There is no denying, times have been tough for businesses, with the rate of business closures in Australia hitting their highest since October 2020. It comes as no surprise, with the downfall in construction companies, and high-cost pressures of living, the hospitality and construction sectors have seen the most insolvencies and closures, with overall numbers of administrations growing by 39% in 2023-2024 compared to previous years.

It is important for creditors to consider what flow on effects may occur once a debtor becomes insolvent, and their ability to recover debts during administration or receivership processes.

In Australia, a company is insolvent if it is unable to pay its debts as and when they fall due (section 95A of the Corporations Act). This is determined on a 'cash flow' basis, and considers whether a company can in fact pay its debts, which may be obvious to the company, but less obvious to creditors.

Administration

The role of an external administrator is to take control of the company, so the company's affairs are administered in an orderly and fair way, for the benefit of creditors.

There are two likely outcomes for a voluntary administration: strike a deal with the company to enter into a Deed of Company Arrangement, or for the company to be placed into liquidation. If you are a creditor, and a DOCA fund is established and agreed upon, this may see the company continuing to trade, contribute funds relating to claims and company debt, to assist with repayment.

Administrations can occur for varying reasons, including the deliberate and orderly winding down of the company by selling off assets, and can be voluntary or involuntary.  Administrations are usually short, lasting no more than a month and are designed to give the company some short breathing space from creditors whilst decisions around the company's future can be made.

When administrators are appointed, an unsecured creditor's enforcement rights are largely suspended during the period of the administration. They are prohibited from beginning, continuing or enforcing claims against an insolvent company, without an administrator's consent or court orders. Further, a creditor holding a personal guarantee from the company's director or other person cannot act under that guarantee without a court order.

In many circumstances unsecured creditors could be left out of pocket. This will depend upon what other secured/unsecured creditors are owed and what funds if any, are available for distribution amongst creditors following administration.

If you are a secured creditor of a company in administration, there may options available to secure possession of that asset during the administration. Whilst there are general moratoriums imposed on creditors, there are exceptions that enable secured creditors to enforce during the administration. The main exceptions are:

• where a secured creditor has already commenced enforcement action prior to the appointment; or
• a secured creditor with a charge over the whole or substantially the whole of the company's property decides within the 13 business days following notice by the administrator of the administration that they are going to enforce their security during the administration.

Depending on the nature of the security/asset, there may be certain statutory and common law requirements for notices and compliance before a creditor has a right to take possession of, and sell that asset.  There may also be legal obligations to comply with when considering the method of sale, market value of that asset, taking into account any subsequent interest holders and reporting to the administration accounting for the sale.

Receivership

If the insolvent company is under receivership, you need to consider if the receivership is in respect of the company, or just a specific asset. Your enforcement action will depend on whether or not the receiver is appointed for all of the company or a specific security.

The distinction between receivership and other forms of external administration is that receivers are usually appointed by secured creditors under a security interest, for the purpose of ensuring that secured creditor gets paid.

The role of a receiver is to sell enough of the charged assets to repay the secured creditors' debt. Creditors may receive funds from the receiver, however as is the case with administrators, will only be after the receiver has had their costs and fees paid, and payment of certain priority claims, including employee entitlements.

Whilst receivership is not an ideal sign for other creditors, it's not all doom and gloom, and may not necessarily be terminal for the company. However, it is not uncommon for administrators to be appointed after receivership.

The receiver's primary duty is to the company's secured creditor. However, holds a duty to an unsecured creditor to take reasonable care to sell the charged asset for not less than market value, or if there is no market value, the best price reasonably obtained.

For an unsecured creditor, legal action may be commenced or continued against the company, despite the appointment of a receiver. This means an unsecured creditor can apply to the court to have the company put into liquidation on the basis of an unpaid debt. If a liquidator is appointed, they must carry out the liquidation for the benefit of all unsecured creditors.

Small Business Restructure (SBR)

ASIC has reported on spike in the past 18 months in SBR appointments, growing over 200% in 2023-24 compared to the previous years. This spike might be attributable to the uptake in the scheme, having only commenced from 1 January 2021 to assist businesses impacted by COVID-19.

The SBR process enables eligible companies (i.e., those whose liabilities not exceeding $1,000,000) to retain control of their businesses whilst developing a restructuring plan with the assistance of a restructuring practitioner. The restructuring practitioner will assist the business entering into arrangements with creditors. If the restructuring plan is approved by creditors, the company can continue to trade and the SBR practitioner administers the plan and distributes funds to creditors.

Creditors need to understand they have very little time (5 business days) to respond to any dispute about the amount they're owed, by a company going through the SBR process.

If a creditor fails to object to the restructuring plan, then the plan could be accepted and thereafter become binding on them. A creditor may find they receive a poor return under a restructuring plan that has been approved by the other creditors, and you are unable to take any legal enforcement action against the company and/or director.

If the restructuring plan is not approved, the process ends and the company's directors can then decide to place the company into administration or liquidation.

Unlike a voluntary administration, the restructuring practitioner is not personally liable to pay creditors for any trading debts incurred once appointed. This means a creditor will only have a claim against the company if it continues to provide credit to the company.

This article is provided for informational purposes only and does not constitute legal advice.

This article was originally published in the February/March 2025 newsletter of the Institute of Mercantile Agents, The Agent.

‍