When a company is experiencing a shortage of business opportunities, overwhelming tax or superannuation liability, or unmeetable loan or bill payments, that company may be nearing insolvency. Insolvency is defined as being unable to pay one’s debts as and when they fall due, and in situations like these company directors have an obligation to avoid the company trading whilst insolvent. Entering voluntary administration is one of the most effective strategies directors can use to fulfil this duty.
The Corporations Act 2001 (Cth) (the Act) confers numerous powers and responsibilities on directors of Australian companies. Among these responsibilities is the duty to prevent insolvent trading of their company under s588G. A director that allows his or her company to incur a debt either:
• That causes the company to become insolvent; or
• When the company is insolvent or likely to become insolvent;
at a time when there are reasonable grounds to suspect insolvency, can become personally liable to repay that debt and may be banned from being a company director. If that failure to prevent insolvency was done dishonestly, then the director may also incur criminal penalties or even jail time.
Directors have a clear obligation under corporations law to prevent insolvent trading, and it is undoubtedly within their personal interest to do so to avoid civil and criminal penalties.
What Is Voluntary Administration and How Does It Work
Voluntary administration involves the appointment of one or more insolvency practitioners who will take responsibility for the operations and finances of the company and investigate the affairs in order to report to creditors on a view concerning the future of the company.
Within eight business days of the administrators’ appointment, they must hold a meeting of creditors, who will vote to either ratify the appointment or replace with a different administrator. The administrators will then conduct their investigation and within 28 days a second meeting is held, where the administrators will provide a report and a recommendation to creditors, to put the company into liquidation, to return control to the directors, or enter into a Deed of Company Arrangement (DOCA).
What Are the Benefits of Voluntary Administration?
The benefits of entering voluntary administration are numerous, including:
• Providing temporary protection from legal actions and creditor demands;
• Potentially improving the efficiency of the company and possibly improving profitability;
• Preventing insolvent trading;
• Potentially salvaging the business to allow it to continue trading after administration; and
• Directors may avoid claims against them for breaches such as the duty to prevent insolvent trading.
Many of these benefits will not apply if the company goes into liquidation.
Option or Obligation?
While entering voluntary administration is strictly speaking optional, the consequences for failing to do so could prove disastrous for directors. Given the statutory duties placed on directors and the consequences for failing to meet them, the voluntary administration scheme becomes more of a must than a maybe for most directors of near insolvent companies. Despite directors usually having to indemnify administrators for their costs, which could be thousands of dollars, it is difficult for directors to justify not entering voluntary administration when there is clear evidence of insolvency.
While voluntary administration should always be investigated as an option for a company nearing insolvency, it may not always be the most effective strategy. Clients facing bankruptcy should seek advice from an insolvency practitioner about their best options, as well as legal advice on the legal risks associated, and then consider how to proceed. Attempting to reach informal arrangements with creditors or obtaining finance to consolidate and manage debt might prove useful alternatives in less severe cases of financial distress. Conversely, companies that are so far gone in terms of insolvency that they have no feasible chance of being able to enter a DOCA or continue trading might opt for skipping voluntary administration and going straight to the inevitable outcome. This can save time and avoid further depleting the company resources available to creditors but may leave directors vulnerable to incurring personal liability.