Debt recovery from a company in liquidation can be difficult. If a company enters liquidation and owes you money, retrieval of the balance of the debt is dependent on several factors. Most significantly, one of these factors is whether the company in liquidation has any money to make repayments to you, or other creditors. However, specific actions can be taken in the case of insolvent trading.
Liquidation is referred to as the winding up of a company. During this process, the company’s assets are liquidated and the company may cease trading or be deregistered. A company is solvent when that company can repay its debts when they fall due. If they cannot repay their debts when they fall due, then the company is insolvent.
The pari passu principle means that all unsecured creditors have an equal entitlement to share in a proportionate distribution of the assets of an insolvent debtor. Notably, the differing characteristics of the creditors, including the nature of their credit relationship with the insolvent company, and their concurrent vulnerability to the risk of insolvency do not have an influence on how the assets are distributed. This principle may be seen as inflexible; however, it is efficient as it allows for lower costs of distribution, making available more credit to distribute to creditors.
According to the Corporations Act 2001 (Cth) s 588G, it is the duty of directors to prevent insolvent trading by the Company. Insolvent trading occurs where the incur debt without a reasonable prospect for being able to repay that debt. In these circumstances, the director becomes liable for the to compensate the company or creditors for those debts incurred during the insolvent trading.
To commence a proceeding for insolvent trading against the directors of a company in liquidation, the creditor must provide the liquidator with written notice of an intention to begin proceedings to claim the debt. In addition to this, the creditor must also receive notice from the liquidator themselves, which can outline consent to the proceedings. Where consent is communicated, permission from the court for the creditor to commence the proceedings must be provided. Alternatively, the liquidator could provide a written statement which outlines that the liquidator thinks the creditor should not commence proceedings. The reasons why the liquidator thinks proceedings should not be commenced must be provided. However, if the liquidator does not reply, the creditor may need to apply directly to the court for permission to commence an action against the directors.
For a claim of insolvent trading, there are four steps. Firstly, the directors must have contravened relevant insolvent trading provisions in the Corporations Act 2001 (Cth) s 588G. Secondly, the creditor needs to have suffered loss or damage because of the company’s debt. Thirdly, the debt must be wholly or partly unsecured when the creditor suffered the loss or damage. Fourthly, the company must have been in the process of being wound up. Section 588M of the Corporations Act 2001 states that the liquidator has a time limit of six years from the date of liquidation to take action in relation to insolvent trading.
Defences to insolvent trading must also be noted under s 588H of Corporations Act. The first defence is that the director had reasonable grounds to believe or suspect that the company was solvent at the time of trading. Secondly there is a defence if the director had reasonable grounds to expect the company would remain solvent if it incurred the debt and other debts at the time the debt or debts were incurred. Furthermore, if the director took positive action to stop the Company from incurring further debt a defence is available. The director could also prove that they had reasonable grounds not to take part in the company’s management during the time of insolvent trading for reasons of illness or other circumstances as a defence to insolvent trading.
Creditors should be aware of their options to take action against a company or directors of that company during insolvency to recover debt. If you need assistance with this, please get in touch today using the form at the bottom of the page.
This article was authorised by Warwick Heeson.