Bankruptcy and Liquidation Archives | Page 3 of 3

Pre-packs – Do they have a place in Australian insolvency practice?

1 January 2012 by By Lawyers

By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

First published on the website, www.obp.com.au

You may have noticed the occasional reference in the media to fraudulent phoenix activity and attempts by government agencies such as ASIC (Australian Securities and Investments Commission) and the ATO (Australian Taxation Office) to ‘crackdown’ on serial offenders, particularly in the building and construction industry. Phoenix activity typically involves the transfer of the business assets of a company to a new entity, with creditors being left behind with no real prospect of payment.

There has been recent discussion in the profession about the distinguishing features of a phoenix and a bird of a different feather known as a ‘pre-pack’. In the United Kingdom, pre-packs are a legitimate and accepted means to phoenix the business of a company. In Australia, there is no formal pre-pack procedure although variations of the process are often used by those who specialise in the area, particularly in the turnaround sphere. Where this occurs, the bona fides of the directors are often treated with scepticism. However in many instances, the transfer of assets from one company to a related entity may in fact be in the best interest of all stakeholders of the insolvent company.

In this newsletter, we explore phoenix activity and examine the pre-pack concept.

What is a phoenix company?

A phoenix company is usually considered to be one which is established to carry on the business of an insolvent company, using the assets and employing the staff of the insolvent company, but without accepting liability for its debts. In most cases, the members and directors of the phoenix company are the same or at least related to those of the insolvent company. The business rises from its burden of debt in a new corporate entity, using the same or a similar name, but the creditors of the insolvent company are left to recover what they can for the amounts owed to them through the liquidation process.

Is phoenix activity fraudulent?

Current legislation does not explicitly prohibit phoenix activity. However the process is one that can be easily abused with the result that the activity is often referred to as being fraudulent. Examples of phoenix activity generally considered to be fraudulent include:

transferring the business and/or assets of a company to a new entity for less than fair market value and/or on terms considered to be uncommercial;
establishing a corporate structure for the express purpose of defeating creditors by incurring liabilities through that company whilst keeping assets safe in a related entity;
deliberately incurring company debt immediately prior to the transfer of the business and/or its assets, without having any expectation that the company would be able to pay that debt.

In order to combat such activity, remedies are available within the Corporations Act, which has a number of provisions dealing with breach of duties by directors as well as provisions designed to protect creditors in the event of insolvency. Proven breaches of these provisions can result in civil and/or criminal penalties. Furthermore, the ATO is strengthening its powers using the director penalty notice regime by providing disincentives to fraudulent phoenix activity by making directors personally liable in certain circumstances for their company’s unreported unpaid superannuation and pay-as-you-go withholding amounts.

The applicable provisions of the Corporations Act are as follows:

If the phoenix sale of a company’s business and assets is for less than fair market value or on terms considered to be uncommercial, then it may be challenged as an uncommercial transaction (section 588FB), as an unreasonable director-related transaction (section 588FDA), or as a transaction to defeat creditors (subsection 588FE(5)).
If the sale is not in the best interest of the creditors, the directors may have breached their duties to the company and its creditors. These duties include the duty to act with care and diligence (section 180), to act in good faith and for a proper purpose (section 181) and to not improperly use their position or any information obtained because of their position to gain advantage for themselves or cause detriment to the company (sections 182 and 183). Should it be proven that the breach of any of these sections occurred with either deliberate intention or recklessness, then the breach may result in criminal liability for the director/s (section 184).
Pursuant to subsection 598(2), where the court is satisfied that a person is guilty of fraud, negligence, breach of trust or duty and the company has suffered loss or damage as a result, the court may make such orders as it thinks appropriate in relation to that person.
If employees and employee entitlements are not handled correctly, the director risks committing the criminal offence of entering into a transaction with the intention of avoiding employee entitlements (section 596AB).
If the directors do not prevent all unnecessary liabilities from being incurred once they realise a company may be insolvent, or likely to become insolvent, then they may have breached their duty to prevent insolvent trading (section 588G) and risk being held personally liable for those debts. If the failure to prevent liabilities from being incurred is proven to be dishonest, then the breach may constitute a criminal offence (section 588G(3)).

Proponents of pre-packs argue that, if properly completed, directors will avoid breaching the above legislative provisions.

What is a pre-pack?

A pre-pack is a sale process through which the sale of the business and/or assets of an insolvent company is agreed prior to the appointment of an insolvency practitioner, whose task is to review the sale terms and, if thought appropriate, ratify the sale. The model adopted in the United Kingdom has elements that would not be considered acceptable under Australian law and practice. For example, in the United Kingdom, an insolvency practitioner will work with management to arrange the sale of the business and assets and, after those arrangements have been made, he or she will then be formally appointed as administrator. The conflict of interest is obvious. The pre-pack model, modified to suit the Australian environment, has three distinct steps, namely:

Preparation
The directors will have the business and assets of the company valued by a reputable valuer. The sale of the company’s business and assets should be based on this valuation to ensure that fair market price is obtained.
The directors should prevent all non-essential debts from being incurred. In doing so, they will reduce any exposure to insolvent trading.
Execution
The directors then arrange the sale of the company business and/or assets to another entity, for fair market value. A conditional contract would be executed together with an agreement to operate the business under licence. To prevent the appearance of any impropriety, the completion of the contract should be subject to ratification by an administrator who would in the ordinary course seek creditor input.
The employees of the company would ordinarily be transferred to the new company, which will accept responsibility for their accrued entitlements.
The business continues being operated by the new company.
Ratification
The insolvent company then appoints an administrator (or possibly a liquidator), who will investigate the sale, test the market if appropriate, and report to creditors. The expectation of management is that the sale will be ratified. If that transpires then the administrator will complete the sale.
If the sale is not ratified, then the contract will be rescinded. Responsibility for operating and selling the business would then revert to the administrator.

Importantly, the insolvency practitioner to be appointed administrator should not advise on the process. This ensures that, following appointment, the administrator can act, and be seen to act, independently of those involved in the transaction.

If, for some reason, a sale was completed prior to appointment, then it is likely that the company would be wound up by way of a creditors’ voluntary liquidation. In those circumstances and as in any winding up, the liquidator would review the sale, and in the event it is found to be unreasonable, then he may, if commercial to do so, seek to overturn the sale under the voidable transactions provisions of the Act. The liquidator would then realise the assets for the best price possible.

Why pre-pack and not administration?

The voluntary administration regime was introduced in 1993, and was designed to provide a flexible mechanism for a company’s affairs to be administered in such a way that maximises the chances of the company or its business remaining in existence or, if that is not possible, results in a better return to creditors. It does this by imposing a moratorium on the company’s creditors, giving an administrator time to investigate the company’s affairs and consider a proposal for the company’s debt to be compromised. The proposal can take many forms and, if accepted by creditors, the company will then enter into a Deed of Company Arrangement (DOCA).

As the legislative framework for flexible restructure is already in place, then why bother with a pre-pack sale? Critics of the voluntary administration process argue it is cumbersome, intrusive, costly and detrimental to the business. Proponents of pre-packs claim they offer a better chance for existing management to save their business and for creditors to maximise their return. They say pre-packs do this by:

ensuring the continuation of the business in a new entity;
preserving the goodwill of the business and its suppliers and customers;
maximising the value of company business and assets;
avoiding a costly trade-on administration pending a sale.

In addition, creditors should have the comfort of knowing the sale is subject to review and ratification by an independent administrator. However, there are other considerations that need to be taken into account, namely:

The company will still have go through the administration process and bear the consequential costs of the administrator possibly testing the market and dealing with enquiries which may extend to entering into negotiations for the sale of the business and assets.
The appointment of an administrator and the subsequent winding up of the company will still leave the directors exposed to potential claims under the Corporations Act – for example, claims resulting from trading whilst insolvent. This means that the directors may still have to consider propounding a DOCA as part of the pre-pack process, further adding to the costs that might be incurred.
The directors or owners of the entity acquiring the business and assets will need to arrange funding not only of the agreed purchase price but also ongoing working capital. In many instances buying the business and assets of a company will not be a practical option.

Conclusion

The debate surrounding phoenix activity continues, in which the cost to the community is contrasted with the efficiency and other benefits of the pre-pack process. Should directors who phoenix the business of their companies be held more accountable? Or should the interests of creditors in an increased commercial return supersede government concerns over the director’s bona fides? The government is considering further legislative amendments to inhibit deliberate, cyclic, fraudulent phoenix activity. In this regard you might be aware that earlier this year, the government introduced what is commonly called the Similar Names Bill, which sought to amend the Corporations Act to make a director of a failed company personally liable for its debts where the related entities had the same or similar names. We understand this Bill has made no progress but it is an indication of the government’s intentions.

Whilst the voluntary administration regime already provides a mechanism for the restructure of a company’s business, it is often criticised. Proponents of pre-packs argue that a pre-pack sale of a company’s business will in many instances deliver better results than can be achieved through a standard administration, and that sufficient safeguards already exist within the Corporations Act to protect creditors’ interests. We consider that, in certain circumstances, a formal pre-pack process may be more effective than voluntary administration. We also consider that the concept deserves to be further explored.

This article was written by O’Brien Palmer insolvency authors. They are a specialist practice with national affiliations, focusing on corporate and personal insolvency and business recovery. They are committed to assisting solicitors help their clients understand and navigate the complex realms of insolvency.

The ATO rises and ups the ante – ATO granted new powers to pursue directors

1 January 2012 by By Lawyers

By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

First published on the website, www.obp.com.au

The Tax Laws Amendment (2012 Measures No.2) Bill 2012 received royal assent on 29 June 2012 and has commenced operation. This bill extends the existing director penalty notice (DPN) regime to make directors personally liable for their company’s unpaid superannuation in addition to pay as you go (PAYG) withholding amounts. This legislation acts retrospectively in respect of PAYG liabilities. It is more urgent than ever that directors be aware of the PAYG and superannuation liability position of their companies to ensure they do not become personally liable for the debts of those companies.

The new regime enables the Australian Taxation Office (ATO) to take action under the DPN system for all PAYG and superannuation debts that remain unreported and unpaid from 29 June 2012, including PAYG liabilities incurred prior to the commencement of the bill, which remain unreported for more than three months. Further, directors who fail to comply with their reporting requirements may become liable to pay the new PAYG withholding non-compliance tax, which can be set-off against PAYG credits due to directors. If directors have not reported on these liabilities for the period ending 31 December 2011, it is already too late.

Although it may take some time for the ATO to implement and utilise these new powers, company directors are risking increased enforcement action if they fail to deal with outstanding tax and superannuation liability now. The following is a guide to the director penalty notice regime and a summary of the changes which have taken effect.

Directors to become personally liable for unreported PAYG

Where a company’s PAYG liabilities remain unreported to the ATO for more than three months after the due date, the ATO may make directors personally liable immediately; and, although still required to issue a DPN prior to commencing enforcement action, the appointment of an administrator or liquidator to the company will no longer prevent directors from becoming personally liable for the company’s tax debt. The due date for reporting purposes depends on the company’s PAYG withholding amounts:

small withholders – $25,000 annually or less, 28 days after quarter end; and
medium withholders – $25,001 to $1 million annually, 21 days after month end.

Most companies which haven’t reported to the ATO on PAYG liabilities for the quarter ending 31 March 2012 will have until 21 July 2012 to report, or their directors risk being made personally liable for the amounts outstanding. For the June 2012 quarter, the final date will be 21 October 2012. Lodgement dates vary from month to month and companies lodging via a tax or BAS agent have an extra month.

Directors to become personally liable for unreported superannuation guarantee charge

Where a company has not paid superannuation by the 28th day after the end of each quarter, it is required to lodge a superannuation guarantee charge (SGC) statement by the 28th day of the following month – that is, in the second month. In circumstances where the statement is not lodged on time, the ATO can now make directors personally liable for outstanding superannuation, by issuing a DPN. This includes making directors liable based on estimates of SGC owing, rather than merely on reported figures, and liability will arise three months after the relevant lodgement date. Therefore the lodgement date for a June 2012 quarterly SGC statement would be 28 August 2012, with personal liability arising from 28 November 2012.

PAYG withholding non-compliance tax

In certain circumstances, directors and associates of directors will be prevented from obtaining PAYG credits in their individual tax returns where the company has failed to pay withheld amounts to the ATO. These amounts will be the lesser of the amount that the company has failed to remit to the ATO or the amount of tax withheld by the company from the director’s income.

The new DPN regime

In order to recover a director penalty from a director (in respect of PAYG or superannuation) the ATO must issue a DPN and wait until the expiration of 21 days from the date of the notice to commence proceedings. Personal liability is not triggered if within 21 days of the issue date:

the company complies with the obligation;
an administrator is appointed to the company; or
the company is placed into liquidation.

The critical change is that, where three months has lapsed since the due date, and the underlying liability remains unreported and unpaid, there is no relief from the director penalty by placing the company into administration or liquidation.

Therefore, the key issue under this new regime is that, in order to avoid personal liability, all liabilities should be reported no later than three months after the due date.

What do these changes mean?

To ensure directors do not become personally liable for company debts, directors should take the following steps:

ensure that business activity statements and other reporting requirements are lodged with the ATO within the required timeframes;
ensure that PAYG and superannuation amounts are reported and remitted to the ATO and relevant superannuation funds within the required timeframes;
increase the monitoring and awareness of their company’s taxation and superannuation liabilities, and act promptly where problems are identified;
increase the communication with the ATO where debts have been incurred beyond the company’s ability to meet them within the required timeframes;
seek immediate advice from their accountant or an insolvency practitioner at the first signs of trouble; and
if a DPN is received, then immediate compliance is required to ensure that the corporate veil is not pierced.

If the ATO doesn’t get you, then the OSR might

1 January 2011 by By Lawyers

By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

First published on the website, www.obp.com.au

Much has been written about the alternative courses of action available to the Australian Taxation Office (ATO) in collecting outstanding taxes and the aggressive attitude being adopted by it in effecting debt recoveries. In this paper, we focus attention on the New South Wales Office of State Revenue (OSR), which also has a formidable arsenal at its disposal for the recovery of overdue taxes and in particular payroll tax.

The Office of State Revenue

The OSR is a division of the Department of Finance and Services. It administers state taxation and revenue programs for and on behalf of the government and thus the people of New South Wales. A major source of revenue for the OSR is payroll tax, the imposition of which arises under the operation of the Payroll Tax Act 2007 (PTA).

The Taxation Administration Act 1996 (TAA) provides for the administration and enforcement of the PTA and a number of other taxation laws including the following:

The general administration of the TAA and the other taxation laws including the PTA is undertaken by the Chief Commissioner of State Revenue who assesses the tax liability of a taxpayer and collects the tax payable.

Collection of unpaid payroll tax and other taxes under the Taxation Administration Act

If a tax debt remains unpaid, then the Chief Commissioner can seek payment from third parties and/or directors and former directors of corporations. The relevant provisions of the TAA in relation to the collection of unpaid tax are summarised hereunder:

(a) From third parties

Pursuant to subsection 46(1) of the TAA, the Chief Commissioner can, by written notice, require persons instead of the taxpayer to pay the debt. Those persons include the following:

a person by whom any money is due or accruing or may become due to the taxpayer;
a person who holds or may subsequently hold money for or on account of the taxpayer;
a person who holds or may subsequently hold money on account of some other person for payment to the taxpayer;
a person having authority from some other person to pay money to the taxpayer.

These notices operate in a manner similar to what are commonly referred to as ‘tax garnishee notices’ issued by the ATO. The recipient of such a notice must pay the money to the Chief Commissioner on receipt of the notice, or when the money is held by the person and becomes due to the taxpayer, or after such period (if any) as may be specified by the Chief Commissioner, whichever is the later: subsection 46(5). A person subject to a requirement under subsection 46(1) must comply with the requirement. Failure to do so may result in a penalty of $11,000: subsection 46(6).

(b) From directors and former directors of corporations

Section 47B of the TAA operates in a manner similar to the Director Penalty Notice regime under the Income Tax Assessment Act. Pursuant to subsection 47B(1), if a corporation fails to pay an assessment amount in accordance with a notice issued by the Chief Commissioner, then the Chief Commissioner may serve a compliance notice on one or more of the following persons:

a person who is a director of the corporation;
a person who was a director of the corporation at the time the corporation first became liable to pay the tax, or any part of the tax, that is included in the assessment amount or at any time afterwards.

A ‘compliance notice’ is defined in subsection 47B (2) as a notice that advises the director or former director on whom it is served that if the failure to pay the assessment amount is not rectified within the period specified in the notice, being a period of not less than twenty-one days, the director or former director will be liable to pay the assessment amount.

However, subsection 47B(3) states that a failure to pay an assessment amount is rectified if:

the assessment amount is paid; or
the Chief Commissioner makes a special arrangement with the corporation for the payment of the assessment amount; or
the Board of Review waives or defers payment of some or all of the assessment amount; or
an administrator of the corporation is appointed under Part 5.3A of the Corporations Act 2001 (‘the Corps Act’); or
the corporation begins to be wound up within the meaning of the Corporations Act.

If the failure to pay the assessment amount is not rectified within the period specified in the compliance notice, then the director or former director on whom the compliance notice was served is jointly and severally liable with the corporation to pay the assessment amount: subsection 47B(4).

Directors should note that a person does not cease to be liable to pay an assessment amount because the person ceases to be a director of the corporation, but a former director of a corporation is not liable for any tax for which the corporation first became liable after the director ceased to be a director of the corporation: subsection 47B(5).

The defences that are available to directors and former directors are set out in section 47E, which states that it is a defence to the recovery of an assessment amount if it can be established that:

the director or former director took all reasonable steps that were possible in the circumstances to ensure that the corporation rectified the failure to pay the assessment amount; or
the director or former director was unable, because of illness or for some other similar good reason, to take steps to ensure that the corporation rectified the failure to pay the assessment amount.

Collection of unpaid payroll tax under the Payroll Tax Act

(a) From group members

Readers of this newsletter would be aware, even if it is only in general terms, of the grouping provisions of the Payroll Tax Act. We do not propose to review those provisions in this paper except to very briefly set out the groups that can be constituted:

groups of corporations that are related bodies within the meaning of the Corporations Act (section 70);
groups arising from the use of common employees (section 71);
groups of commonly controlled businesses (section 72);
groups arising from interests in corporations (section 73); and
smaller groups subsumed by larger groups (section 74).

Importantly, if a member of a group fails to pay an amount that the member is required to pay in respect of any period, then pursuant to subsection 81(1) every member of the group is liable jointly and severally to pay that amount to the Chief Commissioner. One or more members in the group will be issued with an assessment for the amount outstanding, with payment to be effected within twenty-one days.

(b) From principal contractors

Part 5 of Schedule 2 of the PTA applies where a principal contractor enters into a contract for the carrying out of work by a subcontractor and employees of the subcontractor carry out work in connection with a business undertaking of the principle contractor: clause 17(1) of Schedule 2.

If, at the end of the period of 60 days after the end of a financial year, any payroll tax payable by the subcontractor in respect of wages paid or payable to the relevant employees during the financial year for work done in connection with the contract has not been paid, then the principal contractor is jointly and severally liable with the subcontractor for the payment of the payroll tax: clause 17(2).

However, the principal contractor is released of the liability if the subcontractor provides a written statement declaring, inter alia, that all payroll tax payable for work done in connection with the contract has been paid: clauses 18(1) and (2).

Finally, the principal contractor is entitled to recover from the subcontractor, as a debt in a court of competent jurisdiction, any payment made by the principal contractor as a consequence of a liability arising under Part 5: clause 19.

This article was written by O’Brien Palmer insolvency authors. They are committed to assisting solicitors help their clients understand and navigate the complex realms of insolvency. As part of that commitment, they are pleased to answer any questions regarding their services and offer a complimentary and obligation free initial consultation to establish the nature of the problem and the manner in which they can be of service.

O’Brien Palmer is a specialist practice with national affiliations, focusing on corporate and personal insolvency and business recovery.

Technical guide: Voluntary administration

1 January 2010 by By Lawyers

By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

First published on the website, www.obp.com.au

Introduction

The Voluntary Administration process is regulated by the Corporations Act 2001 (Cth) (‘the Act’) and provides for the business, property and affairs of an insolvent company to be administered in a way that:

maximises the chances of the company continuing in existence; or
results in a better return for the company’s creditors and members than would result from an immediate winding up of the company.

Appointment

Who may appoint an administrator?

Pursuant to section 436A of the Act, an Administrator, who must be a registered liquidator, can be appointed by:

the majority of the company’s directors; or
a Liquidator of the company; or
a person holding a charge over the whole or substantially the whole of a company’s property.

Making the appointment

Pursuant to subsection 436A(1) of the Act, the company’s directors can appoint an administrator by passing a resolution to the effect that the company is insolvent or is likely to become insolvent at some future time.

A Liquidator, pursuant to subsection 436B(1), may by writing appoint an Administrator to the company if he or she thinks that the company is insolvent or will become insolvent. In compliance with subsection 436B(2)(f), the Liquidator can appoint himself or herself Administrator if:

at a meeting the creditors pass a resolution approving the appointment; or
the appointment is made with leave of the Court.

Pursuant to subsection 436C(1), a person who is entitled to enforce a security interest over the whole or substantially the whole of a company’s property may by writing appoint an Administrator to the company, if the security interest has become and is still enforceable.

The appointment of an Administrator cannot be made unless the proposed Administrator has consented in writing to the appointment (section 448A). A person cannot consent to be appointed Administrator unless the person is a Registered Liquidator (section 448B).

The administrator’s independence

In accordance with section 436DA of the Act and the Code of Professional Practice issued by the Australian Restructuring Insolvency & Turnaround Association (‘ARITA’) a person appointed Administrator must as soon as practicable after being appointed make out a Declaration of Independence, Relevant Relationships and Indemnities (‘DIRRI’). The purpose of the DIRRI is to establish the independence of the appointee. In accordance with subsection 436DA(3), the Administrator must circulate a copy of the DIRRI to creditors when he gives notice of the first meeting of creditors.

The first meeting of creditors

Pursuant to subsection 436E(1) of the Act, the Administrator must convene the first meeting of creditors, to be held within eight (8) business days after the administration begins. The purpose of the meeting is to consider:

whether or not to appoint a Committee of Creditors; and/or
to replace the Administrator.

The functions of a Committee of Creditors as per subsection 436F(1), are to consult with the Administrator and to receive and consider reports from the Administrator. The Committee cannot give directions to the Administrator (subsection 436F(2)) except to require the Administrator to report to the Committee (subsection 436F(3)). Furthermore, a Committee of Creditors can approve the remuneration of the Administrator (subsection 449E(1)).

The outcome of the administration

Second meeting of creditors

In accordance with subsection 439A(1) of the Act, the Administrator must convene a second meeting of creditors, such meeting to be held within five (5) business days before or within five (5) business days after, the end of the convening period, which is normally twenty (20) business days beginning on the day after the Administration began. Attached to the notice of meeting will be a copy of the Administrator’s Section 439A report. The purpose of the meeting is to:

decide upon the future of the company by passing a resolution for the company to adopt one of the normal outcomes of the administration set out in subsection 435C(2), which are that;
the company executes a Deed of Company Arrangement (‘DOCA’); or
the Administration should end; or
the company be wound up.

Alternatively and pursuant to subsection 439B(2), creditors can resolve to adjourn the meeting from time to time for a period not to exceed forty-five (45) business days from the date of the second meeting.

determine the remuneration of the Administrator, if it has not already been dealt with by a Committee of Creditors.

In circumstances where it is proposed that employees will surrender their priority status under a DOCA that they would otherwise be entitled to pursuant to sections 556, 560 and 561, then it may be necessary, pursuant to section 444DA, for a separate meeting of eligible employees to be convened in order to pass a resolution approving the priority adjustment. This is most relevant where employees agree to accept payment of their outstanding entitlements in the ordinary course of their employment rather than having them paid out in full under the DOCA.

The section 439A report

When convening the second meeting, the Administrator is required to prepare a comprehensive report to creditors (pursuant to subsection 439A(4) of the Act) that;

1. details the results of his or her investigation into the business, property, affairs and financial circumstances of the company; and
2. sets out the Administrator’s opinions and the reasons for those opinions on each of the alternative courses of action set out above; and
3. provides such other information as will enable creditors to make an informed decision in relation to the potential options regarding the future of the Company; and
4. includes a statement setting out the details of and DOCA that has been propounded.

Voting at the meetings

Pursuant to Corporations Regulation 5.6.19, a resolution put to the vote at a meeting must be decided by majority on the voices (or on a show of hands) unless a poll is demanded. Subregulation 5.6.21(2) states that a resolution is carried under a poll if a majority in number and value of creditors present vote in favour of the resolution. Conversely, Subregulation 5.6.21(3) states that a resolution is not carried under a poll, if a majority in number and a majority in value of creditors present vote against the resolution.

In the event that a resolution is neither carried nor lost, then regulation 5.6.21(4) gives the chairperson the power to determine the outcome by exercising a casting vote either for or against the motion. If the chairperson declines to exercise a casting vote, or votes against the resolution, then the resolution will be lost.

If creditors resolve to wind up the company?

In the event creditors resolve to wind up the company, then pursuant to subsections 446A(1) and 446A(2) of the Act, the company is taken to have passed a resolution under section 491 of the Act that the company has been wound up voluntarily.

In the event that creditors resolve to wind up the company, then pursuant to subsection 499(2A)(a), creditors can seek to appoint a person to be Liquidator for the purpose of winding up the company. If no such appointment is made, then pursuant to subsection 499(2A)(b), the Administrator will automatically become Liquidator of the company.

If creditors resolve that the company executes a DOCA?

In the event creditors resolve that the company executes a DOCA, then pursuant to subsection 444B(2) of the Act, the DOCA must be executed within fifteen (15) business days after the end of the meeting of creditors, or such further period as the Court allows on an application made within those fifteen business days.

For further information in relation to DOCA’s, you are referred to our separate technical guide on the subject, which is available at www.obp.com.au/publications.

If creditors resolve to bring the administration to an end?

In the event creditors resolve to bring the administration to an end, then control of the company simply reverts to the directors.

The role and powers of the administrator

In accordance with section 437A of the Act, while a company is under administration, the Administrator:

has control of the company’s business, property and affairs; and
may carry on the company’s business and manage its property and affairs; and
may terminate or dispose of all or part of the company’s business or property; and
may perform any function, and exercise any power, that the company or any of its officers could perform or exercise if the company was not in administration.

Section 437B states that when performing a function or exercising a power, an Administrator is taken to be acting as the agent of the company.

Pursuant to section 438A, an Administrator must investigate the company’s business, property, affairs and financial circumstances and form an opinion about whether it is in the interests of the company’s creditors for either the company to execute a DOCA, or for the administration to end, or for the company to be wound up.

Section 442A, sets out the additional powers of an Administrator, which comprise:

removing from office a director of the company;
appointing a person as a director;
executing a document, bringing or defending proceedings, or doing anything else in the company’s name or on its behalf;
whatever else is necessary for the purposes of Part 5.3A.

Continuation of trading

As stated above, an Administrator has the power to carry on the business of a company. However the Administrator will only do so if he or she can be satisfied that the continuation of trading is in the interests of creditors. The reasons that would support the continuation of trading are:

the ability of the company to generate a positive cash flow;
to maximize the realisable value of assets such as stock;
to facilitate the sale of the company’s business;
to enable a DOCA to be propounded in the expectation that the return under the DOCA will be greater than if the company was wound up;
the availability of fixed assets to cover trade on debts and expenses.

Pursuant to section 443A, an Administrator is personally liable for debts he or she incurs in the performance or exercise of his or her functions and powers. Section 443D gives the Administrator an entitlement to be indemnified out of the company’s property for debts, liabilities, damages or losses sustained for which he or she becomes liable. The indemnity extends to the remuneration of the Administrator.

The administrator’s remuneration

The remuneration of an Administrator is normally calculated on a time basis using hourly rates set by his or her firm. The actual costs will depend upon the circumstances and complexity of the administration and can only be drawn down once approved. Pursuant to section 449E of the Act, the Administrator’s remuneration can be determined;

by agreement between the Administrator and the Committee of Creditors (if any); or
by resolution of creditors; or
if there is no agreement or resolution, then by order of the Court.

As noted earlier herein, the remuneration of the Administrator would normally be determined at the second meeting of creditors or at any adjournment of that meeting, unless of course the remuneration has already been dealt with by a Committee of Creditors, assuming of course one is in existence.

The effect of the appointment on directors and members

Pursuant to section 437C of the Act, while a company is under administration, company officers cannot perform or exercise a function or power unless the Administrator has provided written approval for the person to so act.

Following the commencement of the administration, each director must deliver to the Administrator all of the company’s books and records in their possession (subsection 438B(1)) and attend upon the Administrator providing such information about the affairs of the company as the Administrator reasonably requires (subsection 438B(3)).

Furthermore, in compliance with subsection 438B(2), the directors must, within five (5) business days after the administration began or such longer period as the Administrator allows, give to the Administrator a statement about the business, property, affairs and financial circumstances of the company.

In so far as members are concerned, pursuant to section 437F, a transfer of shares made after the administration began is void unless either the Administrator gives written consent and any conditions attaching thereto are satisfied, or the Court makes an order authorising the transfer.

The position in relation to personal guarantees

Pursuant to section 440J of the Act, during the administration of a company, a guarantee of a liability of a company cannot be enforced against a director of a company or a relative or spouse of a director, except with leave of the Court and in accordance with such terms (if any) as the Court imposes.

The effect of the appointment on creditors

Section 440D of the Act provides that during the period of the administration, there is a general stay of proceedings against the company or in relation to any of its property. Proceedings cannot be commenced or proceeded with except, with either the written consent of the Administrator or with leave of the Court.

If a creditor holds a charge over the whole or substantially the whole of the company’s property, then pursuant to section 441A, the creditor is able to enforce the charge either before or during the ‘decision period’, which is defined in the Act as the period of thirteen (13) days after receipt of notice of the Administrator’s appointment.

Furthermore, pursuant to section 440C, the owner or lessor of property that is used or occupied by, or is in possession of the company, cannot take possession of the property or otherwise recover it except with the Administrator’s written consent or with the leave of the Court.

The effects of the appointment if a winding up application has been filed

If a winding up application has been filed, then an Administrator can still be appointed. In compliance with subsection 440A(2), the Court is to adjourn the hearing of an application to wind up a company already in administration, if the Court is satisfied that the continuation of the administration is in the interest of creditors. In our experience, there will need to be evidence put before the Court that will lead the Court to conclude there is a real likelihood that a DOCA will be propounded and that the return under the proposed DOCA will be greater than if the company was wound up. If that cannot be done, then it is likely that the Court will order the winding up of the company in which case the administration ends.

Other relevant sections

Section 447A to Section 447E of the Act – Powers of the Court Pursuant to section 447A, the Court has general powers to make such orders as it thinks appropriate. The sections that follow deal with specific powers, namely the protection of creditors (section 447B), the validity of the Administrator’s appointment (section 447C), the ability of the Administrator to seek directions (section 447D) and the supervision by the Court of Administrators (section 447E).
Section 449A of the Act – Appointment cannot be Revoked Section 449A states the appointment of a person as Administrator of a company cannot be revoked.
Section 450E of the Act – Notice of Appointment in Public Documents Subsection 450E(1) provides that a company under administration, must set out in every public document and in every negotiable instrument, after the company’s name where it first appears, the expression ‘Administrator Appointed’.

Conclusion – the benefits of administration

The benefits of a company entering into Administration include the following:

allows immediate action to be taken and sets a fixed time frame for dealing with the issues;
control of the company is given to an independent person;
prevents unsecured creditors, owners and lessors of property from taking action which may adversely affect the value of a company’s business and assets;
allows a company and its creditors to consider the merits of a compromise arrangement which may maximise the return to creditors; and
enables directors in certain circumstances to avoid personal liability for company debts except for debts that have been personally guaranteed.

Directors of companies that are insolvent or are likely to become insolvent should seek immediate professional advice in relation to their specific circumstances. The procedure normally requires consultation and certain investigative work before implementation, particularly when the intention is to carry on the business of the company or where a secured creditor is in existence.

Bankruptcy and other options

1 January 2010 by By Lawyers

By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

First published on the website, www.obp.com.au

This article summarises the basic information conveyed in conference to insolvent individuals (‘debtors’) who, as a means of solving their debt problems, need to decide between becoming a bankrupt or entering into an arrangement with their creditors.

Bankruptcy

Introduction

Bankruptcy is a legally declared inability by an individual to repay debts. The applicable legislation is the Bankruptcy Act 1966 (‘the Act’). It applies to individuals, partnerships, joint debtors and deceased estates. The bankruptcy is administered by a Trustee in Bankruptcy who is either the Official Receiver (a public servant) or a private trustee.

Becoming a bankrupt

There are two ways a debtor can become bankrupt, namely:

Debtor’s petition – Where the debtor presents his or her own petition to the Official Receiver; or
Creditor’s petition – When a creditor presents a petition to the court, a sequestration order may be made against the estate of a debtor.

For a petition to be presented, the debtor will need to have committed an act of bankruptcy, the most common being noncompliance with a bankruptcy notice, and be indebted to the creditor for an amount of at least $5,000.

In the case of a debtor’s petition, the debtor can nominate a trustee as compared with a creditor’s petition where the creditor can nominate a trustee. The role of the trustee is to investigate the financial affairs of the bankrupt; realise all available assets including transactions that may be voidable, and distribute to creditors realised funds in accordance with the Act without undue delay.

The period of bankruptcy

A bankrupt is automatically discharged three years from the date the bankrupt files with the Official Receiver a statement of affairs. However, if the conduct of the bankrupt is unsatisfactory, then the period of bankruptcy can be extended by up to five years upon an objection being lodged by the trustee. Alternatively and at any time before discharge, the debtor can:

seek an annulment pursuant to section 73 of the Act by submitting a proposal to creditors;
seek an annulment pursuant to section 153A of the Act by paying out all creditors in full plus the costs of the bankruptcy; or
in the case of a creditor’s petition, seek an annulment pursuant to section 153B of the Act by making an application to the court.

Consequences of bankruptcy

The main consequences of becoming a bankrupt include the following:

A bankrupt will be recorded on the NPII (National Personal Insolvency Index) for life;
A bankrupt’s credit rating will be affected for seven years;
Creditors are unable to commence or continue any further action for recovery of their debts against the bankrupt;
A bankrupt’s property including after-acquired property will vest in the trustee during bankruptcy and continue to vest with the trustee after discharge if the property remains unsold. Certain property of the bankrupt is excluded from vesting in the trustee;
A bankrupt is required to make contributions from income to his or her estate if the income exceeds prescribed limits;
A bankrupt cannot, without disclosing that he or she is an undischarged bankrupt, obtain credit (including the lease or hiring of goods) for an amount greater than an indexed amount;
A bankrupt cannot carry on business alone or in partnership under a name other than their own unless he or she discloses their real name and the fact that he or she is an undischarged bankrupt;
A bankrupt is allowed to travel overseas but only with the written consent of the trustee. However the bankrupt is required to deliver his or her passport(s) to the trustee;
A bankrupt is disqualified from acting as director and managing a corporation;
On discharge from bankruptcy, the debtor is released from all debts provable in the bankruptcy including secured debts. There are a number of exceptions such as fines imposed by a court and debts incurred by fraud.

Property the bankrupt can retain

The bankrupt is able to retain certain property including:

Property held in trust for another person;
Necessary clothing and household property and such other household property that creditors may resolve;
Items of sentimental value, including awards of sporting, cultural, military or academic nature, as creditors may resolve;
Property that is used by the bankrupt in earning income by personal exertion whose aggregate value does not exceed an indexed value and such other equipment as the creditors may resolve or the court may order;
Property used primarily as a method of transport up to an indexed value;
Subject to certain conditions, life assurance and endowment assurance policies and proceeds from the policies in respect of the bankrupt and the bankrupt’s spouse and the bankrupt’s interest in superannuation policies and proceeds thereof;
Any right of the bankrupt to recover compensation, damages and right of action for the death, personal injury or wrongs to oneself, their spouse or any family member;
Property purchased from the proceeds received from endowment and annuity policies, compensation/damages claims or rural adjustment schemes.

Income contributions

If the debtor receives or is deemed to have received income above indexed amounts, then the debtor is liable to make contributions to his or her bankrupt estate. The definition of income is quite broad and includes income from personal exertion, certain benefits provided by third parties, income from trusts and superannuation funds, loans and so on.

The amount of the contribution is calculated by using the following formula:

Assessed Income – income tax – a statutory threshold amount – child support payments

Arrangements with creditors

There are three types of arrangements that debtors can make with their creditors, namely:

formal arrangement under Part X of the Act;
formal arrangement under Part IX of the Act;
informal arrangement.

Part X – Personal insolvency agreements

Introduction

Part X of the Act offers an alternative to bankruptcy by providing a debtor in financial difficulty with a formal but expensive mechanism to reach a binding arrangement with his or her creditors. The arrangements are individually tailored to suit the debtor’s unique financial circumstances. The debtor is able to negotiate a settlement with creditors that most likely involves the payment of less than 100 cents in the dollar. A typical arrangement will usually provide for money to be paid by the debtor or on account of the debtor either by way of lump sum or by instalments over a certain period of time. The arrangement can also provide for sale of specified assets with the remaining assets to be retained by the debtor.

The process

The provisions of Part X are invoked by the debtor signing what is called a section 188 authority, authorising either a registered trustee, a solicitor or the Official Trustee (who is then referred to as the controlling trustee) to call a meeting of his or her creditors and to take control of his or her property. At the same time, the debtor must provide the controlling trustee with a proposal, including a draft personal insolvency agreement (‘PIA’), and a statement of affairs outlining all known assets and liabilities of the debtor. A PIA takes the form of a deed and must include specified terms as set out in the Act.

The controlling trustee immediately takes control of the debtor’s property and undertakes certain investigations into the affairs of the debtor. In addition, the controlling trustee is required to issue a report to creditors detailing the results of his or her investigations. This report is also required to contain a statement as to whether or not the PIA proposal is in the best interests of creditors.

The meeting to consider the debtor’s proposal must be held not more than 25 working days after the appointment or 30 working days if the appointment was made in December. At the meeting, creditors may resolve by special resolution that the debtor be required to execute a PIA. Under the Act, a special resolution requires 50% in number and 75% in value of creditors present at the meeting voting in favour of the motion. If the proposal for the PIA is not accepted by creditors, then the most common outcome is for creditors to pass two special resolutions: one that the debtor presents a debtor’s petition within seven days, and the other that the debtor’s property be longer subject to control.

In the event that the proposal is accepted by creditors, then the deed must be executed by the debtor and the controlling trustee within 21 days from the day on which the special resolution is passed. Once all the terms of the deed are satisfied, the PIA is terminated. The Act also provides for the termination of the PIA if the debtor defaults on its terms. Alternatively the PIA may be varied. In addition and in specific circumstances, the court may also set aside a PIA and make such orders as it sees fit.

The effect on the debtor

Obviously, on signing a section 188 authority, the debtor will lose control of his property. Control of property that is excluded under the PIA will revert to the debtor on execution of the PIA. In addition and pursuant to subsection 206B(4) of the Corporations Act, a person is disqualified from acting as a director of a corporation if that person has entered into a PIA and the terms of the agreement have not been fully satisfied.

The effect on creditors

The effect of appointing a controlling trustee is that creditors are unable to commence or continue any further action for the recovery of their debts from the debtor until the outcome of a subsequent meeting of creditors is known. The rights of a secured creditor remain intact.

Once the PIA has been signed, creditors, whether present at the meeting or not, are bound by the terms of the PIA and cannot take any action to recover their debts outside the PIA.

Commentary

Unfortunately, entering into a PIA will not be an appropriate alternative for all debtors, especially those with no resources (or access to limited resources) and relatively nominal debt exposure. The main reason for this is that the cost of proposing an arrangement under Part X of the Act can be prohibitive. In this regard, the controlling trustee is obligated to carry out the tasks detailed earlier herein and will incur significant time charge in doing so. As there is no guarantee that the proposal will be accepted by creditors, the prospective controlling trustee will normally seek a cash advance (or some other form of security) to meet his estimated costs in acting in that role. Furthermore, the debtor will need to fund the cost of preparing a formal deed setting out the provisions of the arrangement.

In considering whether or not to put a proposal to his or her creditors, a debtor should also take into account the likelihood of the proposal being accepted, bearing in mind that under the Act a special resolution is required being 50% in number and 75% in value of creditors voting on the motion. From experience, we have found that some creditors will vote against a proposal on the basis of policy, notwithstanding the commerciality of the proposal.

Nevertheless, entering into a PIA does have its advantages, some of which are summarised hereunder:

The debtor avoids the stigma of bankruptcy;
A PIA provides for the flexible administration of the debtor’s affairs including the opportunity to carry on business, which is difficult for an undischarged bankrupt;
The execution of a PIA avoids court process;
The return to creditors under the PIA is invariably greater than that if the debtor was made bankrupt;
Subject to the terms of the PIA, there is no requirement to contribute after-acquired property or income;
The PIA will normally terminate within the short to medium term.

Part IX – Debt agreements

Part IX of the Act provides another alternative to bankruptcy by providing debtors who have a relatively low income, minimal assets and low debt levels with an inexpensive mechanism to reach a binding arrangement with their creditors to release them from their debts. This part of the Act is only available to be utilised by those debtors who have:

not, within the previous ten years, been bankrupt, a party to a debt agreement or given an authority under section 188 of the Act;
unsecured debts that are below the specified threshold amount;
property, which would be divisible among creditors in a bankruptcy, that is below the threshold amount;
after tax income that is below the adjusted threshold amount in the year beginning at the proposal time.

The current threshold amounts are set out in the table below.

Unsecured debts	$92,037.40
Property	$92,037.40
After Tax Income	$69,028.05

The process

To initiate a debt agreement, a debtor must give the Official Receiver a proposal for a binding agreement between the debtor and his or her creditors. Any such proposal must be in the approved form and identify the property to be dealt with under the agreement; specify how it is to be dealt with; and authorise the Official Receiver, a registered trustee, or another person, to deal with the property as specified.

The proposal must be accompanied by a statement of the debtor’s affairs. If the proposal is accepted by the Official Receiver, the Official Receiver must write to creditors asking them whether the proposal should be accepted. The proposal is accepted if the majority in value of creditors who reply state that the proposal should be accepted.

The debt agreement ends when all the obligations that it created have been discharged. At that time the debtor is released from all debts that would be provable in a bankruptcy. This release from debts will not occur if the debt agreement is terminated by the debtor, creditors or the court, or if the debt agreement is declared void by the court. The Act also provides a mechanism to vary a debt agreement.

The effect on creditors

All creditors with provable debts are bound by the debt agreement, even those who voted against the proposal. While the debt agreement is in force, creditors cannot take or continue action against the debtor for recovery of their debts. A debt agreement does not affect the rights of a secured creditor to realise or otherwise deal with the creditor’s security.

Commentary

Readers requiring further information about the administration of debt agreements should access the web site maintained by the Australian Financial Security Authority at https://www.afsa.gov.au/.

Informal arrangement

An informal arrangement is simply an arrangement not made under the Act that a debtor makes with his or her creditors to settle his or her debts. Normally an adviser such as the debtor’s accountant would firstly write to creditors summarising the debtor’s financial position and putting forward a settlement proposal. Follow up contact by either the debtor or the advisor is recommended, with the aim of addressing any concerns creditors may have and reinforcing the benefits of the proposal. Preferably any agreement reached with creditors should be documented by way of deed.

Informal arrangements are more likely to proceed in circumstances where there are a small number of creditors involved and some goodwill still exists between the parties. The difficulty is that just one hostile creditor can make the arrangement unworkable.

When the grim reaper comes knocking

1 January 2010 by By Lawyers

By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

First published on the website, www.obp.com.au

‘There is always death and taxes: however, death doesn’t get worse every year’– author unknown

Based upon our recent experiences, it would appear that the Australian Taxation Office (‘ATO’) is becoming much more aggressive in relation to the collection of overdue PAYG and taxes. More particularly, we have:

noticed an increase in the number of winding up applications filed by or on behalf of the ATO.
been provided with copies of notices issued by mercantile agents engaged by the ATO to recover debts that had only recently become overdue.
met with directors who have been served with a Director Penalty Notice (‘DPN’) pursuant to Section 222AOE of the Income Tax Assessment Act.

This aggressive attitude adopted by the ATO will in all probability impact adversely on thousands of Australian businesses already suffering from poor cash flow.

According to an article which appeared in The Australian newspaper on 20 May 2010, credit reporting agency, Dunn & Bradstreet, has reportedly downgraded the risk profiles of almost 80,000 companies after watching payment terms deteriorate in the first quarter of this year. The expectation is that many of those businesses are now more likely to experience financial distress over the next year.

In light of the foregoing, we thought it timely to comment upon the weapons in the ATO’s arsenal for the recovery of taxation liabilities owed by corporate debtors.

Director Penalty Notices

A discourse on DPN’s is outside the scope of this newsletter. Suffice to say that a director in receipt of a DPN has fourteen days from the date of the notice in which to cause the company to undertake one of the following alternative courses of action:

discharge the debt in full, or
enter into an arrangement with the ATO for the payment of the debt, or
appoint an Administrator or Liquidator to the company.

If the director(s) fail to comply with the DPN by not causing the company to undertake one of the alternatives set out above within the specified time period, then each director is liable to pay by way of penalty an amount equal to the unpaid debt.

The DPN is a powerful weapon that should focus the attention of the directors on addressing the problems affecting the financial position of their company. Directors who neglect to deal with a DPN could face personal financial consequences that could be significant. Yet notwithstanding this, we have encountered a number of directors who for a variety of reasons have ignored a DPN whilst others have convinced themselves as to the viability of their businesses and accepted personal liability totally ignoring the advice of their accountants and/or solicitors. We do not monitor what later happens to those that we meet, however in some cases it has been brought to our attention that the outcomes have been disastrous for those concerned.

It is therefore vital that directors maintain a working knowledge of the financial position of the company under their control particularly when it comes to cash flow and the incurring of taxation and other liabilities. The reality is that a company under financial stress will often defer payment of taxation liabilities thus preserving cash for other outgoings considered more vital. This approach may well ease cash flow constraints short term. However, the unpaid taxation liabilities remain and will continue to accrue. In our experience, directors who proactively seek to address the problem in a timely and considered manner are likely to achieve a more satisfactory outcome as compared to those who seek to find a solution under direct pressure from the ATO.

Statutory Demands

Like any creditor, the ATO can issue a Statutory Demand under Section 459E(2)(e) of the Corporations Act (‘the Act’) for payment of a debt within 21 days after service. The debtor company must within the time period specified either pay the debt in full or make an application to the Court to have the demand set aside pursuant to Section 459G of the Act. Alternatively, the debtor company can take pre-emptive action by:

appointing an Administrator. Such an appointment is normally made in circumstances where there is some prospect of a Deed of Company Arrangement (‘DOCA’) being propounded; or
appointing a Liquidator to wind up the affairs of the company.

If no action is taken by the directors in response to the Statutory Demand, then almost certainly the ATO will commence winding up proceedings.

There are many and varied reasons why directors fail to respond to a Statutory Demand. In many instances, the companies in question will have ceased to trade and have no assets in which case the directors will often not care if the company is liquidated. Other companies will be trading and have assets. It is not uncommon for directors of these companies to simply ignore the Statutory Demand by putting it into the ‘to-hard basket’. For others, the Demand may not be received. One reason for that might be the failure by the Company to notify ASIC of a change in the address of its registered office.

Winding Up Proceedings

The serving of a winding up summons will certainly focus the attention of the directors especially if the business conducted by the company is considered to be viable. In these circumstances, the directors will urgently seek advice as to their options under the Act. By that stage, the options are not what they were.

One option might be to attend Court and oppose the application to wind up. However, as the Statutory Demand has expired, there is a presumption of insolvency pursuant to Section 459C(2)(a) of the Act. Therefore, if the directors want to oppose the application, then they will have to satisfy the Court that the company is in fact solvent and that there is some compelling reason why it should not be wound up. Proving solvency can be difficult and the process is likely to be costly.

The directors may consider they have the option of pre-empting the ATO by appointing their own Liquidator. However, pursuant to Section 491 of the Act, a company cannot be wound up voluntarily if an application has been filed to wind up the company in insolvency. Therefore this is not an option available to the directors.

Another option available to the directors is to appoint an Administrator to take charge of the affairs of the company. Whilst technically possible, there is a complication. Pursuant to Section 440A of the Act, the Court is to adjourn an application to wind up a company already in administration, if the Court is satisfied that the continuation of the administration is in the interest of creditors.

The complication arises from the interpretation of the phrase ‘the Court is satisfied’. In our experience, this means that there will need to be evidence put before the Court that will lead the Court to conclude there is a real likelihood that a DOCA will be propounded and that the return under the proposed DOCA will be greater than if the company was wound up. From a practical point of view, it is not always possible to settle upon the likely terms of a DOCA within the time left before the winding up application is heard. In addition, the costs of attending Court and presenting a case can be significant.

In light of the foregoing, it is imperative that Statutory Demands are dealt with within the stipulated time period as this keeps all options open to the debtor company thus giving it the best chance of achieving an optimum outcome.

In the event a company is wound up by order of the Court, then all is not lost. Pursuant to Section 482 of the Act, the Court has the power to stay or terminate the winding up. For such an order to be made, the applicant which is usually the directors, will need to satisfy the Court that the company is solvent and should be allowed back into the market place.

Section 260-5 Notices

Another weapon available to the ATO is the issuance of a notice (commonly referred to as a ‘garnishee’) pursuant to Section 260-5 of the Income Tax Assessment Act which allows the ATO to collect monies from third parties in satisfaction of taxation liabilities due by other entities.

We dealt with this subject matter in a newsletter issued in April 2006, a copy of which can be found on our web site. For the purposes of this newsletter, all we can state is that we have not encountered any such notices over recent times.

Conclusion

The team at O’Brien Palmer is committed to assisting our contacts help their clients understand and navigate the complex realms of insolvency. As part of that commitment, we would be pleased to answer any of your questions regarding our services. We also offer a complimentary and obligation free initial consultation to establish the nature of the problem and the manner in which we can be of service.

Technical guide: Voting at meetings of creditors of insolvent companies

1 January 2010 by By Lawyers

By Russell Cocks, Solicitor

First published in the Law Institute Journal

Introduction

The holding of meetings of creditors is a necessary and important part of the corporate insolvency regime and is the primary mechanism for creditors to exercise their rights in dealing with insolvent companies.

The necessity to hold such meetings arises from the operation of numerous sections contained in Parts 5.3 to 5.6 of the Corporations Act 2001 (‘the Act’). Regulations 5.6.11 to 5.6.36A of the Corporations Regulations 2001 govern the meeting process.

This technical guide will address the right of creditors to vote at meetings and summarise the manner in which resolutions are carried.

Who is a creditor for voting purposes

The term ‘creditor’ is not defined in the Act. Generally, a ‘creditor’ is taken to mean a person who has a debt or claim against a company that is provable in a winding up. Pursuant to section 553(1) of the Act, debts or claims provable in every winding up means;

‘all debts payable by, and all claims against, the company (present or future, certain or contingent, ascertained or sounding only in damages), being debts or claims the circumstances giving rise to which occurred before the relevant date, are admissible to proof against the company’.

For the purposes of voluntary administration, a ‘creditor’ is taken to have the same meaning as set out above: Selim v McGrath[2003] NSWSC 927 at 68.

Section 553(1) of the Act refers to ‘debts’ and ‘claims’. A debt may be defined as a liquidated sum in money which is due from the debtor to the creditor: Rothwells Ltd v Nommack (No 100) Pty Ltd [1990] 2 Qd 85 at 86. The term ‘a liquidated sum’ refers to an agreement between the parties of a precise amount. This is contrasted to a ‘claim’ which is unliquidated which requires the court to determine the amount payable. The classic example of an unliquidated claim is a claim for damages for breach of contract.

Section 553(1) also refers to future and contingent debts or claims. An often used definition of ‘contingent creditor’ is a person towards whom, under an existing obligation, the company may or will become subject to a present liability upon the happening of some future event or at some future date: Re William Hockley [1962] 1 WLR 555.

The importance of these words lies in their insistence that there must be an existing obligation and that out of that obligation, a liability on the part of the company to pay a sum of money will arise in a future event, whether it be an event that must happen or only an event that may happen: Re William Hockley [1962] 1 WLR 555.

‘A future claim is distinguishable from a contingent claim in that, while both are foundered on an obligation existing as at the commencement date of the winding up, a future claim will arise at some time thereafter while a contingent claim may arise. A typical example of a future claim is a claim for rent that will become due under a lease which is in existence at the commencement of the winding up’: Community Development Pty Limited v Engwirda Construction Company [1966] (120 CLR 455 at 459).

Notwithstanding the broad meaning of ‘creditor’, there are certain debts that are not provable in a winding up. These include debts that are court imposed penalties (s 553B of the Act) and debts that are not legally enforceable such as debts arising from illegal transactions, statute barred debts and court imposed penalties.

Creditors who may vote

Pursuant to regulation 5.6.23(1), a person is not entitled to vote as a creditor at a meeting of creditors unless his or her debt or claim has been admitted wholly or in part by the administrator or liquidator, or he or she has lodged with the chairperson of the meeting particulars of his or her debt or claim, or if required, a formal proof of debt.

Regulation 5.6.23(2) states that:

a creditor must not vote in respect of:

an unliquidated debt; or
a contingent debt; or
an unliquidated or a contingent claim; or
a debt the value of which is not established,

unless a just estimate of its value has been made.

This regulation is consistent with section 554A(2) of the Act which states that where the liquidator admits a debt or claim as at the relevant date that does not bear a certain value, he or she must either make an estimate of the value of the debt or claim, or refer the question of the value of the debt to the court.

In addition, regulation 5.6.24 deals with the debts or claims of creditors holding security. These claims will be discussed later herein. There are further regulations (5.6.23(3) and 5.6.46) dealing with bills of exchange, promissory notes and other negotiable instruments or securities that are outside the scope of this technical guide.

Entitlement of unsecured creditors to vote

Debts and Claims Not Requiring a Just Estimate

The power to either admit or reject a proof of debt or claim for the purposes of voting is given to the chairperson pursuant to regulation 5.6.26(1). Notwithstanding the unqualified reference in that regulation to proofs or claims being admitted or rejected, a chairperson can partially admit a debt or claim: Expile Pty Limited v Jabb’s Excavations Pty Limited and Anor [2004] NSWSC 284 at 37.

Generally speaking, the admitting for voting purposes of claims not requiring a just estimate, is a relatively simple process as most debts or claims, such as those of trade suppliers, can be easily established to the chairperson’s satisfaction. However, the process can become quite complicated, especially when dealing with contingent and unliquidated claims. Meetings involving large numbers of creditors can also present problems as proofs of debt and particulars of debts and claims are often handed up for adjudication immediately before the commencement of the meeting. In such circumstances, there is no time for extensive debate and deliberation on the merits of a claim nor is it possible to undertake extensive enquiry in relation to those claims.

As stated above in regulation 5.6.23(1), a chairperson will admit a creditor to vote in circumstances where that:

creditor’s proof of debt has been admitted, either in part or in full;
creditor has furnished to the chairperson particulars of the debt or claim, whether it be formally by way of a proof of debt not yet admitted or informally by way relevant documentation such as copy statements and invoices.

In relation to those creditors who fall under category (ii) above, a chairperson will be mindful of the significant difference between establishing an entitlement to vote at a meeting and establishing an entitlement to participate in a dividend distribution. This means that in the case of the former, a person need only establish a prima facie entitlement to vote as compared to the latter where there is a much greater burden of proof.

Obviously the adequacy of the particulars provided in support of a debt or claim will vary enormously and depend on the circumstances. In addition, the chairperson may have preexisting knowledge of a debt or claim, gained from access to a company’s books and records or from discussions with directors where such matters as disputed debts or claims are raised. A chairperson when adjudicating for voting purposes upon proofs of debt not yet admitted and particulars of debts or claims, will be looking to ensure:

that the debt or claim was incurred with the company concerned;
that the date the debt or claim was incurred predates the date of administration or liquidation;
that the documentation provided in support of the debt or claim is adequate to prima facie establish the existence of a liability for a debt or claim;
whether there are any claims for set off;
whether the debt or claim is subject to any security;
whether the debt or claim is disputed by the directors.

If the chairperson is in doubt as to whether a proof of debt or claim should be admitted or rejected, then in accordance with regulation 5.6.26(2), he or she must mark the proof of debt or claim as objected to and allow the creditor to vote, subject to the vote being declared invalid if the objection is sustained. However this regulation will only apply where there is actual doubt in respect of whether the proof should be admitted or rejected as compared to doubt as to the value which should be assigned to the claim.

Debts and Claims Requiring a Just Estimate

Debts and claims requiring a just estimate comprise contingent and unliquidated debts and claims and debts the value of which has not been established. Before these creditors can be admitted to vote, regulation 5.6.23(2) requires a just estimate to be made of the debt or claim. These debts or claims should be dealt with as follows:

if an estimate has been made of the debt or claim by the person attending, then the chairperson will need to assess whether or not the estimate is just. If so, the claim should be admitted for voting purposes;
if no estimate has been made or if the chairperson considers the estimate made by the person is not just, then the chairperson, acting reasonably, will need to make the just estimate of value and permit the person to vote for that amount;
if a just estimate cannot be made, then the person should not be allowed to vote (regulations 5.6.23(2));
if the claim cannot be quantified by a just estimate, but it appears that the person is a creditor for at least some amount, then it is appropriate to admit the person for voting purposes at a nominal value of one dollar;
if a just estimate has been made as required by the regulation, but the chairperson remains in doubt as to whether the person should be allowed to vote at all, then the chairperson must mark the proof or claim as objected to in accordance with regulation 5.6.26(2).

Entitlement of secured creditors to vote

In order to vote, a secured creditor must pursuant to regulation 5.6.24(1), estimate in its proof of debt or claim, the value of the security held otherwise the security is surrendered. The creditor is entitled to vote only in respect of the balance, if any, due to the creditor after deducting the estimated value of that security: see regulation 5.6.24(2). If the secured creditor votes in respect of the whole debt or claim, then the creditor is taken to have surrendered the security, unless the court on application, is satisfied that the omission to value the security arose from inadvertence: see regulation 5.6.24(3).

Importantly, regulation 5.6.24(4) states that regulation 5.6.24 does not apply to meetings of creditors convened under Part 5.3A of the Act dealing with voluntary administration, or meetings held under a deed of company arrangement.

Two interesting questions arise, namely:

Can a secured creditor vote in a winding up without surrendering its security notwithstanding the provision of regulation 5.6.24(1)?

The answer to the question is yes but only if voting is on the voices rather than a poll, the reason being that voting on the voices or by a show of hands does not involve voting on the whole of the debt. This is because when a vote is taken on the voices or by a show of hands, each creditor who votes has one vote only and thus the outcome is determined by numbers, not the value of debt: Selim v McGrath[2003] NSWSC 927 at 81. That being said, if the secured creditor uses the full value of its debt when voting by way of a poll, then it has surrendered its security in doing so.

Does a chairperson have a duty to inform a secured creditor when voting of its actions or omissions?

We consider that a chairperson has no such duty to inform. However, a chairperson, acting reasonably when determining the voting entitlements of a secured creditor, would in the ordinary course look at the value, if any, that had been attributed to the security. If no value was attributed to the security, then it is likely that a discussion would ensue and in our opinion that discussion would eventually lead to a prudent chairperson, informing the creditor of the consequences of its actions.

Voting on resolutions

Outcome of voting on the voices

Pursuant to regulation 5.6.19(1), a resolution put to the vote of a meeting of creditors must be decided on the voices unless a poll is demanded, before or on the declaration of the result of the voices by:

the chairperson; or
at least 2 persons present in person, by proxy or by attorney and entitled to vote at the meeting; or
by a person present in person, by proxy or by attorney and representing not less than 10% of the total voting rights of all the persons entitled to vote at the meeting.

Unless a poll is demanded, the chairperson must declare that a resolution has been carried, or carried unanimously, or carried by a particular majority, or lost: see regulation 5.6.19(2). A declaration is conclusive evidence of the result to which it refers, without proof of the number or proportion of the votes recorded in favour of or against the resolution, unless a poll is demanded: see regulation 5.6.19(3).

Notwithstanding these regulations, many chairpersons will ask creditors to vote by raising their hand as this gives a more accurate counting of the vote.

If a poll is demanded, then regulation 5.6.20 states that the chairperson is to determine the manner in which it is to be taken and the time at which it is to be taken.

Outcome of voting by way of poll

If a poll has been demanded, then pursuant to regulation 5.6.21(2), a resolution is carried if:

a majority of the creditors voting (whether in person, by attorney or by proxy) vote in favour of the resolution; and
the value of the debts owed by the corporation to those voting in favour of the resolution is more than half the total debts owed to all the creditors voting (whether in person, by proxy or by attorney).

Conversely, regulation 5.6.21(3) states that a resolution is not carried if:

a majority of creditors voting (whether in person, by proxy or by attorney) vote against the resolution; and
the value of the debts owed by the corporation to those voting against the resolution is more than half the total debts owed to all creditors voting (whether in person, by proxy or by attorney).

To put it more simply, for a motion to be carried, there will need to be a majority in number and value of creditors voting for the motion. For a motion to be lost, there will need to be a majority in number and value voting against the motion. It will therefore be obvious that it is possible for a motion to be neither carried nor lost. This outcome is provided for in regulation 5.6.21(4) which states that, if no result is reached under sub-regulations (2) or (3), then the chairperson may either;

exercise a casting vote in favour of the resolution, in which case the resolution is carried; or
exercise a casting vote against the resolution, in which case the resolution is not carried; or
not exercise a casting vote, in which case the resolution is not carried.

Exercising the chairperson’s casting vote

The chairperson has been given the power to exercise a casting vote in order to quickly resolve a deadlock. It is most often used in the context of voluntary administration where the future of a company is to be determined. The chairperson’s use of the casting vote has been examined extensively by the courts. The main legal principles that govern the use of that vote are summarised here under: see Provident Capital Limited v Kelso Building Supplies Pty Ltd (In Liquidation)(Receiver & Manager Appointed) [2008] FCA 868 at 19.

The chairperson should exercise the casting vote to resolve a deadlock unless there is some good reason to refrain from doing so. Failure to exercise the casting vote for some irrational or irrelevant reason is inconsistent with the person’s duty;
The chairperson must weigh up all relevant factors and act honestly and according to what he or she believes to be in the best interests of those affected by the vote, and for a proper purpose;
The exercise of the casting vote is most appropriate in circumstances where either creditors with a majority in value have such an overwhelming interest that it is inappropriate to allow a majority in number who do not have the same monetary interest to carry the day, or vice versa;
However, there is no presumption in favour of the majority in value, although any large disproportion between the values of the debts of the numerical minority and the numerical majority will be a factor to be taken into account. In favouring the numerical minority, the chairperson will need to be satisfied that he or she is acting in a manner consistent with (ii) above.

By way of general comment:

1. When determining the future of a company under administration, the chairperson would normally exercise a casting vote consistent with the opinion expressed in his or her section 439A report.
2. Before exercising a casting vote, the chairperson must declare his or her rational for exercising the vote (whether for or against a resolution) or choosing not to exercise the vote. The reasons are to be minuted: see Code of Professional Practice for Insolvency Practitioners issued by the Australian Restructuring Insolvency & Turnaround Association 2015 at 24.7.4 page 187.
3. Exercising a casting vote in favour of a resolution approving remuneration is generally unacceptable and considered to be a breach of fiduciary duty: see Code of Professional Practice for Insolvency Practitioners issued by the Australian Restructuring Insolvency & Turnaround Association 2015 at Pg 188.
4. Exercising a casting vote in favour of a resolution to remain in office is generally acceptable if it can be shown to be in the interest of the administration of the company: see Krejci as liquidator of Eaton Electrical Services [2006] NSWSC 782.