COVID-19 created a tough economic environment and the government made changes to allow small businesses to restructure debt more easily and with less expense to adapt and save the business—while staying in control of the business.
Small business owners/directors have two additional formal insolvency solutions available to them effective as at 1 January 2021 under the federal government’s JobMaker plan in response to the COVID-19 pandemic’s economic pandemic.
One of new insolvency solutions is the simplified liquidation pathway, which simplifies the regulatory obligations. The government touted that this type of liquidation for small business will be “commensurate to the asset base, complexity and risk profile of eligible businesses”. The government introduced the simplified liquidation process to “free up value for creditors and employees, and allow assets to be quickly reallocated elsewhere in the economy supporting productivity and growth”.
Why would directors choose a simplified liquidation?
Directors may consider this pathway to be a less expensive and quicker way to liquidate their company, however, this is subject to eligibility criteria.
Who can administer a simplified liquidation?
All types of liquidations can only be administered by specialist practitioners who are registered liquidators with the Australian Securities and Investments Commission (ASIC). They can take all types of corporate insolvency appointments, including those ordered by the courts and the simplified liquidation process effective 1 January 2021.
A Small Business Restructuring Practitioner cannot act in simplified liquidation process.
What are the benefits of the simplified liquidation process?
The federal government introduced the reform for small businesses, its creditors, and its employees to get the benefits of:
- reduced costs
- shortened turnaround times
- increased returns/dividend to creditors.
Who can access the simplified liquidation process?
Incorporated companies with liabilities less than $1 million (including contingent liabilities) are eligible. All tax lodgements due prior to the date of liquidation must be up to date. This means that the company has lodged all returns, notices, statements, applications, or other documents as required by taxation laws (within the meaning of the Income Tax Assessment Act 1997).
The simplified liquidation process can only be used once in a seven-year period. This applies to both the company and the directors (including former directors who resigned in the previous 12 months). It also is excluded if both the company and directors used either the simplified liquidation or the small business restructuring process (which was introduced with the simplified liquidation reform) in the same seven-year period.
A company that has its debt restructuring plan terminated has 20 business days from the date of termination to take the simplified liquidation path. Furthermore, if the director is a director of other entities, there are limitation periods on those other entities entering a simplified liquidation or a business restructure.
The following criteria also applies:
- The directors/members resolve to wind up the company.
- The directors give the liquidator a report concerning the company’s affairs and a declaration that the company will be eligible for the simplified liquidation process.
- The company is insolvent.
- The company’s total liabilities do not exceed $1 million (including contingent liabilities, see examples below).
- The company’s tax lodgements are up to date.
Examples of contingent liabilities are:
- Potential tax liabilities (not yet raised).
- Possible damages claim arising from a breach of contract e.g. a lessor’s claim in respect of future rent and for the performance of the lessee’s covenants.
- A personal guarantee that gives rise to a contingent claim of the guarantor against the insolvent company.
- A possible damages liability arising in tort, such as negligence or defamation.
- Warranty claims that may arise during the agreed warranty period.
- Possible statutory claims for misleading and deceptive conduct.
- A possible claim against a holding company in liquidation in respect of insolvent trading by its insolvent subsidiary.
What if the company is solvent?
If the company is solvent, meaning it can pay its debt when they fall due, then the simplified liquidation pathway is not available.
Solvent companies can be wound up by its members via a members’ voluntary winding up.
Solvent companies can also be wound up by the court by way of an application to the court by its directors or members. Court appointments are common when there is a conflict with the control or conduct of the company and its members are unable to reach a resolution or cannot agree to appoint a liquidator voluntarily.
How will the simplified liquidation process work?
The simplified liquidation process will modify the existing liquidation framework to reduce the time and cost associated with investigations, creditor meetings, and reporting. This means that the following liquidator duties/obligations are modified:
- Reducing circumstances to seek unfair preference payments from unrelated creditors (to the company).
- Reporting to ASIC on potential misconduct only where there are reasonable grounds.
- Removing creditor meeting requirements and committees of inspection.
- Simplifying the dividend process and proof of debt process.
- Maximising technology neutral means (i.e. email) to vote and communicate.
Critically, secured creditors’ rights and priority creditors’ payments (such as employees) under the statutory rules will not be modified.
What is liquidation?
Liquidation is the process of winding up a company’s financial affairs to dismantle the company’s structure by conducting investigations—in the simplified liquidation this means appropriate to the company’s size and affairs—and enabling a fair distribution of company’s assets to its creditors. Liquidation occurs either because the company cannot pay all of its debts (i.e. it is insolvent), or its members want to end the company’s existence and have it struck off from ASIC’s register.
How do you prove that a company is insolvent?
A company is insolvent if it cannot pay all its debts as and when they fall due, even if the company has an asset surplus but no way to liquidate those assets quickly. A company is deemed to be insolvent when it does or fails to do certain things prescribed by law. Most commonly a company is deemed insolvent if it fails to satisfy a creditor’s statutory demand.
What powers do liquidators in a simplified liquidation have?
The Corporations Act sets out liquidator’s powers. These powers include all the powers vested in the directors of the company, plus the powers to:
- investigate and examine the affairs of a company
- identify transactions that are considered void
- examine the directors and others under oath in a public examination
- realise the assets
- conduct and sell any business of the company
- admit debts and pay dividends.
What does the liquidator do?
Shortly after appointment the liquidator will notify creditors:
- That they intend to adopt the simplified liquidation process and that they believe the company meets the eligibility criteria for a simplified liquidation.
- Outline what a simplified liquidation is.
- That they will not adopt the simplified liquidation process if within 20 business days at least 25 percent in value of the creditors (related entity creditors are not taken into account) direct the liquidator in writing not to do so.
How does a liquidator deal with preferences?
A liquidator in a simplified liquidation can recover preferential payments; however, the scope of available preferential payments is reduced.
A liquidator cannot claim a preferential payment if:
- the payment was made more than three months before the date of the liquidation; and
- if it was a payment to an un-related party within that three-month period, the payment/s must be for more than $30,000 in total.
What about voidable transactions?
A range of transaction types and periods apply to whether a company transaction can be voidable by a liquidator. These are:
- Uncommercial transactions—within two years prior to the relation-back day.
- Related-party transactions—within four years prior to the relation-back day.
- Transactions intended to defeat creditors—within 10 years prior to the relation-back day.
- Unfair loans—no limit.
What is the effect of a simplified liquidation on a company?
When a company is liquidated, its structure survives the appointment of a liquidator, but not the liquidation. Control of assets, conducting business, and other financial affairs are transferred to the liquidator. The directors cease to have any authority. All bank accounts are frozen, any employment can be terminated, but necessary labour may be engaged by the liquidator. At the end of the liquidation, the liquidator applies to ASIC for the company to be deregistered, after which the company will cease to exist.
Can a company trade while in a simplified liquidation?
A liquidator may continue trading a company if it is in the creditors’ best interest. A trade-on is considered if there is a prospect to sell the business as a going concern, or to complete and sell any work-in-progress. A liquidator is obligated to end trading and wind up company affairs as quickly but as commercially responsible as is practical.
What must the directors do to help the liquidator?
Directors must cooperate with liquidators and supply the liquidator with a report concerning the company’s affairs. They must also make a declaration that the company will be eligible for the simplified liquidation process. Directors must assist the liquidator as required during the liquidation.
How is the process different to the standard liquidation process?
Under the simplified liquidation, the investigations and reporting requirements are reduced. For example, the requirement to provide a report on offences to ASIC is removed unless reasonable grounds exist to suspect misconduct.
Other aspects that differ are:
- Reduced meetings. The obligation for liquidators to convene meetings is removed.
- Removes Committees of Inspections. Creditors may no longer appoint a committee of inspection, which is currently used to advise and assist the external administrator and can approve and request certain aspects of the liquidation process.
- No Reviewing Liquidators. Creditors may no longer appoint a reviewing liquidator to review the incumbent’s remuneration.
What about insolvent trading?
Directors have a duty to ensure that their company does not continue to incur debts when it is insolvent. If the director breaches that duty, the liquidator can bring an action against them for recovery of the amount of the debts incurred during the period that the company was insolvent. The insolvent trading claim is made against the directors personally, making them personally liable to compensate the company for the unpaid debts.
Can a liquidator attack a director’s personal assets?
No. A liquidator can only take possession of a company’s assets. However:
- If a liquidator can prove that the directors have taken company assets, the liquidator may then recover those assets.
- If a company has loaned money to the directors, the liquidator will seek to recover the money, and if necessary, may instigate legal proceedings to recover these funds.
- If a liquidator can establish an insolvent trading claim, they may take recovery action against any directors.
In all of these circumstances, if necessary, the liquidator may commence bankruptcy proceedings against that director. This allows a bankruptcy trustee to access the director’s assets to satisfy the liquidator’s claim.
What happens to personal guarantees?
When directors, or other parties, execute a personal guarantee, it becomes a personal arrangement between creditor and guarantor, and therefore not affected by liquidation.
How are secured creditors impacted?
Secured creditor’s rights are not affected by liquidation. Commonly, secured creditors allow liquidators to sell the assets while recognising the secured creditor’s rights. A secured creditor can prove for any shortfall in the liquidation after their security is realised.
What powers do creditors have?
The 2016 Insolvency Practice Schedule/Rules still apply with the exception of creditors being able to request/appoint a Committee of Inspection. Creditors can still request for meetings to be held if reasonable.
There are many processes for how insolvency practitioners must respond to the above but are also protected from compromising the administration in terms of privilege, confidentiality, and prejudice.
How are unsecured creditors impacted?
Unsecured creditors lose their right to recover money from the company but gain a right to prove for dividends in the liquidation.
Can a liquidator pay dividends in a simplified liquidation?
Yes. The process of creditors lodging a claim (proof of debt) and dividend payment will be simplified in the following ways:
- A liquidator has discretion over whether they will require creditors to formally prove their claims.
- Only one dividend is paid (as opposed to multiple).
Are the dividends paid under certain priorities?
Yes. The liquidator must pay dividends in the order of priorities set out in section 556 of the Corporations Act. These priorities include:
- costs and expenses of the liquidation
- costs of the applicant creditor (if the company was wound up by the court)
- employee entitlements
- other unsecured creditors.
Is the Fair Entitlements Guarantee scheme available to employees?
Yes. The Fair Entitlements Guarantee (FEG) scheme is available to employees as per the standard criteria.
How long does the simplified liquidation process take?
There is no set time limit for a liquidation. The liquidation lasts for as long as necessary to complete all the required tasks of liquidation; however, a liquidator will usually aim to finalise the liquidation as soon as possible.
How does the simplified liquidation end?
The liquidation ends when:
- the company is dissolved by a court order on the application of the liquidator, or
- the company is struck off the register of companies by ASIC at the request of the liquidator, or
- the winding up is set aside or stayed by the court.
Last updated: 19 02 21