Liquidation

Liquidation is the process of winding up a company’s financial affairs.

Typically, a company is placed into liquidation because the company cannot pay all of its debts (i.e. it is insolvent). Liquidation is a formal process to dismantle a company’s affairs. It can provide relief to those running the company by placing company control into the hands of a third party - a liquidator. The liquidator then deals with the company’s operations and its debts.

Liquidation is the only way to fully wind up the affairs of a company and end the existence of the company. An independent party undertakes the process and protects the interests of creditors, directors, and members while the company structure is dismantled.

Liquidation allows a fresh start for the directors and can give immense relief from the stress and burden being carried.

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Corporate insolvency

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FAQ

If the company is solvent, meaning it can pay its debt when they fall due, then the simplified liquidation pathway is not available.

Solvent companies can be wound up by its members via a members’ voluntary winding up. Contact Worrells to learn more about this process.

Should the company meet certain eligibility criteria, a liquidator may adopt the simplified liquidation process rather than the standard liquidation appointment.

The criteria are:

  • the company has passed a special resolution that the company be wound up voluntarily;

  • the directors give the liquidator a report concerning the company’s affairs and a declaration that the company will be eligible for the simplified liquidation process;

  • the company is insolvent;

  • the company’s total liabilities do not exceed $1 million;

  • no director has been a director of a company that has previously used the simplified liquidation process or a debt restructuring process; and

  • the company’s tax lodgments are up to date.

If the company is eligible, a simplified liquidation appointment is different to standard liquidation appointment through:

  • Reduced investigation and reporting requirements. The requirement to provide a report on offences to the Australian Securities and Investments Commission (ASIC) is removed.

  • Reduced meetings. The obligation for liquidators to convene meetings is removed.

  • Removed Committees of Inspections. Creditors may no longer appoint a committee of inspection, which is currently used to advise and assist the external administrator and can approve and request certain aspects of the liquidation process.

  • No Reviewing Liquidators. Creditors may no longer appoint a reviewing liquidator to review the incumbent’s remuneration.

  • Fewer voidable transactions. The liquidator cannot claw back unfair preference payments from creditors not related to the company.

  • Simplified dividend process. The process of creditors lodging a claim (proof of debt) and dividend payment is simplified.

A number of processes and duties to report to ASIC have been reduced with the simplified liquidation appointment.

If the company is eligible, a simplified liquidation appointment is different to standard liquidation appointment through:

  • Reduced investigation and reporting requirements. The requirement to provide a report on offences to the Australian Securities and Investments Commission (ASIC) is removed.

  • Reduced meetings. The obligation for liquidators to convene meetings is removed.

  • Removed Committees of Inspections. Creditors may no longer appoint a committee of inspection, which is currently used to advise and assist the external administrator and can approve and request certain aspects of the liquidation process.

  • No Reviewing Liquidators. Creditors may no longer appoint a reviewing liquidator to review the incumbent’s remuneration.

  • Fewer voidable transactions. The liquidator cannot clawback unfair preference payments from creditors not related to the company.

  • Simplified dividend process. The process of creditors lodging a claim (proof of debt) and dividend payment is simplified.

Liquidators investigate transactions they believe were not beneficial, or were in fact detrimental, to the company. These types of transactions are called uncommercial transactions.

Who may void uncommercial transactions?

Only liquidators may seek to void uncommercial transactions. This recovery is not available to provisional liquidators, voluntary administrators, deed administrators or controllers.

What makes an uncommercial transaction voidable?

The transaction must have:

  1. no financial benefit to the company, or was detrimental to the company

  2. occurred when the company was insolvent

  3. involved another party who should have suspected the company was insolvent.

Why void uncommercial transactions?

A liquidator must make an equitable distribution of the company’s assets to its creditors. If

the company entered into a transaction that reduced the assets available for distribution to creditors, a liquidator will recover these assets, or its monetary equivalent.

What is the transaction?

Generally, uncommercial transactions are sales, transfers, or purchases of assets or services. What can be a transaction is broad, but there must

be an identifiable event between the parties.

What makes a transaction uncommercial?

A transaction is uncommercial if it had no or limited financial benefit or was detrimental to the company’s financial position. If the transaction reduced the company’s net asset position, the transaction is uncommercial. The ‘reasonable person test’ can assist to test the situation.

Two main circumstances that make an uncommercial transaction are when:

  1. The company disposes of property for less than its true value.

  2. The company purchases property at a price for more than its true value.

Usually, these types of transactions are made with related entities to the company.

Must the company be insolvent at the time?

The company must have either been insolvent at the time of the transaction or became insolvent because of the transaction. Section 95A of

the Corporations Act defines insolvency as not being able to pay debts as and when they fall due. The reasoning is the company must be insolvent, as a solvent company can pay all of its debts and therefore the transaction cannot cause detriment to creditors.

What is a ‘reasonable person’ test?

The court will look at the transaction from the view of a ‘reasonable person’ in the company’s circumstances. This is someone

that has knowledge of the company’s financial position, who is not trying to gain a personal benefit, or give a benefit to anyone else, or cause a loss to the company. It is assumed that a reasonable person would not enter

into a company transaction that would cause detriment to the company or reduce its assets.

What periods are applicable?

Three periods apply to when the transaction happened, and before the ‘relation-back day’ during which the transaction must occur. These are:

  1. six months—for non-related parties

  2. four years—if the recipient is related to the company

  3. ten years—if there is any ‘attempt to defeat, delay or interfere’ with creditors’ rights.

What is valuable consideration?

Usually, the easiest condition to prove is the creditor gave valuable consideration. For trade creditors, the initial supply of goods or services provides the valuable consideration. A loan creditor can rely on the initial loan to the company. The creditor will only have to show that they have given something of value in consideration for receiving the payment.

What is good faith?

The creditor must not have acted in any manner that would indicate they were not acting in good faith or under normal trading conditions. Actions that may repute good faith are commencing proceedings or issuing statutory

notices; ceasing supply; or changing to a cash on delivery (COD) basis. They must not have forced the payment by any form of threat or action.

What is needed to suspect insolvency?

The creditor must not have received or have known of any information or circumstance

Who may void uncommercial transactions?

Only liquidators may seek to void uncommercial transactions. This recovery is not available to provisional liquidators, voluntary administrators, deed administrators or controllers.

What makes an uncommercial transaction voidable?

The transaction must have:

  1. no financial benefit to the company, or was detrimental to the company

  2. occurred when the company was insolvent

  3. involved another party who should have suspected the company was insolvent.

Why void uncommercial transactions?

A liquidator must make an equitable distribution of the company’s assets to its creditors. If the company entered into a transaction that reduced the assets available for distribution to creditors, a liquidator will recover these assets, or its monetary equivalent.

What is the transaction?

Generally, uncommercial transactions are sales, transfers, or purchases of assets or services. What can be a transaction is broad, but there must

be an identifiable event between the parties.

What makes a transaction uncommercial?

A transaction is uncommercial if it had no or limited financial benefit or was detrimental to the company’s financial position. If the transaction reduced the company’s net asset position, the transaction is uncommercial. The ‘reasonable person test’ can assist to test the situation.

Two main circumstances that make an uncommercial transaction are when:

  1. The company disposes of property for less than its true value.

  2. The company purchases property at a price for more than its true value.

Usually, these types of transactions are made with related entities to the company.

Must the company be insolvent at the time?

The company must have either been insolvent at the time of the transaction or became insolvent because of the transaction. Section 95A of

the Corporations Act defines insolvency as not being able to pay debts as and when they fall due. The reasoning is the company must be insolvent, as a solvent company can pay all of its debts and therefore the transaction cannot cause detriment to creditors.

The relation-back day is the day that the

liquidation commenced. For the various types of liquidations, the relevant days are:

  • For a liquidation that follows a voluntary administration, it is the day the administrators were first appointed.

  • For other voluntary liquidations, it is the meeting date that the members held to wind up the company.

  • For an official liquidation (a court appointment) it is the day that the application was filed in the court.

What defences are available to the other parties to transactions?

Statutory defences are available to the parties to the transaction under section 588FF of the Corporations Act. The other party to the transaction must prove all three parts of the defence, which are:

  1. valuable consideration was given

  2. the party acted in good faith

  3. there was no reason to suspect insolvency.

The other party must be able to prove all three parts of the statutory defence. The onus is on that party to prove their defence, the liquidator does not have to disprove the defence.

that would lead them (or a reasonable person in their position) to suspect that the company was insolvent. It is not necessary that the creditor knew, or believed, or even expected that the company was insolvent to lose the benefit of this defence. The mere suspicion of a reasonable person is enough.

Actions such as receiving post-dated cheques, dishonouring cheques, entering into repayment agreements, knowing of other creditors that are unpaid and pressing for payment can reasonably lead to this suspicion. Whether or not a person should have suspected insolvency is often difficult to determine particularly as the courts recognise a distinction between a short-term cash-flow problem and insolvency.

How long does the liquidator have to make a claim?

A claim application for an uncommercial transaction must be made within three years after the relation-back day. It is insufficient for the liquidator to only issue a demand within that period. The court can grant an extension, but the court application must be made within the three-year period after the relation-back day, and the liquidator must show the court a reasonable reason, for the delay in initiating the claim.

Last updated date: 01. 11. 2021

Preferences are payments or transfers of assets that give a creditor an advantage over other creditors. Any payments or transfers made to a creditor before to liquidation may be recovered by liquidators in certain circumstances.

What are preferences?

Preferences are usually payments of money, although a variety of transactions could be deemed ‘preferential’.

Who may recover preferential payments?

Liquidators can recover preferential payments; however, recovery may require a court order to perfect the entitlement to recovery. Recovering preferences is not available to provisional liquidators, voluntary or deed administrators, or receivers and managers.

Why do liquidators void preferential payments?

The liquidator’s main role is to distribute a company’s assets between its creditors on an equal basis (pari passu). Liquidators must determine whether any creditor received treatment, prior to liquidation that was not equitable compared to the distribution to other creditors in the liquidation. Liquidators can void transfers that involve one creditor to make a more equitable distribution to all creditors, including the creditor who received the preference.

What are the elements of a preferential payment?

When considering whether a payment is preferential, a court must be satisfied that:

  1. a transaction was entered into (this is usually a payment of monies)

  2. was between the company and a creditor of the company

  3. happened when the company was insolvent

  4. happened within the statutory period before the liquidation started

  5. the transaction gave the creditor an advantage over other creditors

  6. the creditor suspected, or had reason to suspect, that the company was insolvent.

When is a company insolvent?

The definition of solvency is being able to pay one’s debts as and when they fall due. Conversely, if a company is not solvent, it is therefore insolvent. In the context of preferences, the company must have either been insolvent at the time of the transaction or became insolvent because the transaction was made. The reasoning is that a solvent company has the capacity to pay all of its debts (whether they actually did or not) and therefore no creditor could have been advantaged over others.

Who has to prove insolvency?

The onus of proving insolvency lies with the liquidator.

The main elements of a preference

  1. There must be a debtor–creditor relationship
    The transfer of property must have involved or been done at a creditor’s direction, and must satisfy a debt that would be a provable debt if the transfer had not been made. A cash-on-delivery (COD) payment for goods is not a payment to a creditor, so is never deemed preferential.

However, suppliers often supply goods on COD with a requirement for further payment towards satisfying an existing debt. This additional payment is deemed preferential and is therefore recoverable by a liquidator.

An advance payment for future works, or the future supply of goods, cannot be preferential, but would be required to be repaid to the liquidator if the services/products have not been used by the company

  1. There must be a transaction
    There must be a transaction between the company and creditor. Commonly, a transfer is a payment from a company’s bank account, although any asset passing from a company to a creditor is sufficient to establish a transaction.

For example, the return of stock that is not subject to the Personal Property Securities Act 2009 (PPSA), or assignment of a debt, would be a transaction for the purposes of the preference provisions.

  1. The relevant time period
    The transaction must have occurred during a specific period before the ‘relation back-day’. The actual period depends on whether the recipient is related to the company, and on the company directors’ intention. The periods are:

  • six months for non-related parties

  • four years for related parties

  • ten years for any evidence of “attempt to defeat, delay or interfere” with the rights of creditors.

The relation-back day is the date that the liquidation is deemed to have started. For the various types of liquidations, the relevant days are:

  • for a liquidation that follows a voluntary administration or Deed of Company Arrangement (DOCA), it is the day that the voluntary administrators were first appointed

  • for other voluntary liquidations, it is the date of the members’ meeting that the liquidators were appointed

  • for a court appointment it is the day that the application was filed in the court.

  1. The debt must be unsecured
    A preference does not apply to a creditor holding a valid and subsisting security over company assets pursuant to the PPSA, where the value of the assets secured is greater than the payment amount. But, if the security is not properly created or registered, or the value of the security is less than the payment amount, the liquidator may render it void and the debt may be deemed unsecured.

Other provisions also apply to securities provided to related entities and created within six months of the start of the liquidation. The creation of a security itself within the six months can also be a preference.

  1. Continuing business relationship
    The continuing business relationship provision is similar to what was previously known as a ‘running account’. The business relationship provision is used to determine the amount of any preference received by a particular creditor; it takes into account all transactions between relevant dates. It shows whether the owed debt increased or decreased to the creditor during that period.

If the balance owing decreased, this amount is the potential preference amount, with all other factors being considered. If the balance owing increased, there is no preference as the creditor is actually disadvantaged by the transactions.

The liquidator determines the start date and concludes on the date the winding up commenced.

  1. The creditor must obtain a preference
    The creditor must have received more than they would have received if they refunded the monies and proved for that amount in the liquidation process. If the creditor did not receive more by way of the payment than they would have received from a dividend, there is no advantage or preferential treatment.

What defences are available to creditors?

Section 588FG of the Corporations Act 2001 provides defences that may be available to creditors who received preferential payments. To rely on a defence, a creditor must be able to satisfy all three conditions of the defence. The onus of proving the defences is on the creditor, it is not for the liquidator to disprove them.

The three conditions of the statutory defence are:

  1. the creditor gave valuable consideration for the payment

  2. the creditor received the payment in good faith

  3. the creditor had no reason to suspect the insolvency of the company.

Each of these conditions is outlined as follows:

  1. What is valuable consideration?
    Usually, the easiest condition to prove is the creditor gave valuable consideration. For trade creditors, the initial supply of goods or services provides the valuable consideration. A loan creditor can rely on the initial loan to the company. The creditor will only have to show that they have given something of value in consideration for receiving the payment.

  2. What is good faith?
    The creditor must not have acted in any manner that would indicate they were not acting in good faith or under normal trading conditions. Actions that may repute good faith are: commencing proceedings or issuing statutory notices; ceasing supply; or changing to a COD basis. They must not have forced the payment by any form of threat or action.

  3. What is needed to suspect insolvency?
    The creditor must not have received or have known of any information or circumstance that would lead them (or a reasonable person in their position) to suspect that the company was insolvent. It is not necessary that the creditor knew, or believed, or even expected that the company was insolvent to lose the benefit of this defence. The mere suspicion of a reasonable person is enough.

Actions such as receiving post-dated cheques, dishonouring cheques, entering into repayment agreements, knowing of other creditors that are unpaid and pressing for payment can reasonably lead to this suspicion. Whether or not a person should have suspected insolvency is often difficult to determine particularly as the courts recognise a distinction between a short-term cash flow problem and insolvency.

What should creditors do if a liquidator claims a preferential payment?

Creditors should ensure that:

  1. the transaction was entered into within the relevant period

  2. they are not a secured creditor

  3. they are (or were) a creditor when the transaction was made, and that it was not a cash on delivery payment

  4. the liquidator demonstrates they received an advantage over other creditors by virtue of the payment.

These basic points are usually easy to demonstrate. The following points are more difficult
to determine:

  1. whether the creditor gave extra credit to the company after the payment or transfer was received, whether it is possible that the claim may be reduced or eliminated by the amount of extra credit granted, that is, to determine whether the creditor had a continuing business relationship with the company

  2. that the liquidator can show insolvency at the time of, or before the payment was received

  3. whether the creditor has a realistic chance of convincing the liquidator that the statutory defences apply.

What can creditors do if required to refund money to a liquidator?

Creditors refunding preferences may lodge a proof of debt with the liquidator for the amount refunded. They may also have some rights under any guarantees.

How long does the liquidator have to make a claim?

Claims must be commenced within three years after the relation-back day. A liquidator must issue proceedings within three years­­—not just make a formal demand. A time extension may be granted by the court, but the application must be made within the three-year period after the relation-back day, and the liquidator must demonstrate a reasonable cause for the delay in initiating the claim.

Last Updated: 3.11.2017

If you are trading through a company and are the director and shareholder, you can voluntarily apply for a liquidation.

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