CHAPTER 2 - THE GENERAL SCHEME OF INSOLVENCY LAW         

 2.1       FUNCTIONS

 

Insolvency law has two principle functions: to provide an avenue for the recovery of debts, and to regulate and supervise the recovery procedure.

 

In addition, the law often gives the administrator of an insolvent debtor's estate the right or duty to carry out investigations. The aim is to unearth or locate assets, to explain why insolvency occurred and to bring to light offences that may have been committed.

 

On the importance of investigation the opinion of the UK Insolvency Law Review Committee (known as the Cork Report) is quite clear:

 

     " We believe that the investigative process is a crucial ingredient of any good modern insolvency law. Creditors and debtors alike must know that in the event of insolvency proceedings taking place there is a risk that an investigation, fully and competently carried out, will take place with a view to uncovering assets concealed from creditors, to ascertaining the validity of creditors' claims and to exposing the circumstances surrounding the debtor's failure. Anything less would, we believe, be unacceptable in a trading community such as our own and would be bound to lead to a lowering of business standards and an erosion of confidence in our insolvency law."

 

 2.2       TYPES OF DEBTOR ENTITIES

 

Companies and individuals are the main debtor entities encountered by creditors. Others include partnerships, trust [of several varieties], co-operative societies, building societies, credit unions, friendly societies and incorporated and unincorporated associations.

 

In law, companies are often classed or defined as persons. The distinction, of course, is that they are artificial persons whereas individuals are natural persons.

 

2.3       LEGISLATION

 

The particular legislation that may be brought to bear when a debtor is insolvent depends on the type of entity the debtor is. In chapter 3 reference will be made to the laws applicable to entities other than companies and individuals. But for now, and for most of this book, only the two main entities - companies and individuals - will be examined.

 

For companies the applicable statutes are the:

 

            * Companies Code,

            * Companies Regulations, and

            * Supreme Court Companies Rules.

            

For individuals the statutes are the:

 

            * Bankruptcy Act, and

            * Bankruptcy Rules.

 

Companies are governed [at the moment] by State laws, insolvent individuals by Federal laws.

 

Fortunately, due to an agreement between the States on co-operation in matters of company law, the various State Companies Codes and Regulations are the same in each State. [1] However, the Supreme Court Companies Rules are not. [2]

 

2.4       TYPES OF CREDITORS

 

A creditor is a person, company or other entity to whom a debt is owing. The debt may be for goods and services supplied, for work or labour done, for money loaned, or for obligations, undertakings or damages arising out of a contract.

 

Creditors fall into two classes: secured and unsecured. The insolvency laws further divide unsecured creditors into preferential and ordinary. These terms, and the distinctions between the various types, are explained in Chapter 3.

 

For simplicity, and because many [but not all] of the rights granted by insolvency law are available regardless of class, the word "creditor" is used throughout this book as a compendious word encompassing all classes. Use of the words "secured creditor", "preferential creditor" and "ordinary unsecured creditor" is confined to those areas where they have particular significance.

 

2.5       CREDITORS' RIGHTS

 

The rights given to creditors by insolvency law fall into two broad categories:

 

                   A. To control and supervise.

                   B. To request orders or action by the court.

 

Included in category A are the rights to:

 

                   * decide on the type of insolvency                         

                         administration;

                   * appoint an administrator;

                   * set the administrator's remuneration;

                   * give directions to the administrator;

                   * attend and vote at meetings;

                   * inspect records; and

                   * receive information.

 

Some of these powers - the first group of four for example - can only be deployed by passing a resolution at a meeting of creditors. The second group can be used by a single creditor acting alone.

 

Included in category B are powers which the courts have to:

                   * remove an administrator;

                   * reverse a decision of an administrator;

                   * inquire into the conduct of an

                     administrator; and

                   * convene a meeting of creditors.

 

A single creditor can ask the court to exercise these powers.

 

As stated above, these are broad categories of rights.  They vary from one type of insolvency administration to another.  In administrations which are designed for secured creditors - such as company receiverships - many of them are not available at all.

 

A special right given to individual creditors in some types of company insolvency administrations is the right to obtain payment of certain debts from the directors and managers of the company. These provisions apply where the court is satisfied that the business of the company has been conducted fraudulently or without due regard to the ability of the company to pay its debts.

 

Later in this chapter there is a summary of the powers given to various governing officials. A large number of those powers are rights rather than duties, which means the official may use them but does not have to. Unfortunately it must be said that unless pushed by creditors or shareholders or a public outcry, officials seldom make use of those rights even though the facts suggest they should. Consequently, many of the rights which are designed to assist creditors and protect the public interest can only be called into play through concerted action by creditors.

 

A similar problem exists with administrators. As many of their powers are discretionary an administrator might overlook some of them unless urged by creditors to act. Also, administrators are, to a large extent, responsible for ensuring that insolvent individuals and the officers of insolvent companies comply with duties imposed on them by insolvency laws.  Here, as in many other areas affecting creditors' rights, the crucial elements are the skill and dedication of the insolvency administrator.

 

2.6       RESTRICTIONS ON CREDITORS

 

Often one of the purposes of placing property of an individual or company in the hands of an administrator is to end spasmodic assaults on that property by separate creditors. The gaol is to ensure that management and realization of the debtor's property, and distribution  of the funds created, is carried out professionally and for the benefit of all those who have money at risk.

 

With this objective in mind, the insolvency laws frequently declare that once an insolvency administration is approved, no creditor is allowed to commence or continue legal action against the debtor unless the court's permission is obtained. Just as frequently insolvency laws declare that nothing in those laws affects the right of a secured creditor to realize or otherwise deal with its security.

 

2.7       NOTICES AND ADVERTISEMENTS

 

Insolvency laws stipulate that creditors be given written notice of certain events occurring prior to and during an insolvency administration. The sorts of events requiring notice are meetings of creditors, the commencement of bankruptcy or winding up, and an administrator's intention to pay a dividend to creditors. Notices are usually sent by the administrator.

 

Of course, notice can only be sent to creditors whose names and addresses are known to the administrator. So to inform the public at large and, perhaps, creditors the administrator is not aware of, the law also requires that certain notices [such as those just mentioned] be published in newspapers and/or the  Australian Government Gazette. Exactly where [and how many days before or after the event] the notice must be published depends on the law, regulation or rule applicable to the event. However, most notices appear in capital city daily newspapers. For example, notices concerning an individual debtor resident in Victoria, or a company incorporated in that State, are likely to appear in the Law Notices section of "The Age" newspaper.

 

2.8       COURTS  

 

The Bankruptcy Act [and Rules] are laws of the Australian Parliament. Accordingly, it is the Federal Court of Australia that has the power to administer and apply those laws, although jurisdiction is also invested in each of the State Supreme Courts.

 

In company law matters the courts with primary jurisdiction are the Supreme Courts of all six States and the two Territories. Matters relating to a particular company will generally be heard by the Supreme Court of the State or Territory in which the company is registered. The High Court of Australia may hear appeals against decisions made in Supreme Courts.

 

2.9       GOVERNING OFFICIALS AND INSTITUTIONS

 

At the top of the hierarchy of bankruptcy administration is the Federal Minister for Consumer Affairs. The most powerful government official is the Inspector-General in Bankruptcy. Other officials include the Registrars and Deputy Registrars in Bankruptcy, Official Receivers and the Official Trustee in Bankruptcy. The powers and functions of these officials and institutions are summarised in chapter 3.

 

In the area of company law the administrative structure is complicated by the fact that company law is, under the Constitution, a State matter, but the States have agreed to a co-operative scheme of uniform legislation.

 

[ At the time of writing this book the Federal Parliament has passed national companies legislation which is intended to replace the co-operative scheme. However, a successful High Court challenge by some States to the Commonwealth's right to legislate in the area has held up this move. At present it is generally believed that within the next six months the States will agree to transfer their rights to the Commonwealth and Australia will have national legislation.]

 

Under the co-operative scheme the body in charge is the Ministerial Council for Companies and Securities. It consists of the State and Commonwealth Ministers responsible for the administration of companies in their jurisdictions. Next in line, and responsible to the Ministerial Council, is the National Companies and Securities Commission [NCSC]. Then in each State and Territory are Corporate Affairs Commissions, responsible to the relevant State or Territory Government minister. The powers and functions of these bodies are summarised in chapter 3.

 

2.10      TYPES OF ADMINISTRATIONS

 

The types of administrations permitted by bankruptcy law fall into two categories: bankruptcy and arrangements with creditors.

 

Bankruptcy can be brought on by a creditor or voluntarily by the insolvent debtor. Either way, a petition must be presented to the Court.

 

The arrangements that can be made with creditors are a Deed of Assignment, a Composition and a Deed of Arrangement. The initiative for proposing such an arrangement rests with the insolvent debtor. But the decision on whether or not to enter into one rests with creditors.

 

Company law provides for five types of insolvency administrations:

          

          * Winding up [or Liquidation];

          * Provisional Liquidation;

          * Official Management;

          * Scheme of Arrangement; and

          * Receivership.

 

Usually winding up [or liquidation, as it is commonly called] is brought about either by a creditor's application to the Court or a special resolution passed by the owners of the debtor company. Those liquidations which result from a court order are classified as Official Liquidations whilst those resulting from a shareholders' resolution are termed Voluntary Liquidations.

 

Provisional liquidation of a company is an administration which the Court may order in special circumstances if there is an application before the Court to wind up the company.

 

Official Management and Scheme of Arrangement are names given to two types of arrangements that a company may enter into with its creditors in certain circumstances. The company takes the initiative in proposing the arrangement and its creditors decide whether or not to accept.

 

Receivership ordinarily results from action by a secured creditor who, under the terms of a debenture given to him/her or it by the company, has the right to take possession of company assets if the company fails to keep up its loan repayments.

 

It is possible, and not uncommon, for a company to be in receivership and liquidation at the same time. This situation arises because receivership is primarily concerned with the interests of the secured creditor rather than those of the company and all its creditors; and there are often assets which can be realized or recovered for unsecured creditors only through a liquidation. 

 

It is also possible, but extremely rare, for receivership to exist together with official management or a scheme of arrangement. But the other forms of administration -liquidation, official management and scheme of arrangement - are incompatible.

 

An essential ingredient in each type of administration is the person appointed to run the company and/or realize the assets and/or distribute the proceeds, as the case requires. In this book that person is called the administrator. Typically, upon the appointment of an administrator the directors of the debtor company lose their powers and authority.

 

2.11      ADMINISTRATORS

 

Every bankruptcy and arrangement under the Bankruptcy Act must be administered by a registered trustee or the Official Trustee in Bankruptcy. A registered trustee is a person, usually an accountant in private practice, accredited by the Registrar in Bankruptcy. The Official Trustee in Bankruptcy is a government institution.

 

In the company area administrators go by several different, but predictable, names:

 

             ADMINISTRATION                EXTERNAL ADMINISTRATOR

 

               Winding up - voluntary          Liquidator

               Winding up - court order       Official liquidator

               Provisional liquidation           Official liquidator

               Receivership - private           Receiver Receiver and Manager

               Receivership - court order     Court appointed receiver

               Official Management            Official manager

               Scheme of Arrangement       Scheme administrator

 

Normally to be eligible for appointment as a corporate administrator a person must be registered with a Corporate Affairs Commission as a liquidator. [The exceptions to this rule are mentioned in chapter 3.] Most registered liquidators and corporate administrators are accountants, and most accountants are members of either the Institute of Chartered Accountants or the Australian Society of Certified Practising Accountants or both.

 

2.12      INFORMAL SCHEMES OR ADMINISTRATIONS

 

The types of insolvency administrations mentioned so far may be called formal administrations because they are approved and regulated by the insolvency laws. However, in the area of company insolvency, informal schemes are gaining in popularity. The reasons for this development include, a widely held belief that the cost of formal administrations is too high and the return to creditors too low; a desire to avoid publicity [which can, amongst other things, cut realizations from asset sales]; and the cost and delay in implementing formal schemes of arrangement.

 

The structure and ingredients of a particular informal scheme for a company will depend on the type of business the debtor operates and the nature of its assets, liabilities and financial problems. Consequently any attempt to portray the typical informal scheme is fraught with danger. Nevertheless, the following points will serve as a guide:

 

               * An informal scheme is a documented agreement between a debtor and some or all of the debtor's creditors.

               * The purpose of the agreement may be:

                    [a] to release the debtor from some or all of its liabilities through the payment of a dividend to creditors; or,

                    [b]  to give the debtor more time to sell its business or part of its assets in an orderly way, or to trade out of its difficulties, or both.

               * In the case of a scheme designed to give the debtor time to sell its business, etc., creditors or their representatives may take part in management of the debtor's affairs.

               * Approval of the court or the Corporate Affairs Commission is not obtained.

               * Operation of the arrangement is not supervised by the court or the Corporate Affairs Commission.

 

The rights of those creditors who join in a particular informal scheme are expressed in the terms of their agreement with the debtor. Those creditors who do not participate in the scheme retain the rights given to them by law, such as the right to apply for the winding up of the company.

 

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