Chapter 5: Corporate Insolvency Workshop questions

Question One

Jonathan has just started his career in accounting after graduating from University. His is positioned
in the audit team of his employer and he is looking at the financials of a client, Jupiter Ltd. Jonathan
notices that last month Jupiter Ltd defaulted on a loan payment to a major creditor APB Bank Ltd.
Jupiter Ltd owes APB Bank $17,500. Jonathon also notices that Jupiter Ltd’s liabilities exceeds it
assets and its bank account is in the red.

Advise Jonathan of the following:

a) Is Jupiter Ltd insolvent?

Definition of solvency refers to a company being able to pay all debts when they
become due and payable under S95A(1) while a company who cannot do is insolvent
under S95A(2).
The company will go through a test of cashflow test but the company’s situation
must be considered in its entirety as a temporary lack of liquidity does not
necessarily mean that a company is insolvent.
Relevant case study of Sandell v Porter, court held that inability to pay a certain debt
does not prove insolvency but shows a temporal lack of liquidity and if the company
are still able to obtain funds through other means, it is not insolvent.
Applying it to this case, although assets and its bank account does not exceed the
liabilities, if assets and bank accounts are able to cover what is owed to APB bank of
$17,500, Jupiter Ltd is still solvent

Answer: Depends. Refer to the 5 bullet points under page 108 and also refer to
section 95A and cashflow test
b) Can APB Bank Ltd issue a statutory demand for payment of the debt owed by Jupiter Ltd?
A statutory demand can only be served if the debt is overdue and the amount owing
is at least $2,000 as per section 459E
In this case, APB Bank can issue a statutory demand as Jupiter has defaulted on a
loan payment which means the debt is over due and the amount owing is $17,500
which meets both the criteria of section 459E

Answer: Explain what is a ‘genuine’ dispute of the debt and if it arises what are the
implications to the creditor who had pursued a statutory demand notice – possible
implications – increased cost – refer to S459N
c) If the bank correctly serves a statutory demand on Jupiter Ltd, what are the two options
available for Jupiter in dealing with the statutory demand?
If the company admits the entire amount of debt specified in the statutory demand,
it can comply with the demand by paying the amount in full to the creditor. This
must be done within 21 days of receiving the statutory demand;

The company can try to reach a compromise with the creditor. This option may be
appropriate where it disputes part of the debt, or has an offsetting claim which
reduces the total amount of the debt in the demand. If the company manages to
reach a compromise with the creditor, it should be recorded in writing and include
an undertaking from the creditor to withdraw the demand.
 If the company cannot reach a compromise with the creditor, it can apply to either
the Federal Court of Australia or a Supreme Court of an Australian state for an order
setting aside the demand. There is no requirement to negotiate with the creditor
before making this application.

https://www.twobirds.com/en/news/articles/2017/australia/dealing-with-statutory-
demands

Answer:
Option 1: If there is a genuine dispute, contest the debt
Option 2: ensure that the debt is paid within 21 days to prevent the company from
being wound up
1
1
1

Question Two

a) What is the aim of voluntary administration (VA)?

Sign of insolvency
The fact that the directors of a company have placed the company into voluntary
administration is a signal to investors who have shares in the company, and to every
person dealing with the company (eg, entering into contracts with the company), as
well as to the company’s creditors, that the company is in serious financial difficulty
and that the directors suspect that the company is, or may become, insolvent.

Protecting directors from liability

The main reason directors place a company into voluntary administration is that
they are very concerned about their own personal liability for the company’s debts
under s 588G of the Corporations Act 2001 if they allow the company to continue to
incur debts when it may be insolvent. Putting an insolvent or potentially insolvent
company into voluntary administration removes risk of directors’ personal liability
for future company debts (although liability until the point of entry into
administration remains).

Answer: Attempting to ensure that the creditors get the best possible outcome –
particular in a situation where the company is (likely) to be insolvent – usually
appointed by the directors through a board resolution refer to para 5.90 textbook

b) What effect does VA have on the company and its creditors?

No share transfers
Most importantly for the investor, any share transfer during the period the company
is “under administration” will be void unless the court orders otherwise. Thus, once
administration occurs, the investor is unable at law to divest the investor’s shares in
the company unless the administrator unconditionally consents (and can only do this
if the administrator is satisfied that the transfer is in the best interests of the
company’s creditors as a whole) or if a court order is obtained: s 437F. This also
affects other alterations in the status of members – for example, the conversion of
 equity securities to debt securities would not be permitted.

Protection of company property - Mo

The company’s property is protected during the administration: ss 440A-440J.

For example, property that is used, occupied or possessed by the company during
administration cannot be seized or claimed by the owner or the possessor of a
security interest, unless a court order is obtained or the administrator consents: s
440B.

Further, existing court proceedings (including the enforcement of judgment debts)

are suspended, and new proceedings cannot be commenced without court approval
or the consent of the administrator: s 440D(1).

Such debts cannot be recovered under directors’ guarantees of the company’s debts
unless the court allows: s 440J.

However, an exemption now exists for property which is either cash, a negotiable
instrument, derivatives or a security, and is subject to a possessory security interest
held by an authorised deposit-taking institution (ADI) or the operator of a clearing
and settlement facility: s 440JA.
While the company is in administration, it cannot be voluntarily wound up by its
members, nor placed in provisional liquidation except under s 446A or s 446AA
(where the administrator becomes the liquidator): s 440A(3). The holder of a
security interest cannot enforce a security interest against the company unless it
covers perishable property, or the administrator consents, or the court so orders, or
if the security interest covers all or substantially all of the company’s assets and
enforcement occurs within the first 10 days of the administration: s 441A.

Answer: Moratorium which prevents creditors from purusing an action against the
company – to wind-up the company. Refer to 5.120 and 5.130 para
c) Do the directors of a company in VA still have powers and duties?
Yes, directors will lose their powers but duties remain and are obliged to assist the
appointed administrator with the investigation of the company’s business, property,
affairs and financial circumstances.

Answer: Refer to 5.140 3rd paragraph – under section 437D

d) What is a DOCA and what does it try to achieve?
DOCA is a deed of company arrangement which is a binding arrangement between a
company and its creditors governing how the company's affairs will be dealt with —
and is agreed to after the company enters voluntary administration

Answer: DOCA – deed (contract) of company administration = compromise – refer to

section 444A
Question Three

a) What is “liquidation” in the winding- up process?

“Liquidation” is the process of ending a company’s life, that is, of “winding up” the
company. The person who takes control of a liquidation is known as a “liquidator”.

Answer: Liquidation is merely part of the process of winding up the company.

Liquidators is to ensure that the debt owing the company is collected and placed in
an account together with other assets of the company – subsequently these funds
are used to ensure that creditors are paid based in order of priority.

b) What are the different types of winding up?

- Creditors
- Members
- Court order

c) Ben is a director of Float-a-way Pty Ltd, a company which specialises in holidays on yachts to
exotic Pacific islands. Unfortunately, due to a tidal wave many facilities have been destroyed
and the Pacific tourist industry has suffered a significant downturn.

Two months ago, Float-a-way Pty Ltd sold one of its luxury yachts to Mary, a director of
Float-a-way Pty Ltd for $2,000.

Float-a-way Pty Ltd owed $10,000 to South Pacific Supplies Ltd for provisions supplied to its
yachts. This amount was outstanding for many months. Percy, a director of South Pacific
Supplies Ltd has been a friend of Ben for some years and Ben had kept Percy informed about
Float-a-way Pty Ltd’s financial position. One month ago, Ben arranged for the total amount
owing to South Pacific Supplies Ltd to be paid by Float-a-way Pty Ltd.

REQUIRED:

If the assets of Float-a-way Pty Ltd are insufficient to meet its debts, are any of the
transactions described above voidable under the provisions of the Corporations Act?

Voidable transactions are referred to unfair transactions or situation where a particular

transaction is uncommercial.

Definitions
Under S588FA – Unfair preferences
Under S588FB – Uncommercial transactions
Under S588FC – Insolvent transactions
Under S588FD – Unfair loans to a company
Under S588FE – Voidable transactions
Under S588FDA – Unreasonable director-related transactions

Effects are under S588FE

S588FE(5) insolvent transaction and the company become a party to it for the purpose of
defeating, delaying or interfering with the rights of any or all of its creditors on a winding up
of the company.

Answer:
South Pacific – unfair preference – refer to S588FA – this is a voidable transaction by
liquidator – resulted in unsecured creditor obtaining a preference. Unfair preference will fall
under S588FE and order under S588FF may be given. Relation back period may be up to 10
years from the commencement of the winding-up – refer to S588FE(5)

Sale of the yacht – may amount to an uncommercial transaction – under S588FB – test is
based on a reasonable person – to determine if the company would have entered into such
a transaction. The relation back period is 2 years from wind-up commencement under
S588FE(3) and the court is entitled to make the order under S588FF.
Question Four

Johan and Marsha are the directors of JM Building Pty Ltd. Johan is the MD and controls all aspects
of the business, whilst his wife Marsha does not concern herself with the company at all. Marsha is
aware however that the company has severe financial problems. Last month, Johan purchased
$100,000 worth of building supplies on 30-day credit terms in the company’s name from Honest
Hardware Ltd. Despite numerous demands for the money to be repaid on terms, the debt has not
been paid. Honest Hardware Ltd has successfully applied to the court to have JM Building Pty Ltd
wound up.

Discuss whether the liquidator of JM Building Pty Ltd can make both Johan and Marsha personally
liable for all of the company’s unpaid debts. Do Johan and Marsha have any defences?

Both directors are in breach of S588G.

Very difficult to succeed in S588H

Safe harbour S588GA - If directors could satisfy the reason