Corporate insolvency mechanisms
There are numerous insolvency mechanisms available to companies in distress. Often complex and jurisdictionally nuanced, it is common for these mechanisms to be misdescribed in announcements and press coverage, with important implications for creditors and stakeholders.
Learn more about Australia's corporate insolvency mechanisms using this helpful glossary of key terms.
Winding up (compulsory or involuntary)
There are numerous terms to describe insolvency. These three terms in particular share the same meaning ─ they describe an insolvent company where:
If the business of the company has not already shut down or had its assets stripped away, the liquidator's role is to:
At the end of a liquidation, the company is deregistered and ceases to exist.
Creditors' voluntary liquidation (CVL)
Creditors' voluntary liquidations (CVL) arise when a company is insolvent and its directors, and then shareholders, resolve that the company ought to be wound up and a liquidator appointed.
This usually occurs after some external pressure from a creditor (often the Australian Taxation Office) or from the company losing a contract on which it was dependent.
In these circumstances, the liquidator takes on a similar role to a court-appointed liquidator and the company will be deregistered at the end of the process.
Members' voluntary liquidation (MVL)
A members' voluntary liquidation (MVL) occurs when the shareholders of a solvent company, being one that has paid or can pay all its debts when due and payable, wish to wind up the company's affairs and have it deregistered. During an MVL, a liquidator is appointed to undertake the process.
A corporate group with multiple dormant subsidiaries may undertake a MVL program to rid itself of the compliance burden and costs associated with its subsidiaries. The MVL process gives the corporate group more assurance that previously unknown or latent liabilities will be identified and managed. A MVL can become a CVL if the liquidator determines that a company is in fact insolvent.
A provisional liquidation may be necessary where the winding up of a company is pending but urgent ─ for example, where assets of the company are in jeopardy.
A liquidator is given interim control to take stock of a company and report back to the court on its position. A later winding up order of the company is common but a provisional liquidation can allow for order to be restored to the company and the winding up application dismissed.
There are two types of receivership ─ private, and court-appointed.
Private: The holder of a general security agreement (GSA) or mortgage from a company, such as a bank, may give itself power in the GSA or mortgage to appoint a receiver or, more commonly, a receiver and manager over the secured assets in the event of default.
A receiver may continue to operate a business over which they are appointed to realise its maximum value. The receiver's role is to collect and preserve the secured assets of a company, and then realise them for the benefit of the appointor.
The interests of unsecured creditors are generally not the receiver's concern, although they do have duties that assist to protect such interests. A voluntary administration (VA) or creditors' voluntary liquidation (CVL) may run at the same time as a receivership, particularly where the company has several leasehold interests that the secured creditor wishes to preserve under the moratorium that applies in a VA.
Court-appointed: A court-appointed receiver may result from a shareholder/director dispute or, for example, where a former corporate trustee seeks to protect its indemnity against trust assets. Court-appointed receiverships are also often used in the resolution of partnership disputes.
Scheme of arrangement
Generally reserved for large and complex company reconstructions because of the time and costs involved, a creditors' scheme of arrangement is a court-supervised mechanism to divide creditors of a company into different classes and then bind them to a compromise or arrangement to which the different classes and the court agree. Each class may be treated differently by the scheme, some more favourably than others, and some may be left out or "crammed down" by the scheme.
Voluntary administration (VA)
Voluntary administration (VA) is an important restructuring tool in Australia's insolvency regime.
When a company's directors determine that it is insolvent or likely to become insolvent, they can appoint a voluntary administrator to take control of the business, property, and affairs of the company.
During the administration, the aim is to maintain the company's status quo through a month-long moratorium against creditors and others taking recovery action against the company or seizing control of its property. This gives the company, its directors and the administrators breathing space to prepare a restructuring plan that can be implemented through a deed of company arrangement (DOCA). As an example, the complex Virgin Australia restructuring proceeded via a VA and a DOCA that was approved by the creditors.
The administrator also investigates the company's affairs during the moratorium period. They then report to creditors on voidable transactions and any corporate wrongdoing, the recovery actions available if the company ends up being wound up, any DOCA proposal, the options available to creditors, and whether a CVL may end up a better option for creditors than proceeding with a DOCA. In the end, the creditors decide the future of the company.
Each corporate insolvency mechanism has its own nuances. Directors, managers, and in-house counsel facing an insolvency situation, be it a supplier or customer (or even a situation involving their own company), should seek specialist advice on insolvency mechanisms and the events that may occur during its course.
Even during situations of financial distress, there can be opportunities to protect, and even maximise, a company's position.