivership: This involves the realization of specific assets of the organization for the benefit of secured creditors. This receiver is appointed by the secured creditors or sometimes by the court. The person appointed as the receiver shall possess control of the company’s assets and power to dispose of that property, further applying the proceeds to the amount that is owed by the secured creditors. Lastly, he executes all his functions under the supervision of ASIC and the court. His task ends, when the amount owed to the creditors have been paid, when the assets have been realized, or when an order has been passed by the court.

Liquidation Procedures

There is certain eligibility criterion for initiating a liquidation procedure and the procedure is either compulsory (if ordered by the court of law) or voluntary (i.e. initiated by the shareholders of the company). In the case of liquidation on the ground of insolvency, the following parties may apply to the court for a winding-up order: 1. The company itself; 2. A creditor; 3. A contributory; 4. A director; 5. A liquidator of the company; 6. The Australian Securities and Investment Commission (ASIC); or 6. A prescribed agency.

Now there are three types of winding up namely, members’ voluntary winding up, creditor’s winding up, and compulsory winding up. The Procedure for winding up is executed by the Court or it can also be done voluntarily. In the case of a court carrying out the procedure, the same shall be with an application to the court which will appoint the liquidator and ultimately order the winding up of the company. However, in case of a voluntary wind up, shareholders shall initiate the liquidation, but subsequently the process shall be carried out by a liquidator under the control of the creditors. However, if the company is under the control of the creditors then the same shall initiate the voluntary liquidation.

Laws regarding initiation of Bankruptcy procedure in Australia

In the earlier paragraphs, we discussed different aspects of the insolvency laws of Australia. Now, as was said previously, bankruptcy laws apply to individuals and are governed by the Bankruptcy Act, 1966. Now, under Section 41 of the Bankruptcy Act, 1966, in order to lodge a petition by the creditors or declare bankruptcy, the debt must be at least $5000. The Section reads, “ (1)  An Official Receiver may issue a bankruptcy notice on the application of a creditor who has obtained against a debtor:

1. a final judgment or final order that:
   1. is of the kind described in paragraph 40(1)(g); and
   2. is for an amount of at least the statutory minimum; or
2. two or more final judgments or final orders that:
   1. are of the kind described in paragraph 40(1)(g); and
   2. taken together are for an amount of at least the statutory minimum.

(2)  The notice must be in accordance with the form prescribed by the regulations.

(2A)  The notice must specify a period for compliance with the notice. That period must be:

1. if the notice is to be served in Australia–the statutory period after the debtor is served with the notice; or
2. if the notice is to be served elsewhere–the period specified by the order of the Court gives leave to affect the service.

(3)  A bankruptcy notice shall not be issued in relation to a debtor:

1. except on the application of a creditor who has obtained against the debtor a final judgment or final order within the meaning of paragraph 40(1)(g) or a person who, by virtue of paragraph 40(3)(d), is to be deemed to be such a creditor;
2. if, at the time of the application for the issue of the bankruptcy notice, execution of a judgment or order to which it relates has stayed; or
3. in respect of a judgment or order for the payment of money if:
   1. a period of more than 6 years has elapsed since the judgment was given or the order was made; or
   2. the operation of the judgment or order is suspended under section 37.

(5)  A bankruptcy notice is not invalidated by reason only that the sum specified in the notice as the amount due to the creditor exceeds the amount, in fact, due, unless the debtor, within the time fixed for compliance with the notice, gives notice to the creditor that he or she disputes the validity of the notice on the ground of the misstatement.

(6)  Where the amount specified in a bankruptcy notice exceeds the amount, in fact, due and the debtor does not give notice to the creditor in accordance with subsection (5), he or she shall be deemed to have complied with the notice if, within the time fixed for compliance with the notice, he or she takes such action as would have constituted compliance with the notice if the amount due had been correctly specified in it.

(6A)  Where, before the expiration of the time fixed for compliance with a bankruptcy notice:

1. proceedings to set aside a judgment or order in respect of which the bankruptcy notice was issued have been instituted by the debtor; or
2. an application has been made to the Court to set aside the bankruptcy notice;

The Court may, subject to subsection (6C), extend the time for compliance with the bankruptcy notice.

(6C)  Where:

1. a debtor applies to the Court for an extension of the time for complying with a bankruptcy notice on the ground that proceedings to set aside a judgment or order in respect of which the bankruptcy notice was issued have been instituted by the debtor; and
2. the Court is of the opinion that the proceedings to set aside the judgment or order:
   1. have not been instituted bona fide; or
   2. are not being prosecuted with due diligence;

the Court shall not extend the time for compliance with the bankruptcy notice.

(7)  Where, before the expiration of the time fixed for compliance with a bankruptcy notice, the debtor has applied to the Court for an order setting aside the bankruptcy notice on the ground that the debtor has such a counter-claim, set-off or cross demand as is referred to in paragraph 40(1)(g), and the Court has not, before the expiration of that time, determined whether it is satisfied that the debtor has such a counter-claim, set-off or cross demand, that time shall be deemed to have been extended, immediately before its expiration, until and including the day on which the Court determines whether it is so satisfied.”

A bankrupt need to lodge a State of Affairs document with the Australian Financial Security Authority and till the time it has been lodged, no bankruptcy can be annulled.  Also, this document comprises the information related to the assets and liabilities of the Bankrupt. However, it may be noted that under Section 149 of the Bankruptcy Act, 1966 titled as, “Automatic Discharge”, the bankrupt is discharged at the end of 3 years from either the date on which the bankrupt filed the statement of affairs, or the date of the commencement of that section. However, the same can be ended before the expiration of three-years in case all the debts are paid out in their entirety.

Bankruptcy Trustees and its Function

In cases of Bankruptcy, a Bankruptcy Trustee is appointed to deal with matters related to the administration of bankrupt estates. His work includes notifying the creditors of the estates and dealing with creditor inquiries and furthermore making sure that the bankrupt individual complies with their obligations as prescribed under the Bankruptcy Act. Not only this but also investigating the financial affairs of the Bankrupt, discharging the funds with respect to the estate entitled under the Bankruptcy Act and distributing paybacks to the creditors.

Now, it is important to note that discharging of funds usually comes from two main sources namely, the bankrupt’s assets and the same’s wages. Also, there are some protected assets which include the furniture, appliances, tools of the trade, and vehicles up to a certain value. Now, in case these assets are above a certain value, a third party possesses the power to buy the interest from these assets for the bankrupt to utilize the asset. Failure to do so may result in the interest getting vested in the estate and consequently empowering the trustee to appropriate the possession of the asset and sell the same.

Conclusion

To conclude, in this article we discussed the different important aspects of laws relating to both insolvency and bankruptcy in Australia. Australia has a very systematized form of laws for both insolvency and bankruptcy as both are governed under separate legislations. Each legislation focusses on remodeling the financially distressed organizations or individual entities in a well systematic, and time-bound manner as prescribed under different provisions of the legislation.

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References:

[1] [2003] VSC 123