April 7, 2022

What Happens When a Company Becomes Insolvent

Insolvency occurs when a company can no longer repay its debts on time.
In other words, where a company’s debt obligations outweigh its cash flow, the company will be considered insolvent. Most businesses will grow and shrink over time as the market changes. These shifts are normal and largely unavoidable, and a company can be at risk of becoming insolvent if it experiences continued losses, has a low liquidity ratio or has poor access to alternative finance options. In most cases, insolvent companies enter into voluntary administration to repay and seek forgiveness from their debts without jumping straight to liquidation. In this article we will review the administration process and how insolvent companies handle their debt obligations.


Appointing an External Administrator

When a company becomes insolvent, or if the directors suspect it will become insolvent, it can appoint an external administrator and enter into voluntary administration. The external administrator takes control of the company to review its affairs and propose the best course of action to make sure creditors are repaid. Administration benefits both the company and its creditors. By entering into administration, a company effectively earns a reprieve as creditors are unable to take legal action against the company until the administrator has decided on the best course of action.

The administrator investigates the company’s affairs, property, business and financial circumstances. Their findings are presented to creditors and the administrator can recommend one of three outcomes:

  • That control of the company is returned to the directors so that the company can continue to trade while it repays its debts
  • That the company should be wound up and a liquidator appointed
  • That the company enter into a Deed of Company Arrangement with its creditors, through which the company can pay some or all of its debts and then be free of those debts


Deed of Company Arrangement

A Deed of Company Arrangement (DOCA) is the intended outcome of most voluntary administrations. The administrator takes over the insolvent company’s operations, reviews its actions and finances, and then proposes a solution that maximises the amount of money that will be returned to creditors. DOCA agreements are designed to:

  • Protect the interests of creditors and provide them with better returns
  • Improve the likelihood of the company being able to trade-on

While controlling the company’s operations, the administrator will develop a DOCA to present to creditors. Creditors then review the DOCA and either vote to approve or reject the agreement. A DOCA is a binding legal agreement. So, if it’s approved by creditors, the company will proceed according to the administrator’s proposal. In this case, the company will repay its debts under the DOCA and then be free of them. If the DOCA is rejected, the insolvent company will be placed into liquidation.


Paying Back Money Owed to Creditors

Whether the creditors vote for the administrator’s DOCA or place the company into liquidation, money that is owed to creditors still needs to be repaid. Repayments are made based on predetermined priorities. Generally, the priority of payments is:

  1. The costs of liquidatorsor administrators are paid first. This ensures skilled professionals are available to manage these processes
  2. Secured creditors who hold a security over the company’s assets are paid next. Secured creditors include parties such as banks who hold mortgages over the company.
  3. Employees >receive a share next. Employees are designated as Priority Unsecured Creditors for the purposes of liquidation. Employees may also be able to recover money through the Fair Entitlements Agreement which allows them to claim up to 13 weeks of unpaid wages.
  4. Other unsecured creditors, like customers and suppliers, receive payments they are entitled to. Customers who have purchased goods or services that they haven’t received can register as unsecured creditors.
  5. Finally, shareholders receive a share of the money from the liquidation process.


Concerned About Becoming Insolvent? Speak to the SV Partners Team Today

All companies experience financial difficulties sooner or later. If your company has become insolvent, or if you are concerned about the possibility of becoming insolvent, it is important to appoint an administrator as soon as possible. SV Partners are experienced administrators, and our team has helped businesses all over Australia to recover from financial difficulties. Our administration process gives companies the best chance of trading on and reaching a solution that’s agreeable for all stakeholders. Get in touch with us today, or call our confidential assist line on 1800 246 801 to arrange a consultation.

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