COVID-19: Insolvency facts sheet for individuals and small businesses in Australia

Australia Publication 1 April 2020

It is important that small business owners understand their obligations and what relief may be available to them in this evolving COVID-19 crisis.

Is my business ‘insolvent’?

The first thing to consider is whether your company is able to pay its debts as and when they become due and payable.1 If your company is not able to do so, it will be considered insolvent.

What are my obligations as a director when my company is insolvent?

The common director duties you need to consider if you think your company might be insolvent are:

  1. The duty to prevent insolvent trading – you have a duty to prevent the company from trading so as to become insolvent, or from trading whilst insolvent. If you do not, you may be held personally liable for the debt.
  2. The duty to consider creditors - if your company is in financial trouble or insolvent, you have a duty to give proper consideration to the interests of your creditors.

If you think your company might be insolvent, then you may need to take steps immediately to prevent yourself from breaching your director duties. These might include:

  1. Engaging with your bank and creditors to arrange a temporary standstill to give you some short term breathing room.
  2. Appointing a Voluntary Administrator.

What consequences could I face if I am in breach of my directors’ duties?

You may be disqualified from acting as a director for a period of time, fined, and potentially imprisoned in the case of a serious breach.

Are there any alternatives to formal insolvency processes?

The Australian Federal Government has announced various measures to assist businesses during this crisis. These measures include a temporary suspension of personal liability for directors for trading in the ordinary course of business while insolvent for the next six months.

Engaging with your company’s bank is an important step you can take to relieve the stresses your company might be facing. The Australian Bankers Association announced on 20 March 2020 that its members will defer loan repayments for six months for any small businesses affected by coronavirus. There are many other options that your bank may be able to provide you.

Provided you are acting honestly and diligently and comply with the legislative requirements, there are a number of statutory defences available to directors in relation to breaches of director’s duties. You may also be entitled to rely on the ‘Safe Harbour’ regime during this period which provides protection to directors from insolvent trading liabilities.

You should also consult the Australian Government and Treasury websites for updates on the relief available to you as a director.

What is a ‘voluntary administration’ (VA) process?

VA is the process by which an independent, officially registered insolvency practitioner (the voluntary administrator) takes control of the company to try to save the business. If your company is not the subject of insolvency proceedings, a voluntary administrator can be appointed by the directors of a company by the passing of a resolution or by a secured creditor who has security over the whole (or substantially the whole) of the assets of a company (usually your principal bank).

The administrator’s job is to decide whether:

  1. Your company can be salvaged and, if so, on what terms.
  2. Your company cannot be salvaged and should be placed into liquidation.
  3. Your company is solvent and should not be in administration, in which case the administration is brought to an end and normal management restored.

After appointment, the administrator will call together a meeting of your company’s creditors. The administrator will investigate the affairs of the company, prepare a report and hold a second meeting of creditors 25 days after appointment. In that report, the administrator will make a recommendation to the company’s creditors which of the above three options it considers appropriate.

The major advantages of a VA are:

  1. During the VA period, a statutory moratorium applies which stops third parties from exercising rights against your company’s property.
  2. An administrator may be able to negotiate an agreement, called a Deed of Company Arrangement (DOCA) where your creditors agree to accept a lower or delayed amount to allow your company to continue conducting business.
  3. The directors of the company will not liable for any debts incurred by the company during the period of the voluntary administration.

What actions could third party creditors take against my company?

If your company is in default under the loan provided by the bank, or under agreements with the company’s suppliers or leasing providers, and your company does not undergo voluntary administration, third party creditors may be able to:

  1. Repossess your company’s hired or supplied property.
  2. Appoint a receiver to your business or property.
  3. Apply to the court to wind up your company.2

What is a ‘receiver’ and what can they do with my company’s property?

A receiver is appointed by a secured creditor. Receivers essentially receive the assets, rents and profits and pass them onto the secured creditor. They have duties under the Corporations Act, including to obtain market value for any assets sold.

What is ‘winding up’ and what can a liquidator do with my company?

If you are in default under your loan or contracts with your creditors, your creditors may apply to the Supreme Court in your state or the Federal Court to wind up your company and appoint a liquidator.3

If your creditor is successful in its application, a liquidator will be appointed to your company. The role of a liquidator is to sell off any valuable assets and conduct a review of the affairs of the company to discover whether there are any historic transactions that might be avoided because they were unfair.

REMEMBER: As part of the Government’s economic relief package, the Australian Government has pledged to introduce new legislation which will increase the minimum amount of debt required for statutory demands from $2,000 to $20,000. The legislation will also increase the time in which you have to comply with a demand from 21 days to 6 months.

How do these insolvency laws affect my charity?

The rules governing insolvency and external administration are the same for incorporated associations as they are for corporations across each State and Territory.

Members of the committee that governs an incorporated association are required to prevent the association from incurring debts whilst insolvent, or debts that would cause the association to become insolvent.

If your incorporated association is also a registered charity, you may have obligations under the Australian Charities and Not-for-profits Commission Act 2012 (Cth) to prevent the charity from operating whilst insolvent.

More information about governance standards for charities can be found on the ACNC’s website.


Important note: These updates are applicable to Australian law only and are generic in nature. If you have any specific legal concerns relating to the impact of COVID-19 on your people or your business, please reach out to our pro bono team (ausprobono@nortonrosefulbright.com) and we will consider your pro bono legal request. If we aren’t able to help you, we will try to find someone else who can. This update is current as at 1 April 2020.  

Footnotes

1

This is sometimes referred to as the “cash flow test” - whether a company can actually pay its creditors, including any ability to convert assets into cash in a short amount of time.

2

(also known as Court Appointed Liquidation).

3

The most common way that a creditor presents evidence to the Court to show that your company is insolvent is by relying on a failure to pay a statutory demand. If your company is served with a statutory demand by a creditor and fails to pay within the required period, the Court will presume that your company is insolvent.



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