The word insolvency is often heard in the commercial world. But what does it actually mean?

Insolvency is when an organisation, or individual, cannot pay their debts when they are due. Insolvency can arise from poor cash management, a reduction in cash-flow or from an increase in expenses.

Before insolvency proceedings commence, the business (or person) will likely be involved in informal arrangements with creditors, such as making alternative payment arrangements.

It is an offence for the Director of a company to continue operating, and incurring more debts, when they know their company is insolvent.

When a company is insolvent, or its directors or credits believe it may become insolvent, there are three types of formal administration that the company may be placed into:

1. Liquidation or Winding Up;
2. Voluntary Administration or Deed of Company Arrangement;
3. Receivership.

Each of these options has different implications for the directors and creditors of the company.

Liquidation

When a company is placed into liquidation or wound up a formal administrator is appointed. This may be done voluntarily (ie the Directors of the company initiate the process themselves), or involuntary (ie when the company is forced into insolvency by its creditors or by the courts).

The liquidator manages the sale and disposal of company assets to pay as much of the outstanding debts as possible. The company itself is deregistered and ceases to exist.

Voluntary Administration or Deed of Company Arrangement

The objective of a Voluntary Administration is to save a company so it can continue its operations. An administrator is voluntarily appointed (generally by the Director of the company) to investigate the assets and liabilities of the company and its future profitability. They report on the company’s historic and current financial position and make recommendations concerning the company’s future.

Creditors of the company can then decide to liquidate the company, return the company to the control of the directors if the company can be made financially solvent, or enter into what is called a Deed of Company Arrangement.

A Deed of Company Arrangement is a binding agreement between the company and its creditors, and is generally a compromise between what the company owes and what the creditors will accept to satisfy the debt owed. Depending on the circumstances the company can either continue to operate or will be wound up.

Receivership

Receivership removes the company from the control of its owners. When a company is placed into receivership, a court or a secured creditor appoints a receiver who holds custodial responsibility for the property of the company.

A receiver’s primary responsibility is to collect and sell sufficient assets to meet the debt owed to the creditor. They will pay out the funds in the order required by law and reports to the Australian Securities and Investments Commission (ASIC) with any possible errors.

When dealing with a company or individual that has become insolvent it is important to get legal advice early to ensure that your rights as a creditor are preserved and to attempt to secure payment. Contact us now to discuss your situation, we will work with you to address the problem and propose a plan before the matter reaches a crisis point.