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Bankruptcy and Other Options

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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
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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.

Trading whilst insolvent

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By O’Brien Palmer

What is insolvent trading

Directors have many duties, one of which is to prevent their company from trading whilst insolvent. Pursuant to s 588G of the Corporations Act 2001 (the Act), a director breaches that duty if they cause the company to incur a debt in circumstances where they knew, or ought to have known, that the company is insolvent, or likely to become insolvent as a result of that transaction. If proven, directors can be charged, fined and/or become personally liable for the debts incurred by the company whilst it was insolvent.

What is solvency

Definitions

Section 95A of the Act states:

  1. A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable.
  2. A person who is not solvent is insolvent.

Unfortunately, the usefulness of these definitions is limited except to the extent that the wording of the legislation recognises cash availability as the primary determination of solvency. For further guidance it is necessary to refer to case law.

Assessing a company’s solvency

The importance of cash flow in determining solvency was articulated by his Honour Dodds-Streeton J in his judgment in the matter of Crema Pty Ltd v Land Mark Property Developments Pty Ltd [2006] VSC 338, where he stated that:

Section 95A of the Act enshrines the cash flow test of insolvency which, in contrast to a balance sheet test, focuses on liquidity and the viability of the business. While an excess of assets over liabilities will satisfy a balance sheet test, if the assets are not readily realisable so as to permit the payment of all debts as they fall due, the company will not be solvent. Conversely, it may be able to pay its debts as they fall due, despite a deficiency of assets.

The assessment of the solvency of a company requires an analysis of the totality of the company’s circumstances, including industry norms and available credit. This firm was involved in an often reported case known as Southern Cross Interiors Pty Ltd (In Liquidation) & Anor v The Deputy Commissioner of Taxation [2001] NSWSC 621. In his judgment, His Honour Palmer J. stated that the following propositions could be drawn from the established authorities:

  1. A company’s solvency is a question of fact to be ascertained from considering its financial position as a whole.
  2. In considering a company’s financial position as a whole, the Court must have regard to relevant commercial realities, such as what resources are available to a company to meet its liabilities as they fall due.
  3. In assessing whether a company’s position as a whole reveals surmountable temporary illiquidity or insurmountable endemic illiquidity, it is proper to have regard to the commercial reality that creditors will not always insist on payment strictly in accordance with their terms of trade but that does not constitute a cash or credit resource available to the company.
  4. The commercial reality that creditors will normally allow some latitude for payment of their debts does not warrant a conclusion that the debts are not payable at the contracted time.
  5. In assessing solvency, the Court acts upon the basis that a contract debt is payable at the time stipulated for payment in the contract.

These propositions, whilst informative, are somewhat broad. A further and useful commentary on solvency was given by his Honour Mandie J in a judgment delivered in the high profile case of ASIC v Plymin & Anor [2003] VSC 123 (otherwise known as the Waterwheel Case). Justice Mandie adopted 14 indicia of insolvency which are now often utilised in assessing the solvency of a company. However, this list is not exhaustive. The Australian Securities & Investments Commission (ASIC) has published a guide on the warning signs of insolvency. You are also referred to a newsletter previously issued by O’Brien Palmer entitled Practical warning signs of insolvency for small business.

Temporary or endemic cash flow insolvency

A company is insolvent where the available resources are insufficient to meet the debts that are due and payable at that specific point in time. These resources do not necessarily have to be assets of the company, which is why the balance sheet can be irrelevant to the assessment of solvency. The ability of a company to draw on available credit resources is also relevant to any determination of solvency.

It is relevant to distinguish between a company that is insolvent and a company that is experiencing temporary cash flow issues. In the judgment of his Honour Jacobs J in the matter of Hymix Concrete Pty Ltd v Garrity (1977) 13 ALR 321, it was acknowledged that:

…a temporary lack of liquidity is to be distinguished from an endemic shortage of working capital where liquidity can only be restored by a successful outcome of business ventures in which the existing working capital has been deployed.

An endemic shortage of working capital will be apparent where the company is utilising credit funds on terms that it cannot comply with or at debt levels beyond that which it can service. It would also be evident in circumstances where a company is otherwise displaying numerous signs of insolvency.

How a liquidator proves insolvency

Steps to prove the date of insolvency

In order to determine the date on which a company is deemed to have become insolvent, an insolvency practitioner will review the available books and records of a company, as well as records obtained from third party sources such as creditors, banks and statutory authorities. In conducting this review, the practitioner is looking for evidence of indicia of insolvency. The key indicia of insolvency include the following:

  1. overdue trade creditors;
  2. overdue taxation liabilities;
  3. recovery action being initiated by creditors;
  4. no access to alternate finance;
  5. Payment of debts by way of instalments.

As a result of this review, it can become apparent that at a certain point in time, sufficient indicia of insolvency are present to justify a conclusion that the company was insolvent at that time.

Section 588E(3) of the Act provides that where the evidence supports a determination that a company became insolvent at a time within 12 months prior the company being wound up, it is presumed that the company was insolvent throughout the period between that time and the date that the company is wound up.

If the company has not maintained adequate books and records in compliance with s 286 of the Act, then a presumption of insolvency arises for the period in which the books and records have not been properly maintained. Section 588E(4) of the Act states that if a company does not keep comprehensive and correct records of its accounts and financial position, or if it does not keep records of a transaction for seven years after its completion, then that company will be presumed to be insolvent during the period to which the records relate.

Not only is the inability to maintain financial records an indicator of insolvency, but failure to maintain proper books and records may render a company legally insolvent from a date which is earlier than it actually became insolvent.

Debts incurred

After a date of insolvency is established, the liquidator will then assess the debts incurred after that date, in order to determine the quantum of the personal liability of a director for trading whilst insolvent.

Claim for trading whilst insolvent

Where it is determined that a company has traded whilst insolvent, then an insolvency practitioner will in the ordinary course report this alleged contravention to ASIC in accordance with either ss 422, 438D or 533 of the Act.

A liquidator appointed may also take steps to seek compensation from the director(s) for the quantum of the debts incurred by the company after it became insolvent. These steps usually involve the issuance of a letter of demand to the director(s) for repayment of a fixed sum of money. The liquidator may also instruct a solicitor to further pursue the claim where the initial demand is ignored or commercial settlement cannot be reached. The liquidator may be required to commence proceedings against the director(s) to seek compensation orders.

In circumstances where there are multiple directors, the liquidator is entitled to recover from whichever of the directors is most commercial to pursue. That director has a right of indemnity against their fellow directors to recover an equitable share of the amount recovered by the liquidator.

Defences available to directors

Directors may have defences to a claim made for insolvent trading. Section 588H of the Act states that a director can claim a defence where he or she:

  1. had reasonable grounds to believe that the company was solvent at the time it incurred the debt, and that it would remain solvent even after incurring the debt;
  2. can prove that the person in charge of providing accurate information concerning the company’s financial status and solvency was performing this task, and led the director to believe that the company was solvent and would remain to be so even after incurring the debt;
  3. had good reasons not to be involved in the management of the company when it incurred the new debt, such as a result of a serious illness;
  4. can prove that they took all reasonable steps to prevent the company from incurring the debt.

Consequences of insolvent trading

A director who has been charged with insolvent trading faces several consequences.

Civil penalties

Company directors may face fines of up to $200,000 in circumstances where their breach was not dishonest.

Criminal penalties

If trading whilst insolvent is proven to be of a dishonest nature, then directors can face criminal convictions for this breach. A criminal charge carries a maximum penalty of $220,000 and five years imprisonment. A person may also be disqualified from managing corporations.

Compensation orders

If a liquidator suspects a person may have breached their duty in preventing the company from trading whilst insolvent, then he or she, a creditor, or ASIC can take action against the director pursuant to s 588M of the Act. A Court may order that the director repay the company to the value of the debts incurred from trading whilst insolvent.

It should be noted that a creditor can only take this action with the permission of the liquidator or leave of the court, and may only pursue the director for the value of its debt.

Holding company liability

Section 588V of the Act provides that a holding company may be liable for the insolvent trading of its subsidiary in circumstances where the directors of the holding company were aware, or should have been aware, of the insolvency of the subsidiary company.

The impact of repayment arrangements on solvency

Smith v Boné, in the matter of ACN 002 864 002 Pty Ltd (in liq) [2015] FCA 319

Background

Mr Barry Boné was the sole company director of Petrolink Pty Ltd (Petrolink). In December 2011, Mr Smith was appointed as liquidator of the company.

The liquidator brought an action against the director seeking compensation for insolvent trading pursuant to s 588G of the Act for the losses suffered by Petrolink’s creditors.

In this dispute, the liquidator claimed that Petrolink was insolvent from 30 June 2009 until the date on which the winding up commenced and that Petrolink continued to trade and incur debt throughout this period. However, the director argued that his company was only insolvent from July 2011.

Relevant to the outcome of the case was the fact that Petrolink had entered into a payment arrangement with the Australian Tax Office (ATO), its main creditor, in order to discharge its outstanding debts.

The director’s defence

The director argued that any reasonable person would have believed that the company was solvent based on the payment arrangement he had established with ATO, which he argued deferred the debts of the company such that they were no longer due and payable. He also stated the company was generating significant revenue throughout the period.

The ruling

His Honour, Gleeson J, found that any reasonable person in the position of the director would have grounds to believe that the company was insolvent and that despite the revenue being generated by the company, its debts remained unpaid. In regard to the payment arrangement, the Court found that the payment arrangements negotiated with the ATO did not have a material effect on the solvency of Petrolink because of the shortness of their duration and the fact that none of them had the effect that Petrolink was not required to pay its outstanding tax liability imminently. The payment arrangements in fact demonstrated that Petrolink was continuing to experience common features of insolvency.

Ultimately, His Honour determined that Petrolink was insolvent from 12 May 2010 and the director was found to be liable to the liquidator for an amount of $669,582.86.

In addition, while the Court did not find that the director had acted or conducted himself dishonestly, it did not exempt him from being held personally liable for insolvent trading. The Court ruled that the director did not seek professional advice about the company’s financial position despite being advised in June 2010 that if Petrolink continued to trade, it may be trading whilst insolvent.

The principle

Directors should be aware that entering into payment arrangements does not provide relief from the debt being due and payable, and may simply be an assistance measure for companies requiring short-term relief. Director’s should be aware that in entering into repayment arrangements with the ATO, they may be providing evidence to a subsequently appointed liquidator that the company was insolvent and that the director was aware of the insolvency. As such, caution should be exercised by directors when entering into repayment arrangements that they only take on repayment commitments that the company can comply with else they risk incurring a personal liability for insolvent trading.

Conclusion

Directors need to be aware of the serious consequences of trading whilst insolvent, and the importance of seeking early professional advice about their company’s status and financial position. Taking the appropriate steps and action is not only a defence to any proceedings, but may be essential to the survival of the company. Where directors are not adequately informed or fail to deal with the potential insolvency of their companies in accordance with their duties as a company director, then they have a greater risk of becoming personally liable for the debts of their companies.

Tip Box

Whilst written for Victoria this article has interest and relevance for practitioners in all states.

Directors beware

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By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

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

The Director Penalty Regime was introduced to give the Australian Taxation Office (ATO) power to make company directors personally liable for certain unpaid company taxation debts. It is imperative that company directors and their advisors understand the regime and its operation, in order that they can take steps to avoid personal liability.

In this newsletter, we discuss the operation of the regime, and most importantly, how director penalties are enforced. We also discuss changes to the regime introduced on 1 July 2012, which allow the ATO to hold a director personally liable even after an administrator or liquidator has been appointed to the company.

Imposition of Director Penalties

A director penalty is imposed on a director where certain company taxation debts remain unpaid at the end of the day on which they become due. A full listing of the taxation debts covered by the regime can be found in section 269-10 of Schedule 1 to the Taxation Administration Act 1953 (Cth), but the most common taxation debts to which the regime applies are PAYG withholding and superannuation guarantee charge. The regime also applies to estimates issued by the ATO in respect of these types of taxation debts.

For example, if a company withholds amounts from employee wages in respect of PAYG, the amounts withheld will become payable at a future date, known as the ‘due day’. If the withheld amounts are not paid to the ATO before the end of the due day, then a director penalty, equal to the amount of the unpaid PAYG is imposed on all directors of the company at the time the debt was incurred. The regime also applies to newly appointed or recently retired directors.

The due day for PAYG is usually the day on which a company’s BAS or IAS lodgement is due, and for superannuation guarantee charge it is one month and 28 days after the end of each financial quarter. Whilst a director penalty is imposed at this time, the ATO is prohibited from enforcing a director penalty until it has issued a Director Penalty Notice.

The director penalty and the corresponding company taxation debt are concurrent liabilities. If a company pays its taxation debt after a director penalty has been imposed under the regime, then the director penalty is also discharged to the same extent, and vice versa. Please note, discharging of a director penalty is different to remittance of a director penalty, which is discussed below.

Enforcement and Remittance of Director Penalties

The ATO must issue a Director Penalty Notice to a director and allow a period of 21 days before it can bring court proceedings against a director for the recovery of a director penalty.

The ATO is required to send a notice to the address of a director noted in the records maintained by the Australian Securities and Investments Commission, whether or not that address is current. The ATO may alternatively send notice to a director at their registered tax agent’s address.

Once a director penalty has been imposed by the ATO, there are 3 ways in which a director can have that penalty remitted, namely:

  1. causing the company to comply with its obligations to pay amounts to the ATO; or
  2. appointing a voluntary administrator to the company; or
  3. having a liquidator appointed to the company.

Directors should note that these remittance provisions are available prior to the issuance of a Director Penalty Notice by the ATO. It is appropriate for directors to consider exercising these options as soon as they become aware of taxation debts remaining unpaid after the due day.

If a valid Director Penalty Notice has been issued, and 21 days has passed since it was issued, the remittance provisions are no longer available to a company director, and either the company or the director must pay the amount due to the ATO.

Lock-Down Director Penalty Notices – The Importance of Reporting

If PAYG or superannuation guarantee charge remains unreported and unpaid for more than 3 months after the due day, a director is unable to have a director penalty remitted by the appointment of an administrator or liquidator. In these circumstances, the ATO must still issue a Director Penalty Notice, known as a Lock-Down Director Penalty Notice, and wait the required 21 days. Once the 21 days have passed, a director who receives a Lock-Down Director Penalty Notice must pay the director penalty, or cause the company to pay the corresponding company taxation debt.

It is important to note that the ATO is able to issue a Lock-Down Director Penalty Notice even after an administrator or liquidator has been appointed to a company, if applicable taxation debts that were not reported to the ATO within 3 months of the due day remain unpaid. The only way to avoid a Lock-Down Director Penalty Notice is to ensure that all company taxation debts are reported to the ATO within 3 months of the due day.

Defences to Director Penalties

In the event that proceedings are commenced against a director, there are only limited defences available to company directors. Those defences are:

  1. illness or incapacity (A director was unable to take part in the management of a company.);
  2. all reasonable steps (All reasonable steps were taken by a director to comply with his or her obligations, or no such steps were available.);
  3. superannuation guarantee charge – reasonably arguable position (A director adopted a reasonably arguable interpretation of superannuation guarantee charge legislation.).

Right of Indemnity and Contribution

A director that has paid a director penalty to the ATO, is entitled to recover that amount from the relevant company, in the same manner that a person can recover amounts paid under a guarantee of a company debt. A director that has paid a director penalty is also entitled to recover amounts from anyone that was also a director at the time the corresponding company taxation debt was incurred, as if all those directors were joint and several guarantors.

PAYG Withholding Non-Compliance Tax

Whilst not technically part of the regime, the PAYG withholding non-compliance tax was introduced with Lock-Down Director Penalty Notices. This new tax allows the ATO to deny a director, or their close associates, tax credits in their personal tax returns, where the PAYG withholding amounts have not been paid to the ATO. If a director has been issued a Director Penalty Notice, then they can also be denied credits on their personal tax return, for the same underlying principle company PAYG debt, in effect causing a director to pay twice at the same time. Of course if such a director does pay both amounts, it would be expected that they would obtain the benefit of the denied credits in the following period.

Garnishee on Directors’ Bank Accounts

Garnishees allow the ATO to compel payment from a third party that holds amounts due to, or on behalf of, a taxpayer that is indebted to the ATO. Once a Director Penalty Notice has been issued, and the 21 day period has expired, the ATO is entitled to seek a garnishee order against any third party that owes money to, or holds money on behalf of, the relevant director, including a director’s personal bank accounts.

Conclusion

The ATO will not hesitate to use the regime, and in particular Lock-Down Director Penalty Notices, as it is the only legislative method by which the ATO can hold a director personally liable for company debts. Directors and their advisors should ensure that timely and accurate financial information is available to facilitate prompt action when a company begins to have difficulty meeting its taxation obligations, or a director risks becoming personally liable.

The introduction of Lock-Down Director Penalty Notices to the regime means that reporting of taxation debts to the ATO is more important than ever. The looming spectre of a LockDown Director Penalty Notice should motivate all company directors to ensure that taxation debts are reported to the ATO on time, regardless of whether they are able to pay the debts being reported. Once the hard deadline of 3 months past the due day has expired, there is nothing a company director can do to avoid personal liability.

Winding up a corporate trustee

by

By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

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

Introduction

Winding up a company that acts as the trustee of a trust is a common occurrence. Many of the underlying principles in liquidating a corporate trustee have long been established. However, the circumstances in which a liquidator has the power to deal with trust property still lack clarity. This has been highlighted in the conflicting decisions of the court that were handed down late last year; the first in the Federal Court of Australia in Kitay, in the matter of South West Kitchens (WA) Pty Ltd [2014] FCA 670, the second in the Supreme Court of New South Wales in the matter of Stansfield DIY Wealth Pty Limited (in liquidation) [2014] NSWSC 1484 (30 October 2014).

South West

The facts

The liquidator of South West sought directions from the court that he had the power to sell trust property pursuant to s 477(2)(c) of the Corporations Act 2001. The application was made in circumstances where there were potentially conflicting authorities as to the power of a liquidator in dealing with trust property. At the time of the Liquidator’s appointment:

  1. South West was trustee of the South West Kitchen Unit (Hybrid) Trust (the trust).
  2. All of the assets of South West were owned in its capacity as trustee of the trust.
  3. The trust deed for the trust provided that upon liquidation, South West was disqualified from acting as trustee.
The law

The ‘foundational concepts’ based on existing authorities were set out in the judgment of McKerracher J, delivered on 24 June 2014. These concepts are summarised as follows:

  1. A trustee has a right of indemnity out of the trust assets for expenses and liabilities incurred on behalf of the trust and a right of exoneration from liability.
  2. A trustee is entitled to the benefit of an equitable lien over the trust assets as a means of securing its rights of indemnity and/or exoneration.
  3. When a liquidator is appointed to a trustee company, the liquidator acquires the same rights of indemnity and exoneration.
  4. The equitable lien securing the trustee’s right of indemnity and exoneration does not give the (removed) trustee power of sale. Rather, it is a security which is enforceable by the trustee only by way of judicial sale or by the appointment of a receiver with a power of sale.

According to his Honour, the issue arising beyond these concepts and on which there may be some doubt in the authorities, is whether the liquidator of a trustee company that is unable to continue acting as trustee:

  1. can exercise the power of sale granted to liquidators pursuant to s 477(2)(c) of the Act;
  2. is required in each instance to obtain a court order to sell trust assets.

His Honour expressed the view that the operation of s 477(2)(c) in these circumstances had not been expressly considered in previous judgments, except in the decision of Finkelstein J in Apostolou v VA Corporation AUST Pty Ltd [2010] FCA 64A (Apostolou). In that case, his Honour found that the liquidator had a dual power to realise trust assets in the course of winding up a company which acted as trustee, where the company has both legal title and an equitable interest in the trust assets; that power being conferred pursuant to the trust deed and also pursuant to s 477(2)(c) of the Act.

The decision

In delivering his judgment, his Honour followed the decision in Apostolou, finding that:

  1. South West had both legal ownership of the assets of the trust as a bare trustee and beneficial interest in the assets as a holder of an equitable lien.
  2. There is no reason in policy or principle and none referred to in the authorities discussed, as to the why a liquidator’s powers of sale should be limited by the terms of a private trust agreement.
  3. There appears to be no constraint on the power of sale under s 477(2)(c) of the Act, nor does it impose any limitation on the power of sale insofar as the assets of a company held on trust.
  4. In the absence of any statutory constraint or other complication, there appears to be no other reason why a liquidator ought not be permitted in a straightforward case to discharge their duties to conduct the liquidation in the ordinary manner.
  5. Proceeding this way makes good practical sense avoiding the need for liquidators of trustee companies to approach the court on every occasion to seek approval to sell trust assets.

Accordingly, his Honour declared that the liquidator had power pursuant to s 477(2)(c) of the Act to sell, dispose or otherwise deal with the assets of the trust.

Stansfield

The facts

The liquidator of Stansfield sought directions from the court to the effect that the company in liquidation be permitted to sell or otherwise deal with the property of a superannuation fund. This application was no doubt filed in light of the potentially conflicting authorities but with the added complication that the property in question was held on account of a superannuation fund. At the time of the liquidator’s appointment;

  1. Stansfield was acting as trustee of the Elliot Stansfield Super Fund, a regulated selfmanaged superannuation fund (the fund).
  2. The assets of the fund totalled $108,916.
  3. The liabilities of the fund totalled $98,941.
  4. The only function of Stansfield was to act as trustee of the fund.
The law

In his judgment delivered on 30 October 2014, Brereton J said that there were two relevant potential scenarios; the first that the company in liquidation remained as trustee of the fund and the second, the company in liquidation does not remain as trustee of the fund.

The company in liquidation remaining as trustee of the fund

In relation to the first scenario, his Honour concluded that so long as the company in liquidation remained as trustee of the fund, then the liquidator was entitled (subject to the impact of superannuation laws) to administer the assets of the fund, pay the creditors of the fund, wind up the fund and recover all of his remuneration and expenses from the assets of the fund.

The company in liquidation not remaining as trustee of the fund

In relation to the second scenario, his Honour essentially agreed with the foundational concepts set out in South West which are summarised above. His Honour then when on to consider the possible application of s 477(2)(c) of the Act in light of the relevant case law and particular, the judgments delivered in Apostolou and South West.

The conclusion reached by his Honour was that he respectfully disagreed with the decision in Apostolou, finding instead that s 477(2)(c) does not empower a liquidator to sell the beneficial interest in property that a company holds on trust even if the company holds an equitable charge over that property because the property is not itself ‘property of the company’. To put that another way, a liquidator’s power to deal with property does not extend to property that is not beneficially the property of the company.

The impact of superannuation law

His Honour was obliged to also consider the operation of the Superannuation Industry (Supervision) Act 1993 (SISA) concluding that a company in liquidation becomes a ‘disqualified person’ for the purposes of that legislation but notwithstanding, remains as trustee of the fund. However, by continuing to be and act as trustee, a company contravenes s 126K of SISA and thereby commits an offence. If, as would be prudent, a company resigned as trustee once a liquidator has been appointed to it, then the liquidator would have no power of sale.

The decision

In light of the foregoing, his Honour declined to make the direction sought by the liquidator. Rather, his Honour proposed to make declarations and orders pursuant to s 479(3) of the Corporations Act 2001 to the following effect:

  1. The liquidator would be justified in causing the company to resign as trustee of the fund.
  2. The liquidator would be justified in applying to the court to be appointed as receiver without security of the assets of the fund with the powers that a liquidator has in respect of the property of a company under s 477(2)(c) of the Act.

Conclusion

It is obvious from these judgments that the law is not settled in relation to dealing with trust property in circumstances where the trustee company has been wound up and is no longer acting in that capacity. The decision in South West is commercially sensible and avoids the need for a liquidator of a trustee company to approach the court on every occasion trust property is to be sold. This of course conflicts with the judgment in Stansfield. This conflict needs to be resolved either by the legislature or the High Court of Australia. In the meantime, a liquidator appointed to a trustee company will be subject to the law of trusts in the particular state in which he or she practises and will need to seek legal advice as to the appropriate way to deal with trust assets. The partners of O’Brien Palmer are presently minded to follow the process in Stansfield until such time as they are advised otherwise.

Why would anyone want to be a director?

by

By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

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

A GUIDE TO DIRECTOR’S DUTIES

Introduction

Many people who accept an appointment as a company director or secretary are completely unaware of the potential risks they face from personal liability, civil penalty or criminal conviction. These risks arise primarily from failing to comply with statutory duties contained within the Corporations Act 2001 (‘the Act’) that largely mirror those duties which have been enshrined in the Common Law. In addition to those duties, there are a plethora of obligations imposed upon directors by other state and federal legislation such as taxation laws, employment standards, work health and safety regulations, environmental protection measures, consumer protection strategies, Australian Stock Exchange listing rules for publicly listed companies and privacy protocols.

In short, a person acting as a director should take his or her duties seriously. This is especially true in times of financial difficulty. This newsletter will concentrate on the duties of directors, other officers and in some cases employees as set out in the Act and the potential liability for breaching those duties.

Who has a duty to comply?

It is important to consider the persons who are obligated to comply with their statutory duties. Section 9 of the Act defines ‘officer’ to include a director, secretary or any person who acts in the position of a director, regardless of the name that is given to their position. A person who acts in the position of a director is often referred to as a ‘shadow-director’. It is worth noting that external administrators are similarly subject to the same duties as officers.

Directors duties

General Duties – Civil Obligations

Set out in the table below are the duties of company officers which if contravened, give rise to civil obligations.

Duty Relevant Information
Care &
Diligence
Section 180(1)		 An officer of a company must exercise their powers and discharge their duties with the degree of care and diligence that a reasonable person would in the same circumstances.
Defence
Section 180(2)		 Business Judgement Rule – A person who makes a “business judgment” does not breach their duty, if they:

make the judgment in good faith for a proper purpose; and

do not have a material personal interest in the subject matter of the judgment; and

make an informed decision; and

rationally believe that the judgment is in the best interests of the corporation.
Good Faith
Section 181		 An officer of a company must exercise their powers and discharge their duties in good faith in the best interests of the company and for a proper purpose.
Use of
Position
Section 182		 A person who is an officer or employee of a company must not improperly use their position to:

gain an advantage for themselves or someone else; or

cause detriment to the company.
Use of
Information
Section 183		 A person who obtains information because they are, or have been, an officer of a company or an employee must not improperly use that information to;

gain an advantage for themselves or someone else; or

cause detriment to the company.

If a person does not meet these requirements, and the Court is satisfied that the person has contravened one of the sections, then the Court can make a declaration of contravention pursuant to section 1317E of the Act, and:

  1. impose a fine of up to $200,000 (section 1317G of the Act); and
  2. disqualify a director from managing companies (section 206C of the Act).

The Courts are also able to impose other remedies for breach of duty. Section 598(2) of the Act provides that where the Court is satisfied that a person is guilty of fraud, negligence, default, breach of trust, or breach of duty and the company has suffered or is likely to suffer loss or damage as a result, then the Court may, on the application of either the Australian Securities and Investments Commission (‘ASIC’), an Administrator, a Liquidator or a person nominated by ASIC, make an order pursuant to section 598(4) of the Act directing that person:

  1. to pay money or transfer property to the company; and
  2. to pay to the company the amount of the loss or damage.
General Duties – Criminal Offences

Section 184 of the Act effectively states that an offence is committed if a person recklessly or dishonestly breaches sections 181, 182 or 183 of the Act. Persons who commit these offences may be criminally liable and be fined amounts up to $220,000 and/or be imprisoned for up to five years.

Insolvent Trading

Section 588G(1) of the Act imposes a duty on directors to prevent their companies from trading whilst insolvent. This section applies if a person was a director of a company at the time when the company incurs the debt and is insolvent at that time or becomes insolvent as result of that transaction and the director had reasonable grounds to suspect the company was insolvent or would become insolvent as a result of entering that transaction.

Breaching this duty can result is in ASIC seeking from the Court a declaration of contravention against a director and the imposition of a civil penalty pursuant to sections 1317E and 1317G of the Act. In addition and on an application for a civil penalty order, the Court has the power pursuant to section 588J of the Act to make orders:

  1. disqualifying a person from managing companies (section 206C of the Act); and
  2. requiring a person to pay to the company compensation equal to the loss or damage suffered by the company.

A breach of this duty is a criminal offence pursuant to section 588G(3) of the Act if the failure to prevent the company from incurring the debt was dishonest. Furthermore and in the event of liquidation, if a director has breached this section, then pursuant to section 588M(2) of the Act, the company’s liquidator may recover from the director, as a debt due to the company, an amount equal to the loss or damage suffered by the company. Alternatively, a creditor of the company, may with the consent of the liquidator, begin proceedings pursuant to section 588M(3) of the Act to recover from a director as a debt due to the creditor, an amount equal to the loss and damage suffered by the creditor directors who are the subject of claims in relation to insolvent trading may be able to avail themselves of the defences which are set out in section 588H of the Act.

Maintenance of Proper Books & Records

Section 286(1) of the Act imposes an obligation on company directors to maintain adequate books and records that:

  1. correctly record and explain its transactions and financial position and performance;
  2. enable true and fair financial statements to be prepared and audited.

This obligation extends to transactions undertaken by a company as a trustee.

Section 286(2) requires that the books and records of the Company be maintained for a period of seven years. Pursuant to sections 344 and 1317E of the Act, the penalties for breaching these duties may include:

  1. the imposition of a fine of up to $200,000 (section 1317G of the Act);
  2. disqualification from managing companies (section 206C of the Act).

Section 588E(4) of the Act provides that where a company is being wound up, and in circumstances where that company has failed to maintain proper records or retain them for the requisite period, then the company will be presumed to be insolvent for the period for which the records are not available. This can give rise to serious consequences where it is being alleged that a director has allowed a company to trade whilst insolvent.

Click here to view ASIC website – What books and records should my company keep?

Trust liabilities

Corporate trustees are very common. Pursuant to section 197 of the Act, where a company is acting as or purporting to act as trustee and incurs a liability which it cannot meet, a director of that company can be held liable to discharge the whole or part of the liability if the company is not entitled to be fully indemnified against the liability out of trust assets because of one or more of the following:

  1. the company has breached its trust;
  2. the company was acting outside the scope of its powers as trustee;
  3. a term of the trust denying, or limiting, the company’s rights to be indemnified against the liability
General Requirements

In addition to the foregoing, the Act requires directors to:

  1. update the company database maintained by ASIC as required to ensure its accuracy in accordance with sections 142, 146, 168, 205B, and 205D of the Act.
  2. comply with all reasonable requirements and provide proper assistance to validly appointed external administrators pursuant to sections 475 and 530A of the Act.
  3. refrain from acting as a director of a company, whether formally appointed or not, if excluded from doing so pursuant to sections 206B and 206C of the Act. This most relevantly excludes bankrupts or anyone who has entered into a personal insolvency agreement under Part X of the Bankruptcy Act 1966.
  4. disclose to other directors of their companies any potential material conflicts of interests that they might have in relation to the conduct of their duties as director in accordance with sections 191 – 195 of the Act.

External administrators’ obligation to report to ASIC

A liquidator, in carrying out an investigation into the affairs of a company and the conduct of its principles, has a statutory duty pursuant to section 533 of the Act to file a report with ASIC if the expected dividend is less than 50 cents in the dollar, setting out any identified potential offences or breaches of duty committed by officers, employees or shareholders of a Company. At its discretion, ASIC may require the liquidator to submit a supplementary report particularising the alleged offences or breaches of duty, and may also provide funding for that purpose. Similar provisions apply to a voluntary administrator or receiver if appointed.

Conclusion

If company officers and employees adopt ethical and prudent business practices, then they are unlikely to breach their statutory duties. ASIC has issued an explanatory memorandum as to the general duties of directors and other officers, those duties being summarised above. In the summary, ASIC advises that company officers can greatly reduce their exposure by having appropriate insurance, and if they carry out their duties by;

  1. being honest and careful in their dealings.
  2. remaining active and involved in the company’s operations.
  3. making sure that their companies can pay their debts on time.
  4. maintaining proper financial records.
  5. acting in the best interests of their companies.

As always, directors should take appropriate professional advice from their accountants, solicitors and advisors if they are in any doubt as to their duties, or as to the consequences of potential breaches.

Click here to view ASIC website – Your company and the law

Income contributions and accumulated savings in bankruptcy

by

By O’Brien Palmer

INSOLVENCY AND BUSINESS ADVISORY

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

Introduction

Debtors facing bankruptcy often ask questions about the amount of income they can earn as a bankrupt and whether they can retain surplus income that might be accumulated during the period of their bankruptcy. The purpose of this newsletter is to explain the operation of the income contribution assessment regime and the manner in which a trustee is required to deal with any accumulated savings.

Income

Pursuant to sub-section 139W(1) of the Bankruptcy Act 1966 (“the Act”), a trustee is required to make an assessment of the income of a bankrupt that is likely to be derived or which was derived during the bankruptcy period. In practice, at the commencement of the bankruptcy and then every year thereafter, a trustee will issue an income questionnaire to be completed by the bankrupt. Based on the information provided, a trustee will assess whether the bankrupt is liable to make contributions from their income. If the bankrupt is found to be liable, then the bankrupt will normally arrange to make regular installment payments.

Pursuant to sub-sections 139W(2) and 139WA(1) of the Act a trustee can issue a fresh assessment if they are satisfied that the actual income derived by the bankrupt varies from the amount originally estimated. This may occur at any time during or after the end of a contribution period or even after the bankrupt is discharged.

What is income

Section 139L of the Act defines income very broadly and includes:

  1. Wages and salary.
  2. Taxable fringe benefits.
  3. Superannuation receipts, annuities and pensions.
  4. Loans from associated entities.
  5. Income earned overseas.
  6. Business profits of a sole trader.
  7. Super contributions in excess of 9.5%.

Importantly, pursuant to section 139M(1), income is taken as being derived by the bankrupt even though it isn’t actually received by the bankrupt. For example, income which is reinvested or income which is dealt with on behalf of the bankrupt or as the bankrupt directs.

How is the assessment calculated

Section 139S of the Act provides that the amount of the contribution required to be paid by a bankrupt is 50% of the after tax income which exceeds the ‘actual income threshold amount’.

What is the actual income threshold amount

The actual income threshold amount is the amount of income a bankrupt may earn upon which no contribution is payable. In accordance with section 139K of the Act, the threshold amount is determined by reference to the number of dependants for whom the bankrupt is responsible. The current amounts, which are updated twice yearly, are set out in the table below.

Number of Dependants Threshold Amount
0 $53,653.60
1 $63,311.25
2 $68,140.07
3 $70,822.75
4 $71,895.82
Over 4 $72,968.90

It is worth noting that if a bankrupt disagrees with the assessment of their income contributions, then pursuant to section 139Z, they are able to seek a review of the assessment by the Official Trustee.

What happens if a bankrupt earns less than expected

In order to prevent a bankrupt from circumventing the income contribution provisions by earning less money than they would otherwise, a trustee may, pursuant to section 139Y of the Act, make a determination that the bankrupt receives or has received what is called ‘reasonable remuneration’ and increase his or her income for assessment purposes accordingly. This prevents the bankrupt from channelling income into other entities or coming to an arrangement with their employer, especially if related, to reduce their reportable income.

What happens in the case of hardship

If a bankrupt considers that the requirement to pay contributions will cause hardship, then pursuant to sub-section 139T(1) of the Act, they may apply to their trustee for the assessment to be varied. Sub-section 139T(2) sets out the specific grounds upon which such an application can be made. Such an application is required to be in writing and to include evidence of the bankrupt’s income and expenses. The grounds for a hardship application are as follows:

  1. Ongoing medical expenses.
  2. Costs of child day care essential for work.
  3. Particularly high rent when there are no alternatives available.
  4. Substantial expenses of travelling to and from work.
  5. Loss of financial contribution.
What happens if a bankrupt does not comply

Failing to provide information relating to income or expected income as required by the Act constitutes grounds for an objection to automatic discharge pursuant to sub-section 149D(1)(e). In addition, if a contribution amount is owed and remains outstanding prior to discharge, then a trustee may object to the discharge, pursuant to subsection 149D(1)(f). Any such objection may extend the period of the bankruptcy by a further 5 years.

If the bankrupt does not provide particulars of their income or advises that they did not derive any income, however there are reasonable grounds for believing that the bankrupt is likely to derive income then, pursuant to section 139Z, the trustee may determine the income of a bankrupt and prepare an assessment accordingly.

Trustees have a number of other powers available to them to compel the compliance of the bankrupt with their obligations in relation to contribution assessments. These include instructing the bankrupt pursuant to section 139ZIF to pay income into an account supervised by a trustee. A trustee is then required to supervise withdrawals from that account. Furthermore, if an amount remains due and payable after the date of automatic discharge, then a trustee may enforce the debt against the bankrupt in the ordinary course in accordance with sub-sections 139ZG(3) and (4) including making the debtor bankrupt again.

Accumulated savings

Sub-section 58(1)(b) of the Act states that property that is acquired by or devolves upon a bankrupt during the period of their bankruptcy vests in their trustee. Property of this nature is referred to as after-acquired property, one of the best examples being the receipt of an inheritance whilst bankrupt. Another such example might be accumulated savings. These funds would ordinarily be surplus income that may or may not have been assessed for contribution purposes. Until recently there was an assumption based on case law that accumulated savings derived from income do not vest in a trustee. However, a recent decision of the Full Bench of the Federal Court of Australia in the matter of Di Cioccio v Official Trustee in Bankruptcy (as Trustee of the Bankrupt Estate of Di Cioccio)[2015] FCAFC 30, has authoritatively examined the interaction between the income contribution regime and after-acquired property.

The facts of the case are relatively simple. An undischarged bankrupt used money that was held in a bank account to acquire shares, the money was derived from income earned within the period of the bankruptcy that did not exceed the actual income threshold amount. The bankrupt informed the Official Trustee of his intention to acquire a motor vehicle that was to be funded from the sale of the shares. The bankrupt was informed that the shares vested in the Official Trustee pursuant to sub-section 58(1). The bankrupt sought a review of the stance taken by the Official Trustee.

In essence, the court found that the shares vested in the Official Trustee in accordance with subsection 58(1)(b). The court went on to say that accumulated savings derived from income during the period of the bankruptcy would also constitute after-acquired property. In considering this, the court was conscious of sub-section 134(1)(ma) which gives a trustee the power to:

‘make such allowance out of an estate as they think just to the bankrupt, the spouse or de facto partner of the bankrupt or the family of the bankrupt’.

Interestingly, the court also put the proposition that if the money was being accumulated to acquire tools of trade for income earning purposes then the bankrupt may be able to retain the money on the basis that such tools of trade, if acquired, constitute property that is not available to creditors pursuant to sub-section 116(2)(c).

Conclusion

This case makes it abundantly clear that it is in the best interests of all bankrupts to be open and transparent with their trustee in relation to their income and to manage any contributions for which they are liable. In circumstances where a bankrupt saves their surplus income and does not pay regular instalments to their trustee, then a trustee may take possession of the accumulated savings and the bankrupt could remain liable to pay assessed contributions. This may become a situation where a trustee can exercise their discretion pursuant to sub-section 134(1)(ma) of the Act, taking into account the circumstances of the bankrupt.

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

by

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

by

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

by

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:

  1. maximises the chances of the company continuing in existence; or
  2. 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:

  1. the majority of the company’s directors; or
  2. a Liquidator of the company; or
  3. 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:

  1. at a meeting the creditors pass a resolution approving the appointment; or
  2. 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:

  1. whether or not to appoint a Committee of Creditors; and/or
  2. 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:

  1. 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;
  2. the company executes a Deed of Company Arrangement (‘DOCA’); or
  3. the Administration should end; or
  4. 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.

  1. 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:

  1. has control of the company’s business, property and affairs; and
  2. may carry on the company’s business and manage its property and affairs; and
  3. may terminate or dispose of all or part of the company’s business or property; and
  4. 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:

  1. removing from office a director of the company;
  2. appointing a person as a director;
  3. executing a document, bringing or defending proceedings, or doing anything else in the company’s name or on its behalf;
  4. 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:

  1. the ability of the company to generate a positive cash flow;
  2. to maximize the realisable value of assets such as stock;
  3. to facilitate the sale of the company’s business;
  4. 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;
  5. 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;

  1. by agreement between the Administrator and the Committee of Creditors (if any); or
  2. by resolution of creditors; or
  3. 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

  1. 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).
  2. 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.
  3. 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:

  1. allows immediate action to be taken and sets a fixed time frame for dealing with the issues;
  2. control of the company is given to an independent person;
  3. prevents unsecured creditors, owners and lessors of property from taking action which may adversely affect the value of a company’s business and assets;
  4. allows a company and its creditors to consider the merits of a compromise arrangement which may maximise the return to creditors; and
  5. 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

by

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.

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