If you’re dealing with a company in financial distress, it’s critical to understand what (if any) type of external administration you’re dealing with. Just lumping all forms of external administration under a single umbrella of “liquidation” is potentially going to harm you in the long run.
So, in this article we’re going to touch briefly on the significant features of the three most common forms of external administration – administration, liquidation and receivership.
In a nutshell, the critical things to take away from this article are:
- Understanding that there are different types of external administration and how to recognise them;
- Knowing some of the critical differences.
Understanding Insolvency Practitioners Generally
In Australia, most insolvency practitioners are specialist accountants.
They have expertise in reviewing businesses in financial distress, understanding the legal regime relating to insolvent companies, and practical experience dealing with the issues that most commonly arise during company insolvency.
So while we use words like administrators, liquidators and receivers to describe the different roles that insolvency practitioners take on, in practice they are not different types of professional.
That said, each appointment is a different roles with a different purpose. It’s those different roles we are going to discuss here.
Insolvency in a Nutshell
We won’t explore this in detail here, but basically insolvency goes like this:
- A company is solvent if it can pay its debts as and when they fall due;
- A company that is not solvent, is insolvent.
So once a company recognises its own insolvency, or someone else does, there are a few directions the company might head in.
Administration (AKA Administrators Appointed)
Administration is a short term stop-gap solution to company insolvency. It is typically kicked off by a resolution of the directors that the company “is, or is likely to become, insolvent” at which time they will appoint company administrators that they have chosen in advance.
The role of administrators is to assess the situation of the company, determine whether it is viable in its current form or not, and make a recommendation to the creditors about the future of the company.
The administrators will do that by considering the company’s financial position, the reasons for its financial distress, and using their expertise as accountants investigating whether there is a path to company viability.
Once they have done that, they will make one of three recommendations to the creditors (that is, people the company owes money to) to consider:
- Hand control back to the directors and end the administration. In theory, if the company is actually viable and the directors made a mistake, the administration could simply end. In practice this basically never happens.
- Do a deal – called a “Deed of Company Arrangement” (or DOCA), if the administrators are presented with a set of terms (usually from a director) that reasonably satisfies them that the creditors will be better off doing the deal than going into liquidation, then they might recommend a DOCA. Essentially this is a bargain struck between the creditors, the company, and the person who proposes the DOCA.
- Go into liquidation (see below).
The creditors decide which outcome they will go with through a vote. The outcome is determined by considering both the number of creditors voting and the value of their debts.
Liquidation (AKA In Liquidation)
Liquidation is generally commenced by:
- A vote of creditors after administration as described above;
- A resolution of the directors to go straight to liquidation (skipping the administration process); or
- A court order.
Unlike administration, liquidation is pretty much a permanent death knell for the company. While there are some rare circumstances where a company might spring back to life, liquidation’s main function is to permanently finalise the company’s affairs.
To do that, liquidators have a number of important roles. They:
- investigate whether there has been any wrongdoing by the directors and report to creditors and ASIC accordingly;
- collect debts owed to the company;
- pursue claims for specialised types of Court action available only to liquidators called voidable transactions (eg “preference” actions, which we’ll deal with in another article);
- pay out employees, banks and creditors in the order of priority determined by the Corporations Act.
Receivership
Receivership sits slightly to one side of the other two major forms of external administration.
Although a Court can order their appointment, receivers are usually appointed to a company by a secured creditor like a bank. They do this because their agreement with the company contains clauses that permit the bank to appoint receivers in some circumstances.
Receivers have a more specific role than administrators or liquidators. Their purposes is, fundamentally, to sell the assets of the company until they can pay the debt owed to their appointor (again, normally a bank or someone who has lent money to the company).
Despite that fairly specific role, however, receivers ordinarily have full control over the company.
Importantly, receivers can be in place at the same time as an administrator or liquidator, and often are.
If that’s the situation, receivers normally have a greater degree of influence over the company, and the administrators or liquidators are forced to stand by until the receivership ends. By that time the company regularly has precious few assets left to deal with, and the ordinary unsecured creditors might be deeply dissatisfied with the outcome.
Once their appointor is paid out, the receivers will be retired.
Common Complaints About the Insolvency Regime
As you’d expect, when a company goes under there is often significant stress on the people the company was dealing with – including employees, suppliers and general creditors.
Some of the more common issues that people find challenging to deal with are these:
- Fees – as professionals, all insolvency practitioners will charge fees. They get paid these fees as a high priority, and above any amount that might be paid out to creditors. Because it can be hard to know what the practitioners are doing, often people perceive these fees as being unreasonably high.
- Unpaid Debts – in some circumstances people might keep working with a company in administration or receivership, only to find the administrators or receivers then refuse to pay the debt. This can be extremely frustrating, but the legal side is complicated and it will be a case by case assessment of the consequences.
- Liquidator’s powers – as we mentioned above, liquidators have certain powers to claw back payments made by the company in liquidation. The one that many people find unfair is a “preference claim” where, basically, if you got paid money in the last 6 months by the company you’re at risk of getting a demand to pay it back. There are lots of components to such a claim, but even receiving the initial letter can set people on edge.
None of these issues are simple. The best thing we can recommend is that the moment you think you’re dealing with a company in financial distress, get some proper legal advice about the steps you can take to mitigate your exposure, or at least be taking calculated risks.
Dealing with a Company in External Administration?
If you’ve had a contractor, supplier or client go into external administration (or they are getting very late in paying their bills) reach out to us for a chat.
We can help you navigate through the process and make sure you don’t misstep along the way.