Insolvency is the point at which an entity can no longer pay its debts as they fall due. For a company it typically leads to voluntary administration or liquidation; for an individual, bankruptcy. Each process has its own rules, its own timeframes and its own implications for creditors.
Acting quickly and correctly when you learn a debtor is insolvent can make a real difference to what you recover. Doing nothing almost certainly means recovering nothing.
Signs of insolvency
Common warning signs include:
- Payments consistently late, then stopping altogether.
- Bounced cheques or rejected direct debits.
- Requests for extended time or reduced payments without explanation.
- ASIC records showing a change of officeholder or a court winding-up application.
- A notice of appointment of an administrator or receiver.
If you see these signs, act immediately — do not extend further credit, do not accept personal property as payment without advice, and check the ASIC register.
Voluntary administration
Voluntary administration is a process in which an independent administrator takes control of a company to assess its options: a deed of company arrangement (DOCA), liquidation, or returning control to the directors. During administration, most legal proceedings against the company are stayed.
As an unsecured creditor, you are entitled to vote at the creditors' meetings held by the administrator. Attend, or formally appoint a proxy. The administrator must send you a report and a notice of the first meeting — read both carefully. You may be asked to vote on a DOCA that offers partial payment in lieu of liquidation. Whether to accept depends on the proposed return versus what liquidation might realise.
Liquidation
In liquidation, a liquidator realises the company's assets and distributes the proceeds to creditors in a prescribed order. Secured creditors are paid first from the assets securing their debt. Then certain employee entitlements. Unsecured creditors come after, and often receive cents in the dollar — or nothing.
You must lodge a proof of debt to participate in any distribution. The liquidator will send you a form and instructions. Lodge it promptly, with supporting documents (invoices, statements, contracts). If you don't lodge, you may not receive any distribution even if funds are available.
Bankruptcy (individual debtors)
If your debtor is an individual (a sole trader, or a director you have a personal guarantee from), insolvency takes the form of bankruptcy. A trustee in bankruptcy takes control of the bankrupt's assets and distributes them to creditors. Bankruptcy generally lasts three years, after which most debts are discharged.
Again, lodging a proof of debt with the trustee is essential if you want to participate in any dividend. Some assets are protected — a family home (depending on equity) may be protected, as may tools of trade up to a threshold. A trustee can also pursue certain transactions made before bankruptcy (preferences, undervalued transactions) that may increase the pool available to creditors.
Secured vs unsecured creditors
A secured creditor holds a security interest over specific assets — for example, a bank with a mortgage, or a supplier who has registered a security interest under the PPSR. Secured creditors have priority over those assets and are generally much better placed in an insolvency than unsecured creditors.
If you are an unsecured trade creditor, your realistic expectation in most liquidations is a partial recovery at best. This is why pre-emptive steps — registering on the PPSR where possible, obtaining personal guarantees, and acting quickly on overdue accounts — matter so much before insolvency occurs.
Proofs of debt
Lodging a proof of debt is the formal step by which you register your claim in the insolvency process. You will receive a form from the administrator, liquidator or trustee. Complete it accurately, attach your supporting documents, and return it by the deadline specified. A late or unsupported proof may be rejected or ranked below timely claims in distributions.
What you can still recover
Even in insolvency, recovery is not always zero. Options that may remain open include:
- Distributions from the insolvency estate — depending on the assets realised.
- A personal guarantee — if you hold a properly executed guarantee from a director, you may be able to pursue the guarantor personally, independent of the company's insolvency.
- PPSR-registered security interests — if you registered correctly and on time, you may be able to recover the specific goods or their value ahead of unsecured creditors.
- Director liability — in some circumstances directors can be personally liable for insolvent trading. This is a legal remedy requiring specialist advice.
This guide is general information only. It does not constitute legal or financial advice. For advice specific to your situation, consult a qualified professional.