Insolvency affects hundreds of thousands of Australians every year from company directors and shareholders to employees and creditors. Given the scope and seriousness of its impact insolvency law is incredibly complex and specialised.

According to Australian law a company is ‘solvent’ only if it is able to pay all of its debts as and when they become due and payable. This is called the ‘cash flow test’ of insolvency. Companies that are unable to satisfy this test are deemed to be ‘insolvent’ and should not be allowed to trade. These companies should be wound up.

Several formal administrations exist for a company that is experiencing financial distress. The appropriateness of each administration depends on the company’s particular circumstances including:

• whether its financial position is hopeless;
• whether the interests sought to be protected are secured or unsecured creditors; and
• the goals sought to be realised by the affected parties.

There are three formal types of administration:

• Liquidation is the process of ‘winding up’ a company’s affairs to bring to an end its existence.

• The company’s assets are collected and sold to discharge its debts and liabilities.
• At the end of this process the company is deregistered and ceases to exist.
• Although liquidation is typically associated with insolvent companies there may also be reasons why solvent companies may be wound up such as the death of a director.

• Receivership occurs where a receiver is appointed. This is usually initiated by a secured creditor. A secured creditor is a creditor with security such as a mortgage over certain company assets.

• The receiver’s key duty is to protect or sell the secured assets for the secured creditor’s benefit.
• A receivership can and frequently does takes place at the same time as an administration or a liquidation.

• Voluntary Administration is where a voluntary administrator investigates and reports to creditors on the company’s history and financial position and makes a recommendation regarding the company’s future.

• Creditors may be recommended to vote in favour of a proposed deed of company arrangement (DOCA) which becomes binding on all creditors if the deed is entered into.
• Although a voluntary administration can rescue companies from insolvency it can also lead to a liquidation.

The appointment of a formal administrator such as a liquidator may be voluntary if begun by the company or involuntary for example if begun by a creditor or employee.

This Legal Guide on Insolvency and Liquidation provides information about the different administrations including their typical progression and effects. Before making important decisions it is advisable to obtain legal advice specific to your situation. LegalEagle’s™ free directory profiles all lawyers in Australia. You can use it to Find a Lawyer near you.

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Warning: Information provided through LegalEagle™ is for general guidance. It is not legal advice. Laws and procedures referred to may change and differ between states, territories and nationally. There may also be important exceptions or qualifications. Only a lawyer providing formal legal advice can assess your particular circumstances to determine how the law will apply.