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Litigation Update - INSOLVENCY - Is bankruptcy or liquidation the better way to recovery?

Litigation Update - INSOLVENCY - Is bankruptcy or liquidation the better way to recovery?

By Chris Stakis
April 1, 2016

Overview

  • Bankruptcy applies to individuals and is dealt with under the Bankruptcy Act.
  • A liquidation occurs when a company is wound up and is dealt with under the Corporations Act.
  • In the majority of cases,  individuals  or companies face the consequence of bankruptcy or a winding up when they are insolvent and a creditor wishes to recover a debt, although there are other circumstances which can lead to the same result.
  • Insolvency is defined as when an individual or a company is  unable to pay their debts at any given time.   This does not always necessarily lead  to a legal consequence until a creditor or the party themselves take steps.

Bankruptcy

  • Where a creditor wishes to recover a debt by  initiating  a bankruptcy proceeding, the first step is to obtain a judgment for the debt, then serve a Bankruptcy Notice on the debtor.
  • Section 40 of the Bankruptcy Act.  Effectively  provides that an act of bankruptcy occurs when a creditor has obtained against the debtor a final judgment  and the debtor does not comply with the requirement to pay the debt within 21 days under a Bankruptcy Notice.  The debt must be over $5,000.00.
  • If the Bankruptcy Notice remains unsatisfied,   the creditor may present a  petition to the court to have the debtor declared bankrupt.
  • The likelihood of recovery for a creditor will depend on the value of the estate of the bankrupt and the extent of any unsecured assets. Some searches can be undertaken to provide a creditor with information as to the value of a prospective bankrupt estate. This information will enable a creditor to make an assessment as to whether it would be beneficial to take bankruptcy steps against the debtor.
  • Bankruptcy is a relatively expensive process for the creditor to undertake and it is advisable first  to consider all other enforcement action available.  

Winding Up in Insolvency

  • A  common form of recovering a debt against a company is to initiate  winding up proceedings.   This begins with a Statutory demand issued under S459E of the Corporations Act.    The debt must be over $2000.00.  Unlike bankruptcy,  there is no requirement for the creditor to obtain  a judgment concerning the  debt.   A statutory demand can be issued on an unpaid invoice supported by an affidavit.  The creditor must also depose that there is no genuine dispute about the claim. 
  • If a company does not pay the debt on the statutory demand  or bring an application to the court to set it aside within 21 days, the company is deemed to have committed an act of insolvency. 
  • A creditor may then bring a petition to wind up the company on the grounds of insolvency.
  • Similarly to dealing with individuals, when considering  the question as to whether to take action to wind up an organization, it is advisable to consider other enforcement action,  as an unsecured creditor ranks behind many other claims.  A creditor who initiates a winding up, does not usually have any priority to the repayment of the debt.  Typically, we would recommend that various index searches be undertaken first, such as land index  searches and security searches on  the PPS Register before taking steps to wind up a company.

What might happen

In either case , whether in  bankruptcy or winding up, an individual or company can trade out of their legal predicament.   The Bankruptcy Act permits  a bankrupt to enter into a composition with creditors, which if accepted has the effect of annulling the bankruptcy. A company in liquidation can enter a deed of company arrangement with creditors which permits the company to reorganise its affairs and trade.  This process allows  the creditor  to negotiate with all the debtors and provide some return, although usually a small proportion of the actual debt.  This is a further consideration for a creditor who wishes to initiate proceedings in that the initiating creditor may have to share in any distribution, whereas other enforcement steps may enable a creditor a more direct path to recovering the debt.  These include, warrants to seize property or garnishee orders for any payments owed to the debtor.

For more information about e-conveyancing please contact Chris Stakis of our office.