Understanding the broad insolvency framework can help advisors guide their clients through complex insolvency processes. It can also lessen any financial and emotional impact on stakeholders, such as directors, employees and creditors.

How does corporate insolvency work?

The three most common types of formal insolvency appointments used when a company is in financial trouble are:

Voluntary administration

Directors may appoint a voluntary administrator to take control of the company to navigate a way out of insolvency. The administrator will determine if the company and business can be saved. If it’s possible to ‘trade out’ of the difficulties, the administrator will steer the company through that process.

The administrator, who assumes the powers of the company’s directors (which are suspended as a result of the administration), will review the company’s position and provide a report to creditors on the property, business, affairs and financial circumstances of the company.

They’ll also make a recommendation on the most appropriate strategies the company should take.

Depending on the outcome of those investigations, there are three options:

  • End the voluntary administration and return the company to the control of the directors;
  • If the company is able to regain its momentum, to recommend and approve a deed of company arrangement (DOCA) to allow the company to pay all or part of its debts and maximise creditor returns; or
  • Wind up the company and appoint a liquidator

The courts and/or creditors also have the power to appoint an administrator. For example, a secured creditor holding security over most of the company’s assets may decide to appoint an external administrator to govern the company’s affairs.

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Liquidation is the term used to describe the process of winding up a company’s affairs. It includes the realisation of company assets, the ceasing of trade, distribution of proceeds to creditors and distributing the surplus (if any) to its shareholders.

The three types of liquidation are:

  • Court liquidation (as a result of a court order);
  • Creditors’ voluntary liquidation (initiated by the company); and
  • Members’ voluntary liquidation (a procedure initiated by company members of solvent companies to wind up the company)

A liquidator’s primary duty is to secured and unsecured creditors, with shareholders ranking behind company creditors.

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Receivers are generally appointed by secured creditors who hold security over some or all of the company’s assets, such as a bank or financial institution holding security under a mortgage. The appointment is made according to the secured creditor’s security documentation.

A receiver has a duty of care to all creditors and shareholders to sell the secured assets for not less than its market value, or if there is no market value, the best price reasonably obtainable.

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Different stakeholders will have different perspectives on a company’s insolvency situation. Creditors will want their debts paid as soon as possible, directors will likely be concerned with any personal exposure to liability, and employees may wish to profit from their employment entitlements.

Seeking the advice of an insolvency professional can help key players navigate the unpredictable storm of the company’s financial distress.

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