There is often confusion regarding the difference between personal insolvency and an insolvent company. If a company director becomes bankrupt there are consequences for the company and if a company is insolvent, there may be consequences for the directors.
This article will take a look at both situations and identify causes, consequences and alternative options for each.
What’s the difference between personal and commercial insolvency?
An individual is unable to repay debts or agree on a payment plan with creditors. They are unable to obtain credit or additional funding.
A company is unable to pay outstanding debts and is unable to obtain funding or extensions to credit agreements. In the case of a company, the outstanding debts may include payments to employees (wages, holiday pay, etc.) or income tax or superannuation payments.
What’s the difference between bankruptcy and liquidation?
Bankruptcy for an individual is a way to resolve their insolvency. When a person is declared bankrupt, their assets are sold to pay all or part of their outstanding debts. The bankrupt person is not expected to settle outstanding debts and will not be pursued by creditors.
When a company becomes insolvent it is no longer able to repay debts. A liquidator will investigate the financial affairs of the business and identify and sell company assets to pay outstanding debts. At the end of the process, the company is deregistered and ceases to exist.
What happens during a bankruptcy?
The bankruptcy process is started by an individual making themselves bankrupt or an application by a creditor when debts remain unpaid.
A trustee is appointed to investigate the financial affairs of the bankrupt and identify and sell assets to pay debts. The trustee’s responsibility is to the creditors and they will report any financial irregularities or offences to The Australian Financial Security Authority (AFSA).
Assets include property, vehicles, jewellery, money and shares. Some assets are not normally seized by the trustee. These include superannuation, some clothing and household goods, life insurance policies and sentimental property.
Secured creditors, normally banks, have debts tied to assets such as property or vehicles. They will recover the assets, using them to clear part of the debt. Unsecured creditors, often including credit card and utility companies, accept a proportion of their debt and agree they won’t pursue the outstanding part of the debt.
Section 73 proposal
A section 73 proposal is a payment arrangement submitted by the bankrupt individual, often because the bankrupt has obtained funds from a new source.
If the trustee believes the section 73 proposal offers the best option for the creditors the trustee approves the proposal. If the creditors vote to accept the arrangement, the bankruptcy is annulled.
The trustee will ensure that the arrangements within the proposal are completed.
Are there alternatives to bankruptcy?
AFSA identifies two options as alternatives to bankruptcy:
Personal Insolvency Agreement (PIA)
A Personal Insolvency Agreement, also known as a “Part x” is a plan to pay all, or part, of the outstanding debts without becoming bankrupt. The insolvent person draws up an agreement to pay the creditors by a lump sum or by instalments.
If approved, the trustee presents the PIA to the creditors. If they deem the terms to be preferable to bankruptcy (they receive a greater proportion of their debt or payment is to be made sooner, for instance) they will accept the PIA and bankruptcy proceedings won’t be required.
A Debt agreement, or “Part IX” is a documented agreement between an insolvent individual and their creditors. A debt agreement administrator is nominated to receive funds and distribute them according to the term of the agreement.
Secured creditors may recover assets to help cover debts and all unsecured debts should be addressed in the agreement, even if they are not going to be paid.
What are the consequences of bankruptcy?
Following completion of the legal process, the bankrupt person has certain restrictions and conditions applied to them:
- A permanent recordThe National Personal Insolvency Index (NPII) holds a permanent record of bankruptcies in Australia. Maintained by the Australian Financial Security Authority, the NPII records personal data, including the bankrupt’s name address and date of birth.
- Future employment
The bankrupt may be employed but may not take a role as a director or manager of any business. If future income is greater than an agreed threshold, the bankrupt may need to make compulsory payments via the trustee.
- Travel restrictions
The bankrupt individual may not travel outside of Australia without permission, in writing, from the trustee.
- Financial data
All financial data must be made available to the trustee. This includes salary details and any pay rises, plus details of bank accounts and any assets held.
The bankrupt may need to inform providers of credit of their status as a bankrupt individual, depending on the value of the credit requested.
What about my business?
A bankrupt individual may not be a director of a company during the term of the bankruptcy.
If you are the director of a company you will have to resign if declared bankrupt. There is also the possibility that your company’s assets may be seized to cover debts as part of the bankruptcy process.
As a company director, it is highly recommended you seek expert financial advice if you believe you may become personally insolvent. There are solutions and options available other than bankruptcy and the related, serious consequences for your company.
Are there alternatives for my business?
If your business is insolvent, or in danger of becoming so, you may be breaking the law by continuing to trade.
Some strategies you may consider for your company include:
A liquidator will take over the running of the company. The liquidator will investigate how the company has been run and the company finances. They will want to understand how the company became insolvent and ensure all trading was legal and conducted as expected.
The liquidator has a duty to the creditors and will identify company assets to be sold. Proceeds from the assets will be used to cover the costs of the liquidation and repay a percentage of outstanding debts.
When all available funds have been used to cover costs and settle debts, the liquidator will produce a final report. The ‘End of administration return’ documents the liquidator’s payments and receipts and is submitted to The Australian Securities and Investments Commission (ASIC).
The final part of the liquidation process is when the company is deregistered 3 months from the issue of the final report.
- The administrator
As with liquidation, the administrator takes control of the company and investigates finances and the running of the company. As before, the administrator will ensure creditors get the best outcome possible but, in this case, he will try to return the company to the directors to continue trading.
- The process
The administrator’s investigations into the company will aim to identify how the company got into financial difficulties and whether the directors broke any laws in their management of the business.
Ongoing analysis, including possible meetings with creditors, will lead the administrator to recommend an outcome.
- The outcome
Following his investigations, the voluntary administrator will recommend one of three potential outcomes, to be put to a vote by the creditors:
The administrator believes the company can’t be saved from its insolvency issues. A liquidator will be appointed to sell company assets to pay outstanding debts. The company will be wound up.
A Deed of Company Arrangement documents an arrangement for the company to repay some, or all, outstanding debts. When debts have paid, as detailed in the agreement, the company returns to trading under the control of the directors.
- Return the company to the directors
The investigations conducted by the voluntary administrator have led to the conclusion that the company can continue to trade successfully and profitably. Control of the company returns to the directors. All debts should be paid.
Restructure and turnaround
Specialist turnaround consultants review and investigate the financial structure of a company. Inappropriate funding or a poor capital structure may be adjusted as part of a restructure.
The strategy and operations of a business may be investigated in-depth and a ‘turnaround’ may be suggested. This could involve the sale of assets or the loss of employees not deemed to be essential for the company’s existence. A turnaround may include the development of new markets for the company.
Where can I get the best help?
A smart company director will spot the early warning signs of insolvency. It is stressful and upsetting when a business folds, impacting fellow directors, customers, suppliers and employees.
When you notice potential problems with cash flow or the first bills you are unable to settle promptly, you should act. Don’t wait to see if things will improve. They generally don’t!
Seek expert financial advice and assistance.
Corporate Lifeline will review your business and your financial situation and will identify solutions and strategies to help get you back to trading competitively and profitably.
Contact Corporate Lifeline today.