Bankruptcy and Corporate Insolvency: What You Need to Know

Executive Summary

Bankruptcy is the legal process where an individual is declared insolvent (unable to pay their debts when they are due). Bankruptcy can be entered into voluntary by the insolvent individual or the insolvent individual can be made bankrupt through the court process, where a creditor obtains a sequestration order. Bankruptcy generally remains in effect for at least 3 years and 1 day.

Corporate insolvency refers to a situation where a company is insolvent (unable to pay their debts when they are due). Corporate insolvency procedures can include (without limitation) a creditor issuing a statutory demand and/or winding up proceedings.

Within this article, our bankruptcy and corporate insolvency lawyers will particularise the bankruptcy and corporate insolvency processes.

Bankruptcy

What is an act of bankruptcy?

Section 40 of the Bankruptcy Act 1966 (Cth) (Bankruptcy Act) defines acts of bankruptcy as:

‘(1) A debtor commits an act of bankruptcy in each of the following cases:

(a) if in Australia or elsewhere he or she makes a conveyance or assignment of his or her property for the benefit of his or her creditors generally;

(b) if in Australia or elsewhere:

(i) he or she makes a conveyance, transfer, settlement or other disposition of his or her property or of any part of his or her property;

(ii) he or she creates a charge on his or her property or on any part of his or her property;

(iii) he or she makes a payment; or

(iv) he or she incurs an obligation; that would, if he or she became a bankrupt, be void as against the trustee;

(c) if, with intent to defeat or delay his or her creditors:

(i) he or she departs or remains out of Australia;

(ii) he or she departs from his or her dwelling-house or usual place of business;

(iii) he or she otherwise absents himself or herself; or

(iv) he or she begins to keep house;

(d) if:

(i) execution has been issued against him or her under process of a court and any of his or her property has, in consequence, either been sold by the sheriff or held by the sheriff for 21 days; or

(ii) execution has been issued against him or her under process of a court and has been returned unsatisfied;

(daa) if the debtor presents a debtor’s petition under this Act;

(da) if the debtor presents to the Official Receiver a declaration under section 54A;

(e) if, at a meeting of any of his or her creditors:

(i) he or she consents to present a debtor’s petition under this Act and does not, within 7 days from the date on which he or she so consented, present the petition; or

(ii) he or she consents to sign an authority under section 188 and does not, within 7 days from the date on which he or she so consented, sign such an authority and inform the chair of the meeting, in writing, of the name of the person in whose favour the authority has been signed;

(f) if, at a meeting of any of his or her creditors, he or she admits that he or she is in insolvent circumstances and, having been requested by a resolution of the creditors to bring his or her affairs under the provisions of this Act, he or she does not, within 7 days from the date of the meeting, either:

(i) present a debtor’s petition; or

(ii) sign an authority under section 188 and inform the chair of the meeting, in writing, of the name of the person in whose favour the authority has been signed;

(g) if a creditor who has obtained against the debtor a final judgment or final order, being a judgment or order the execution of which has not been stayed, has served on the debtor in Australia or, by leave of the Court, elsewhere, a bankruptcy notice under this Act and the debtor does not:

(i) where the notice was served in Australia—within the time fixed for compliance with the notice; or

(ii) where the notice was served elsewhere—within the time specified by the order giving leave to effect the service; comply with the requirements of the notice or satisfy the Court that he or she has a counter-claim, set-off or cross demand equal to or exceeding the amount of the judgment debt or sum payable under the final order, as the case may be, being a counter-claim, set-off or cross demand that he or she could not have set up in the action or proceeding in which the judgment or order was obtained;

(h) if he or she gives notice to any of his or her creditors that he or she has suspended, or that he or she is about to suspend, payment of his or her debts;

(ha) if the debtor gives the Official Receiver a debt agreement proposal;

(hb) if a debt agreement proposal given by the debtor to the Official Receiver is accepted by the debtor’s creditors;

(hc) if the debtor breaches a debt agreement;

(hd) if a debt agreement to which the debtor was a party (as a debtor) is terminated under section 185P, 185Q or 185QA;

(i) if he or she signs an authority under section 188;

(j) if a meeting of his or her creditors is called in pursuance of such an authority;

(k) if, without sufficient cause, he or she fails to attend a meeting of his or her creditors called in pursuance of such an authority;

(l) if, having been required by a special resolution of a meeting of his or her creditors so called to execute a personal insolvency agreement or to present a debtor’s petition, he or she fails, without sufficient cause:

(i) to comply with the requirements of this Act as to the execution of the agreement by him or her; or

(ii) to present a debtor’s petition within the time specified in the resolution; as the case may be;

(m) if a personal insolvency agreement executed by him or her under Part X is:

(i) set aside by the Court; or

(ii) terminated;

(n) if a composition or scheme of arrangement accepted by the debtor’s creditors under Division 6 of Part IV is:

(i) set aside by the Court; or

(ii) terminated;

(o) if the debtor becomes insolvent as a result of one or more transfers of property in accordance with:

(i) a financial agreement (within the meaning of the Family Law Act 1975); or

(ii) a Part VIIIAB financial agreement (within the meaning of the Family Law Act 1975); or

(iii) a financial agreement within the meaning of Part 5A of the Family Court Act 1997 (WA) (including a superannuation agreement (within the meaning of Part VIIIC of the Family Law Act 1975) that is included in such a financial agreement); to which the debtor is a party.

(2) In calculating for the purposes of subparagraph (1)(d)(i) the period for which property has been held by the sheriff, any time between the date on which an interpleader summons in respect of the property is taken out and the date on which the proceedings on the summons are finally disposed of, settled or discontinued shall not be taken into account.

(3) For the purposes of paragraph (1)(g):

(a) where leave is given by a court to enforce an award made on a submission to arbitration, being an award under which money is payable by a debtor to another person:

(i) the award shall be deemed to be a final order obtained by that person against the debtor; and

(ii) the arbitration proceedings shall be deemed to be the proceeding in which that final order was obtained; and

(b) a judgment or order that is enforceable as, or in the same manner as, a final judgment obtained in an action shall be deemed to be a final judgment so obtained and the proceedings in which, or in consequence of which, the judgment or order was obtained shall be deemed to be the action in which it was obtained; and

(d) a person who is for the time being entitled to enforce a final judgment or final order for the payment of money shall be deemed to be a creditor who has obtained a final judgment or final order; and

(e) a judgment or order for the payment of money made by the Court in the exercise of jurisdiction conferred on it by this Act shall be deemed to be a judgment or order the execution of which has not been stayed notwithstanding that it may not be enforceable at law by execution; and

(f) an order made after the commencement of this paragraph under the Family Law Act 1975 for the payment by a person of arrears of maintenance for another person shall be deemed to be a final order against the first-mentioned person obtained by the other person; and

(g) an order made after the commencement of this paragraph under the Family Court Act 1997 (WA) for the payment by a person of arrears of maintenance for another person shall be deemed to be a final order against the first-mentioned person obtained by the other person.

(4) The act of bankruptcy specified in paragraph (1)(j) shall be deemed to be committed on the day on which the notices calling the meeting are delivered or sent to the creditors or, if they are not all delivered or sent on the one day, on the day on which the last of the notices is so delivered or sent.

(5) The act of bankruptcy specified in paragraph (1)(l) shall be deemed to be committed on the day after the day on which the period within which the agreement is required to be executed by the debtor or the period within which the petition is required to be presented, as the case may be, expires.

(6) The act of bankruptcy specified in paragraph (1)(m) shall be deemed to be committed on the day on which the agreement is set aside or terminated, as the case may be.

(7) The act of bankruptcy specified in paragraph (1)(n) shall be deemed to be committed on the day on which the composition or scheme of arrangement is set aside or terminated.

(7A) For the purposes of paragraph (1)(o):

(a) transfer of property includes a payment of money; and

(b) a person who does something that results in another person becoming the owner of property that did not previously exist is taken to have transferred the property to the other person.

(8) This section applies, so far as it is capable of application, in relation to acts and things done or occurring, and omissions and failures to do acts or things occurring, before, or partly before and partly after, the commencement of this Act, as well as to acts and things done or occurring, and omissions and failures to do acts and things occurring, after the commencement of this Act.’

The most common act of bankruptcy is under section 40(1)(g) of the Bankruptcy Act, being a creditor obtains a final judgment against the debtor, has issued a bankruptcy notice on the debtor and the debtor has failed to comply with the bankruptcy notice.

What is a bankruptcy notice?

Section 41 of the Bankruptcy Act provides that the ‘official receivers [Australian Financial Security Authority (AFSA)] may issue a bankruptcy notice on the application of a creditor who has obtained a final judgment or final order, or alternative, 2 or more final judgments or final orders.

This section goes on further to specify the requirements for a bankruptcy notice, which specifies (without limitation):

a. The notice must be in accordance with the form prescribed by the regulations.

b. The notice must specify a period for compliance with the notice, for notices being served in Australia, this period is twenty-one (21) days (statutory period) after the debtor is served with the notice.

c. The notice will not be issued unless:

i.     the creditor has obtained the final judgment or final order; and

ii.    the final judgment or final order has not been stayed [to suspend proceedings or the final judgment or final order permanently or until a specified date]; and

iii.    no application to stay the final judgment or final order has been made; and

iv.    the limitation period for the judgment has not lapsed, being more than 6 years since the judgment was given or the order was made.

As the application for a bankruptcy notice can be made online through the AFSA website, majority of the above requirements (i.e. form and notice period) are generally automatically completed, to ensure compliance with the Bankruptcy Act.

What happens once a debtor commits an act of bankruptcy?

Upon a debtor committing an act of bankruptcy, the Court may, on a petition presented by a creditor, make a sequestration order against the estate of the debt, pursuant to section 43 of the Bankruptcy Act.

Upon making of a sequestration order against the estate of a debtor, the debtor becomes a bankruptcy and continues to be a bankrupt until they are discharged or annulled.

What happens once a person becomes a bankrupt?

Once a person becomes a bankrupt:

1. A trustee takes control of the person’s assets and finances. The trustee can either be a registered trustee (appointed by the creditor) or the official trustee (AFSA). The trustee may sell assets to repay creditors. However, under the Bankruptcy Act, the bankrupt person is entitled to retain certain assets, tools of trade and income (up to the indexed amount).

2. No further legal proceedings can be commenced against the bankrupt person to recover any debts.

3. If you had commenced proceedings against another party, then you may lose the right to continue with the proceedings.

4. Your name will appear permanently on the National Personal Insolvency Index (NPII).

5. You will generally be bankrupt for 3 years and 1 day, unless the bankruptcy is annulled or discharged earlier.

6. It does not release from all debts.

7. It may affect your ability to travel overseas.

8. It may affect your ability to obtain financing in the future.

In summary, whilst bankruptcy may often be your only option, it does come with significant risks. It’s essential to consider all options and seek professional advice before proceeding.

Corporate Insolvency

Under the Corporations Act 2001 (Cth) (Corporations Act), a company is considered insolvent if it cannot pay its debt as and when they fall due and payable.

In ASIC v Plymin, Elliott & Harrison [2003] VSC 123, the Court summarised the following list of indicators that suggest a company may be insolvent:

1. Continuing losses;

2. Liquidity ratios below 1;

3. Overdue Commonwealth and State taxes;

4. Poor relationship with the present bank, including the inability to borrow further funds;

5. No access to alternative finance or inability to raise further equity capital;

6. Suppliers placing the company on COD, or otherwise demanding special payments before resuming supply;

7. Creditors unpaid outside trading terms;

8. Issuing post-dated cheques or dishonoured cheques;

9. Special arrangements with selected creditors;

10. Solicitors’ letters, summonses, judgments or warrants issued against the company;

11. Payments to creditors of rounded sums which are not reconcilable to specific invoices; and

12. Inability to produce timely and accurate financial information to display the company’s trading performance and financial position and make reliable forecasts.

It naturally follows that if a company can demonstrate the inverse of the above indicators, then they may be able to prove that the company is solvent.      

Presumption of Insolvency

Section 459C of the Corporations Act states that:

(1)  This section has effect for the purposes of:

(a)  an application under section 234, 459P, 462 or 464; or

(b)  an application for leave to make an application under section 459P.

(2) The Court must presume that the company is insolvent if, during or after the 3 months ending on the day when the application was made:

(a)  the company failed (as defined by section 459F) to comply with a statutory demand; or

(b)  execution or other process issued on a judgment, decree or order of an Australian court in favour of a creditor of the company was returned wholly or partly unsatisfied; or

(c)  a receiver, or receiver and manager, of property of the company was appointed under a power contained in an instrument relating to a circulating security interest in such property; or

(d)  an order was made for the appointment of such a receiver, or receiver and manager, for the purpose of enforcing such a security interest; or

(e)  a person entered into possession, or assumed control, of such property for such a purpose; or

(f)  a person was appointed so to enter into possession or assume control (whether as agent for the secured party or for the company).

(3)  A presumption for which this section provides operates except so far as the contrary is proved for the purposes of the application.

Regarding debt recovery, the most common presumption arises from a failure to comply with statutory demand.

What is a statutory demand?

A statutory demand is a formal demand by a creditor to a company debtor, demanding payment of an outstanding debt. It is not a court document, nor does it initiate court proceedings, however, there are serious consequences resulting from a failure to comply with the demand.

To be able to issue a statutory demand:

1. the debt is due and payable.

2. the debt is at least the statutory minimum of $4,000.00.

3. there needs to be no genuine dispute regarding the debt.

Section 459E of the Corporations Act sets out the requirements for a statutory demand:

(1) A person may serve on a company a demand relating to:

(a)  a single debt that the company owes to the person, that is due and payable and whose amount is at least the statutory minimum [$4,000.00]; or

(b)  2 or more debts that the company owes to the person, that are due and payable and whose amounts total at least the statutory minimum.

(2) The demand:

(a)  if it relates to a single debt--must specify the debt and its amount; and

(b)  if it relates to 2 or more debts--must specify the total of the amounts of the debts; and

(c)  must require the company to pay the amount of the debt, or the total of the amounts of the debts, or to secure or compound for that amount or total to the creditor's reasonable satisfaction, within the statutory period [21-days] after the demand is served on the company; and

(d)  must be in writing; and

(e)  must be in the prescribed form (if any); and

(f)  must be signed by or on behalf of the creditor.

(3) Unless the debt, or each of the debts, is a judgment debt, the demand must be accompanied by an affidavit that:

(a) verifies that the debt, or the total of the amounts of the debts, is due and payable by the company; and

(b)  complies with the rules of court.

 (4)  A person may make a demand under this section relating to a debt even if the debt is owed to the person as assignee.

…’          

What happens if you receive a statutory demand?

If you receive a statutory demand, your options include:

1. comply with the demand and pay the debt/s; or

2. compound for the debt/s, which means to reach an agreement with the debtor regarding the debt/s. This can include to pay the debt/s off by instalments or other terms agreed upon by the parties.

3. apply to the Court to set the statutory demand aside (section 459G of the Corporations Act). Pursuant to section 459J, the grounds to set the demand aside include a defect in the demand, substantial injustice, or some other reason (i.e. offsetting claim, the debt is not due and payable or there is a genuine dispute regarding the debt).

You must take any of the above steps within 21 days of delivery of the statutory demand (period for compliance). The 21 days is a strict timeframe unable to be extended. If an application to the court is made to set aside the demand, then the period for compliance extends to 7 days after the application is determined (section 459F(2)(a)(ii)).

Section 459F of the Corporations Act stipulates that if the company debtor fails to take any of the above steps within the period for compliance, then the company is deemed to have failed to comply with the demand, resulting in the presumption of insolvency arising for a period of 3 months and allowing the creditor to commence winding up proceedings.

Winding up proceedings

Upon failure of the debtor company to comply with the demand, the creditor can apply to the Court for an order that the company be wound up (section 459A and 459P of Corporations Act).

If the Court is satisfied that the company is insolvent, they will make an order that the debtor company be wound up and a liquidator be appointed. The purpose of the liquidator is to realise the company’s assets to pay the company’s creditors.

Conclusion

In conclusion, bankruptcy and corporate insolvency carry significant risks and consequences that can impact businesses, creditors, and stakeholders alike. The financial instability and potential loss of assets can lead to a loss of trust and reputation, making it challenging for businesses to recover and rebuild.

At Odyssey Legal, we understand the complexities and stress that come with financial difficulties. That’s why we offer a free 15-minute consultation to help you navigate these challenging times. Our experienced team provides tailored solutions that meet your unique needs.

Don’t let financial troubles dictate your future—schedule your free consultation today and let us be the right partner for your odyssey. Reach out now and take the first step towards resolving your financial disputes efficiently and effectively.