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Insolvency – Bankruptcy of individuals – FED

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Author review

A full review of the By Lawyers Insolvency – Bankruptcy of Individuals guide has been conducted. The review ensures that all content is in line with current law and practice.

This review was conducted by our highly experienced author, Michael Murray.

Updates and enhancements include:

  • New commentary on recent law changes to debt agreements;
  • New commentary on the Federal Court and Federal Circuit Court processes for creditor’s petitions, applications to set aside bankruptcy notices and examinations; and
  • New commentary and matter plan additions because of new online processes for voluntary bankruptcy.

Keep up to date with By Lawyers

This review of our Insolvency – Bankruptcy of Individuals guide is part of By Lawyers commitment to regular updating and enhancement of our publications. By Lawyers always keeps you up to date so you can enjoy practice more.

Insolvency To Do lists – FED

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The By Lawyers Bankruptcy and Liquidation guides have been updated with the inclusion of four Insolvency To do lists.

These new precedents provide practical guidance for practitioners as they progress through a matter.

The To Do lists provide helpful prompts for each important step to be taken in a matter when acting for either the creditor or the debtor in both personal and corporate insolvency matters, including:

  • Liquidation;
  • Winding up;
  • Deeds of company arrangement;
  • Debt agreements;
  • Personal insolvency agreements; and
  • Bankruptcy proceedings.

The new To Do lists can be found in folder A. Getting the Matter Underway in the By Lawyers Bankruptcy and Insolvency guides and will assist practitioners in safely and efficiently managing their matters.

Insolvency – personal bankruptcy and corporate insolvency

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This publication has been updated as the result of an extensive author review, including new content discussing the recent changes introduced by the Insolvency Law Reform Act 2016.
For corporate insolvency up to date case law examples have been included.
Enhanced content on how bankruptcy proceedings are regulated in Australia and the role of creditors.

Bankruptcy and Liquidation

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Bankruptcy and Liquidation

NOVEMBER 
  • Further Information – added more links
  • Costs Agreements – reference to interstate costs laws added and updated interest clause
OCTOBER
  • New article – Trading whilst insolvent
  • Costs Agreements
    • Disputes section improved, fields for client and firm details added, trust account details added, solicitor’s lien added, execution clauses for individuals and corporations added and general formatting
    • VIC/NSW – Included reference to time limit for bringing costs assessment, total estimate of legal costs section with provision for variables, and authority to receive money into trust.
    • WA – Added clause on scale fees.
AUGUST
  • Costs Agreements added for Tasmania and Northern Territory.
APRIL
  • File Cover Sheets for all publications have been completely re-formatted for a better look.
FEBRUARY
  • Making life a little easier for practitioners – look out for Blank Deed, Agreement and Execution Clauses folder in the matter plan at the end of each Getting the Matter Underway.

Practical Warning Signs of Insolvency for Small Business

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imran_kamal-insolvency_new_zealand-2Introduction

This article, which is designed to be used as a resource by business owners, directors, accountants and financial advisors, sets out some of the warning signs of insolvency that can be observed by ordinary business people on a day to day basis, as well as outlining the serious consequences for business owners who fail to recognise and act on those warning signs.

The current economic climate is causing many businesses to experience cash flow pressures, whether it be from reduced revenue or debtors failing to pay within trade terms. In these times, monitoring cash flow is of paramount importance to the survival of a business. Failure to ensure adequate working capital may ultimately result in liquidation or bankruptcy.

The warning signs of insolvency, as set out in this newsletter, need to be recognised and addressed in a timely manner. By obtaining professional and competent advice from solicitors, accountants and advisors, more positive outcomes can be generated for all stakeholders than might otherwise be available should business owners and directors remain in denial of the issues facing their businesses. It is important that early action is taken in order to prevent the negative consequences of business failure impacting on directors and their families.

Defining insolvency

Section 95A of the Corporations Act 2001 states that;

  • ‘A person is solvent if, and only if, the person is able to pay all the persons’ debts, as and when they become due and payable.’ AND
  • ‘A person who is not solvent, is insolvent.’

The same definition is set out in subsection 5(2) and 5(3) of the Bankruptcy Act 1966.

The solvency test imposed by law is a cash flow test, rather than a balance sheet test. Assessing solvency is not as simple as the above definition implies. At the simplest level, solvency is assessed by comparing the available current assets to the extent of liabilities that are due and payable. This is the first step when considering a ‘cash-flow test’ of solvency. Only those assets that can be readily converted into cash, such as debtors or stock, are taken into account as an available resource. Similarly, only amounts that are currently due and payable are to be considered.

However, it is necessary to look at the entirety of a company’s circumstances, rather than focusing on any one factor. Many other factors need to be taken into account, such as the ability of the business to realise assets, utilise credit resources or refinance existing debt.

Warning signs of insolvency

Being aware of the warning signs of insolvency allows directors and business owners to address those issues which may be impacting on the viability of their businesses, and to seek appropriate advice in a timely manner. In our experience, the earlier that action is taken, the better the outcome. As the solvency of a business deteriorates, three distinct phases of warning signs can be readily identified;

  • Early Warning Signs which, if recognised and acted upon, allow for the best chances of a business being able to resolve those issues threatening its ongoing viability.
  • Substantive Warning Signs indicate that a business has serious cash flow issues which need to be addressed immediately.
  • Critical Warnings Signs indicate that the winding up of the business is imminent and formal insolvency solutions need to be considered.

Set out below are the warning signs referred to above.

Early warning signs

These signs are commonly displayed by businesses as they begin experiencing financial difficulties. These early warning signs include:

  • An occasional inability to meet suppliers’ debts within trade terms resulting in increased dialogue with suppliers.
  • Using cash reserves, such as funds set aside for GST, PAYG or superannuation, to cover temporary cash shortages.
  • Reduction in discretionary spending such as stationery, maintenance or staff amenities in order to maintain profitability.
  • Increased use of personal credit cards to pay business expenses.
  • Deteriorating relationship with the bank as it starts to monitor a business more closely.
  • Inability to obtain mainstream finance as the banks have identified an increased risk of insolvency.
  • Increased level of worry about a business’ financial circumstances.
  • Accumulated trading losses eroding a business’ working capital.
  • Non-collection of debtors leading to temporary cash flow shortages.

It is worth noting that there may be no cause for alarm if it is considered that the problems are temporary in nature, and if steps are being taken to address issues if needed.

Substantive warning signs

As the financial circumstances of a business further deteriorate, the indicia of insolvency become more obvious, and begin to have an increasingly detrimental impact on the business. These substantive warning signs are:

  • An inability to obtain finance from alternate/bridging financiers.
  • Suppliers placing customers on stop supply or COD terms and/or seek to reduce the credit limit on trade accounts.
  • An inability to avoid making payments outside of trade terms, having dishonoured payments, issuing post-dated cheques or making round dollar payments in response to specific demands for payment from a supplier.
  • Requirement to negotiate formal payment plans in order to secure ongoing supply or to prevent legal enforcement commencing.
  • The inability to pay superannuation on time.
  • Reduction in staff numbers to save costs as the business cannot fund itself.
  • Choosing to ignore communications with creditors generally.
  • Staff members or internal financial controllers expressing concerns about a business.
  • Inability to prepare timely and accurate financial information, and a lack of records generally.
  • Increased level of worry about a business resulting in family or marital issues.
  • Denial of, or avoidance of dealing with, the financial difficulties of the business.

If a number of these signs are identified, then it is likely that immediate action is warranted to ensure the survival of the business.

Critical warning signs

When the financial position of a business becomes sufficiently impaired, creditors will look to enforce the amounts due by that business. Critical signs of insolvency indicate that creditors will no longer wait for the circumstances of a business to improve and will generally initiate formal recovery action in order to obtain payment. These critical warning signs include:

  • Legal demands for payment from creditor’s solicitors.
  • Commencement of court action to recover amounts owed by a business.
  • Writ’s for possession of property or garnishee notices being issued against a business.
  • Creditor’s Statutory Demands or Bankruptcy Notices being issued against a business.
  • Director Penalty Notices being issued by the Australian Taxation Office (‘ATO’) or the Office of State Revenue (‘OSR’).
  • Repossession of business assets by secured creditors.
  • Winding Up proceedings or Creditor’s Petitions being filed against the business.

These actions by creditors usually sound the death knell for a business, due to the severity of the impact they have on the operations of the business.

Consequences of insolvency

Sole traders are personally liable for the debts of their businesses and may be made bankrupt as a result of their failure to satisfy outstanding liabilities. Directors of insolvent companies risk personal liability through a range of exposures such as director penalty notices from the ATO or OSR, or through claims by a liquidator for trading whilst insolvent. Other issues may arise such as the calling up of debit loan accounts, or the triggering of liabilities under personal guarantees provided to third parties. Directors may also be held liable for breaches of their duties, particularly in respect of their conduct at a time when the company was insolvent. Both civil and criminal sanctions can be imposed against directors for breaches of duties.

O’Brien Palmer has previously issued articles which are available on the O’Brien Palmer website in which the consequences of insolvency for directors are explored, particularly in relation to;

The consequences of the foregoing can be quite serious, and as such it is recommended that where warning signs of insolvency have been identified, then directors should seek immediate professional and experienced advice.

Conclusion – the need for timely action

The warning signs set out above are not exhaustive, and not all of them will necessarily be present in an insolvent business. A business may also exhibit multiple warning signs and not necessarily be insolvent. However, a business that transitions from showing preliminary warning signs, to numerous substantive warning signs, is more than likely insolvent, or will be in the very near future. A business that exhibits any critical warning signs is most likely already insolvent, and has in all probability been so for some time.

Business owners and directors should be concerned when a business begins to show early signs of insolvency. However, as noted earlier, there may be no cause for alarm if the issues are considered to be under control. Pre-emptive action usually results in a broader array of options remaining available to the business than in circumstances where the finances of the business have been neglected.

Directors and business owners should remain cognisant of the warning signs of insolvency, and seek appropriate advice as soon as any of the warning signs are identified. A solvency checklist is available here on the O’Brien Palmer website as an additional resource available to be used when undertaking such assessments.

Saviours or Scavengers

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shutterstock_130099715In recent years, an industry has developed around the perceived needs of company directors and individuals to receive commercial advice prior to the appointment of an administrator, liquidator or bankruptcy trustee. Such advice is sought in the expectation that it will increase the likelihood of achieving positive personal outcomes. Commonly referred to as debt advisory, pre-insolvency advisory or business advisory, the development of this industry has encroached upon an area previously the domain of solicitors, accountants and financial advisors.

Insolvency professionals are now unable to provide advice in this area if they want to subsequently act in a formal capacity. This is as a result of the duties imposed upon them pursuant to the provisions of the Corporations Act 2001, the Bankruptcy Act 1966 and the Code of Professional Practice developed by the Australian Restructuring Insolvency & Turnaround Association (‘ARITA’); in particular the independence requirements and the duty to act in the best interests of creditors.

Debt advisors, acting as advocates for their clients, provide advice on restructuring company and personal assets with the aim of protecting them from the insolvency process. Proponents of the industry say that it maximises asset value for creditors, motivates ethical behaviour by directors and bankrupts and assists in maintaining the integrity of the insolvency industry.

Critics are more inclined to believe that the industry legitimises fraudulent phoenix activity, reduces the assets which might otherwise be available for creditors, results in vulnerable people being taken advantage of and generally undermines the objectives of the insolvency profession.

(For a review of what differentiates fraudulent from legitimate phoenix activity, creditors are referred to our previous newsletter entitled “Pre-Packs – Do they have a place in Australian insolvency practice?” available on our website.)

Corporate debt advisory

Regardless of your point of view and taking into account the number of people operating in this area, the industry appears to be thriving. Unlike solicitors, accountants and financial advisors, debt advisors are unregulated and often do not have professional qualifications.

At O’Brien Palmer, we have had mixed experiences working with corporate debt advisors.

A number of operators have been highly professional in their approach and have delivered positive outcomes for their clients. There are many debt advisors who practice in a manner which maximises asset value for the benefit of creditors, potentially retains asset value for their clients, simplifies the insolvency process and reduces costs.

The same cannot be said for a number of other advisors. Some operators have spent time working in the insolvency industry and take advantage of the realities of modern insolvency administration, such as the limited scope of investigations conducted in circumstances where a liquidator is unfunded, the role played by creditors who rarely fund the activities of a liquidator or bankruptcy trustee, and the limited resources of the Australian Securities & Investments Commission (‘ASIC’). Although ASIC reviews all corporate insolvency appointments in order to identify individuals advising directors to act illegally, and although insolvency practitioners have powers and duties to deal with fraudulent phoenix activity within the current legal frame work, some debt advisors lead their customers to believe that getting caught is a numbers game, and that the odds are in their favour.

We have observed circumstances where directors have been;

  • advised to transfer assets for undervalue or otherwise engage in potentially fraudulent phoenix activity.
  • encouraged to destroy company books and records.
  • instructed to create security interests in an attempt to defeat creditors.
  • charged excessive fees for the services provided.
  • advised to generally engage in behaviour designed to frustrate an insolvency practitioner in the completion of his or her duties.

In the event that such actions are identified as a result of a practitioners’ investigation, then the practitioner may be required to report the conduct to ASIC, or to take appropriate steps to recover assets for the benefit of creditors.

Personal debt advisory

Personal debt advisors can help people manage their debt levels and to avoid formal insolvency solutions such as bankruptcy. By negotiating with individual creditors and with access to alternate sources of finance, personal debt advisors can help people manage their debt levels whilst aiming to avoid formal insolvency. Importantly, they are also helping individuals free up personal capital to assist with the funding of their businesses.

Where formal appointments can’t be avoided, debt advisors have assisted debtors to prepare themselves for the effects of the bankruptcy, and have assisted with the subsequent formulation of a proposal to be put to creditors in order to compromise their debts and to have their bankruptcy annulled.

That said, personal debt advisors are not immune from criticism. We recently became aware of a case where a personal debt advisor claimed fees in excess of $7,000 to open a file and form the view that the only option available to his client was to declare himself bankrupt. Others have paid high fees to advisors who have done nothing more than to process hardship applications with their banks, and then received no further assistance in rectifying their personal financial situation. Unless managed carefully, the engagement of personal debt advisors may merely delay the inevitable, and can make the situation worse.

Selecting a debt advisor

Separating the sales pitch from the substance can be difficult for individuals, especially when facing extreme financial stress. In corporate matters, it is common for highly competitive debt advisors with access to the court lists to make contact with directors before they themselves are aware that an application to wind up their company has been filed, and then use high pressure tactics to ensure directors engage their services.

This occurs not withstanding that the debt advisors are usually unqualified to give legal advice in connection with winding up proceedings and in circumstances where engaging a lawyer will come at an additional cost to the company or its director.

Choosing the right advisor is extremely difficult in such a new and unregulated industry, and the consequences of getting it wrong can be calamitous. If you are aware that a client is in contact with a debt advisor, then we recommend that you advise your client to proceed cautiously.

Specifically, in assessing the services offered by debt advisors, potential clients are encouraged, wherever possible, to;

  • seek advice from multiple sources, including accountants and solicitors who are required to act in the best interest of their clients.
  • be cautious of high pressure sales tactics and advisors who claim to be experts.
  • not be pressured into making an immediate engagement or committing on the spot.
  • be wary of promises which seem too good to be true, as they usually are.
  • enquire as to the background and qualifications of the advisor, and to ensure that the advice provided is impartial and not skewed by the benefits accruing to the advisor for work referred.
  • be realistic about the work to be completed by the advisor, as some advisors will structure a financial solution in order to maximise their fee.
  • negotiate payments which are directly related to positive outcomes.
  • avoid open ended engagements, and restrict engagements to specific tasks.
  • check all written agreements closely and carefully, and have them reviewed by a solicitor.

Conclusion

At O’Brien Palmer, we have worked successfully with some highly professional debt advisors. If you feel unable to advise your clients in relation to pre insolvency matters, then we can recommend a number of operators with whom we have had successful dealings, or we can provide you with some general advice on specific insolvency related topics.

We do not accept commissions for referrals, nor do we pay commissions for engagements, so you can be assured of the impartiality of our recommendation. We encourage individuals faced with financial pressure to work collaboratively with their accountants, solicitors and if appropriate, with reputable debt advisors.

We also encourage such individuals to contact us at O’Brien Palmer for an obligation free assessment of your circumstances and the options which remain available.

By O’Brien Palmer

Insolvency and Business Advisory

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

2015

Fair Entitlements Guarantee Rides to the Rescue

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Introduction

Owners of insolvent or potentially insolvent businesses regularly express concern about the effect liquidation or bankruptcy will have upon their employees, especially if insufficient assets are available to pay entitlements. As a result, they often delay taking the necessary action to close a loss making business in the expectation they may be able to either improve their position or trade out of their difficulties. Invariably, this only increases the shortfall to creditors and in the case of company directors, exposes them to potential liability for insolvent trading.

Fair entitlements scheme

Time to call in the cavalry! The Federal Government provides a limited safety net for employee entitlements via the Fair Entitlements Guarantee, which is a legislative scheme administered by the Department of Employment under the Fair Entitlements Guarantee Act 2012. The catch is that the employing entity must either be a company in liquidation or a person who is bankrupt. This article will concentrate on the corporate aspects, as that is where most claims arise. The Fair Entitlements Guarantee scheme thus forms part of the insolvency regime in respect of which insolvency practitioners play a key role. Typically, the Department of Employment will advance funds in respect of certain entitlements to a liquidator, which are in turn paid to employees, net of tax. The Department of Employment then makes a claim in the liquidation equal to the amount advanced.

Who is eligible?

Eligibility

The Fair Entitlements Guarantee may apply to a person if their employer enters liquidation or bankruptcy on or after 5 December 2012.

Prior to that date, the General Employee Entitlements and Redundancy Scheme applied. The Fair Entitlements Guarantee does not apply to companies that have a controller or receiver and manager appointed (although such a company could also be in liquidation at the same time and therefore qualify) or those currently in voluntary administration, (although if it is subsequently placed into liquidation, it then qualifies). Subject to some exclusions, employees will be eligible if they meet the following conditions:

  • Employment with the relevant employer has ended and the employer has entered liquidation or bankruptcy on or after 5 December 2012.
  • The end of employment;
  • was due to the insolvency of the employer, or
  • occurred less than 6 months before the appointment of an insolvency practitioner to the employer, or
  • occurred on or after the appointment of an insolvency practitioner to the employer.
    • They are owed eligible employment entitlements and have taken reasonable steps to prove those debts in the winding up or bankruptcy
    • They are an Australian citizen or, under the Migration Act 1958, the holder of a permanent visa or special category visa.
    • They have made an effective claim that is eligible for an advance.

Exclusions

Contractors and sub-contractors, although contract outworkers in the textile, clothing and footwear industry may be covered under a special scheme for that industry.

  • Employees who are excluded employees within the meaning of section 556 of the Corporations Act, that is, an employee who has been a director or who is a spouse or relative of a person who has been a director at any time in the period of 12 months prior to the date of insolvency, cannot be paid unpaid wages exceeding $2,000 or annual leave, long service leave or retrenchment payments exceeding $1,500.
  • Employees who are relatives (as defined under the Corporations Act) of a bankrupt or a spouse or de-facto partner of a bankrupt at any time within the 12 months ending on the date of the bankruptcy.
  • Employees who were initially engaged as a contractor within six months ending at the earlier of either the termination of employment or the appointment of an insolvency practitioner.

Eligible entitlements

Entitlements

The Fair Entitlements Guarantee Act covers the following employee entitlements:

  • Wages – up to 13 weeks of unpaid wages ending at the earlier of the following times:
  • the time that employment ended,
  • the first time an insolvency practitioner had power (however expressed) to control or manage the former employer.
    • Annual leave.
    • Long service leave.
    • Payment in lieu of notice – maximum of five weeks.
    • Redundancy pay – maximum of four weeks per full year of service and pro-rata for less than a full year of service, if the governing instrument provides such an entitlement.

The amount of assistance for which an employee may be eligible is based upon the terms and conditions of the ‘governing instrument’, which means a written law, an award determination or order recorded in writing, a written instrument or an agreement (for example, industrial award, collective agreement or contract of employment).

The Fair Entitlements Guarantee Act interacts with the Fair Work Act in some areas, including the National Employment Standards, where contracts may be silent on the issue of redundancy. In this regard, the Fair Work Act specifies which employees are not entitled to redundancy, in particular the small business exemption which applies to businesses which employ less than 15 employees. However, in calculating the number of employees, the grouping provisions of the Fair Work Act apply, and the employees of a related entity may be taken into account.

For the purpose of calculating the amount of any advance, employment entitlements are capped by the Fair Entitlements Guarantee Act maximum weekly wage which is currently $2,451.00, subject to indexation. If an employee earned more than the Fair Entitlements Guarantee maximum weekly wage, the Department of Employment will calculate the entitlements based on the Fair Entitlements Guarantee maximum weekly wage at the time when employment ended.

Excluded entitlements

Excluded entitlements under the Fair Entitlements Guarantee Act include superannuation, discretionary payments such as bonuses, expense reimbursements, travel and relocation expenses and amounts that are not payable on an ongoing basis.

Transfer of employment to new employer

Employees will not be eligible to claim under the Fair Entitlements Guarantee Act for payment in lieu of notice and redundancy if the business of the former employer is transferred to a new employer and, within 14 days of the end of employment, the new employer makes an offer of employment:

  • to do work that is the same, or substantially the same, as the work done for the former employer; and
  • on terms and conditions substantially similar to, and considered on an overall basis, no less favourable than those under which the employee was employed immediately before termination.

The more cynical readers may perceive this is an anti- phoenix measure to limit exploitation of the Fair Entitlements Guarantee scheme. It is noted that under section 596AB of the Corporations Act, it is an offence to enter into agreements or transactions to avoid employee entitlements.

Making a claim

A Liquidator or Trustee in bankruptcy will generally advise employees of their right to make a Fair Entitlements Guarantee claim and will assist in the process by providing details of entitlements if the business records are available and contain sufficient information. Whilst the Fair Entitlements Guarantee Act contains a provision that advances may be denied if the Insolvency Practitioner expects to have sufficient funds to pay entitlements within 112 days of appointment, the practical reality is that given the time taken to realise assets to generate sufficient cash, together with the statutory timetable for payment of a distribution, it is often quicker for employees to receive their entitlements under Fair Entitlements Guarantee.

The current procedure requires employees to submit their claims to Department of Employment, preferably via an online form. The claims are then assessed by Department of Employment and sent to the insolvency practitioner for verification. It should be noted that Fair Entitlements Guarantee advances can be reduced by any amounts owing to the employer.

To make an effective claim, employees must lodge a Fair Entitlements Guarantee claim form and include all mandatory information and documentation. For more information about lodging a Fair Entitlements Guarantee claim form, kindly refer to the How do I apply for FEG assistance fact sheet available on the Fair Entitlements Guarantee website. A claim must also be made:

  • no more than 12 months after the end of employment or the date of the insolvency event (whichever is later); and
  • before the discharge of the former employer’s bankruptcy (if the employer was a bankrupt).

The Department of Employment currently has an objective to process Fair Entitlement Guarantee claims within 16 weeks. Earlier this year, Department of Employment conducted its annual stakeholder survey with insolvency practitioners with a view to improving its administration and processes.

Back to the future

The Fair Entitlements Guarantee Recovery Programme

Back in 2007, the Department of Employment and Workplace Relations, (as it was then known) commenced the Active Creditor Pilot Program, in a bid to partially recoup the increasing costs of the General Employee Entitlements and Redundancy scheme. The Active Creditor Pilot Program was intended to fund liquidator’s recovery actions against directors and others in situations where an insolvency event had resulted in unpaid employee entitlements. A particular focus was the conduct of controllers and receivers and managers who did not properly fulfill their statutory obligations under section 433 of the Corporations Act to pay employee entitlements from floating charge assets before paying the proceeds to their appointor, being the secured creditor. At the time, the annual cost of the General Employee Entitlements and Redundancy scheme was approximately $85 million p.a. The Active Creditor Pilot Program was terminated in 2009.

Fast forward to 2015 and the costs of Fair Entitlements Guarantee scheme have averaged $204.1 million p.a. in the four years to June 2014, whilst recoveries in the same period averaged $23.6 million p.a. The estimated cost of General Employee Entitlements and Redundancy scheme and Fair Entitlements Guarantee scheme for 2012-13 was $304 million. The 2015-2016 Federal Budget included funding of $11.5 million over two years from 1 July 2015 for the Fair Entitlement Guarantee Recovery Programme to enable the Department of Employment to more actively pursue its interests as a creditor for fair entitlements guarantee advances. The Fair Entitlements Guarantee Recovery Programme will provide funding to pursue actions such as unfair preferences or loans, noncommercial transactions and insolvent trading.

The introduction of the Personal Properties Security Act 2009 on 31 January 2012 replaced the concept of the fixed and floating charge with a security interest over all the present and after acquired property of a company. However, section 433 of the Corporations Act and the Personal Property Securities Act still recognise that in some circumstances, employee entitlements have a priority over secured creditors in respect of funds realised from the assets subject to a circulating security interest, those assets for example being inventory, debtors and cash at bank. For many years, secured creditors have sought to create fixed charges over circulating assets, with varying degrees of success. To date, there has yet to be a definitive test case run in Australia on this issue. To pursue such a case would require a very brave liquidator or lawyer with very deep, well- funded pockets and no conflicts of interest.

Conclusion

The Fair Entitlement Guarantee scheme can provide piece of mind and support to businesses and employees in situations where:

  • There are insufficient assets available to meet employee entitlements.
  • Secured creditors claims take priority over employee entitlements.
  • There is likely to be a long time frame to recover sufficient funds to pay entitlements and the Fair Entitlements Guarantee scheme will enable payment of most entitlements in a much shorter time frame.

Bankruptcy and Other Options

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bank

Bankruptcy

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.

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 non-compliance 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 Actby submitting a proposal to creditors;
  • seek an annulment pursuant to section 153A of the Actby 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 Actby 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
2

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 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.

A Bankruptcy and Liquidation publication is available on the By Lawyers website.

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