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"CREDITORS' RIGHTS IN INSOLVENCY IN AUSTRALIA:

A PRACTICAL GUIDE"

Written by P Keenan

 Written between 1990 and 1994

(Published for the first time on this site on 5/5/2007)

CHAPTER 4 - CREDITORS VOLUNTARY LIQUIDATION

PART A


 

4.1    NATURE OF ADMINISTRATION                                                                                              Caution long narrow

 

To the extent that the phrase "creditors' voluntary liquidation" suggests such liquidations are brought about by creditors it is misleading; for in fact only the members (shareholders) of a company have the power to voluntarily place the company in liquidation. What the phrase really means is that creditors are empowered to play a key role in the winding up of the company.

 

The first step in a creditors' voluntary liquidation is a meeting of the company's directors, convened because of the company's apparent insolvency. At this meeting the directors decide to call a special meeting of members to consider a proposal that the company be wound up. Directors also decide, in conformity with the law, to call a meeting of creditors to be held on the same day as, or the day following, the meeting of members.

 

Then follows a period of time, usually 14 days, until the meetings are held. During this period, referred to in this book as "the transition period", the company remains under the control of its directors.

 

If the meetings of members and creditors go as planned the company is placed in liquidation (by the members) and a registered liquidator appointed. Creditors are entitled to decide who will be liquidator. But if they fail to nominate someone the person nominated by members gets the job. A director or member may contest the creditors decision in court, although such challenges are rare and few succeed.

 

On appointment the liquidator takes charge of the company. He or she realizes its assets, investigates its affairs, sends reports and accounts to the Australian Securities Commission and distributes the net proceeds of asset realizations to creditors.

 

Often much of this work is done in consultation with creditors. For this purpose a committee might be formed. If not, meetings of all creditors may be held from time to time. In any case the liquidator will report to creditors on his/her activities at annual meetings and again at a meeting held after the winding up is finalised.

 

Occasionally a creditors' voluntary liquidation is brought about by the failure of a "members' voluntary liquidation" (a winding up of a solvent company). When the liquidator of a members' voluntary liquidation forms the view that the company will not be able to pay its debts in full within 12 months, he/she must convene a meeting of creditors. After the meeting - at which creditors may appoint some other person to be liquidator - the winding up proceeds as if it were a creditors' voluntary winding up, except that where the creditors do not replace the liquidator he/she may not have to call an annual meeting.

 


4.2    EFFECTS ON UNSECURED CREDITORS

 

To obtain payment of their debts creditors of a solvent company possess certain rights (remedies) against the company itself and against the company's property. The rights to sue for the debt and to petition for a winding up are examples of the former, whereas the rights to have property seized and sold or to exercise a lien are examples of the latter.

 

However, when a company becomes insolvent and its winding up "commences" the insolvency laws take away most - but not all - of those remedies. The purpose of this interference is to convert such remedies into a right to claim in the liquidation and participate equally with other creditors in the proceeds of an orderly realisation of the company's assets.

 

A creditors voluntary liquidation "commences" when a special resolution to wind up the company is passed by its members. But before that can happen the directors of the company must give creditors formal notice of the proposed resolution (see old 4.3). Clearly receipt of this notice could lead to a scramble for the company's assets. So the law restricts the rights of creditors against the company and its property from the time notice is given. If, as occasionally happens, the members do not pass the special resolution, the creditors rights are automatically reinstated.

 

Chapter 13 (Remedies Outside Liquidation) looks at the sometimes complicated effects that both the formal notice and the special resolution have on the remedies ordinarily available to creditors. The remedies examined are:

 

*    civil proceedings;

*    petition to wind up;

*    payment;

*    execution and attachment;

*    sequestration and distress;

*    re-entry;

*    repossession;

*    lien;

*    stoppage in transit;

*    withholding delivery; and

*    set-off.

As that study shows, there are several opportunities for creditors to take action against a company and/or its property even though the company is insolvent.

 

It also shows that the despatch of notices convening meetings ("the notice of insolvency") does not restrict creditors remedies as much as the actual commencement of liquidation ("the special resolution"). By doing so the study highlights an important distinction which creditors should not overlook.

  


4.3    EFFECTS ON SECURED CREDITORS

 

A secured creditor is an entity (a person, company, etc.) which holds a mortgage, charge or lien on property of the debtor company as a security for a debt due to that entity.

 

For the most part the rights and powers of secured creditors are not altered by the notice of insolvency or the special resolution: they are entitled to stand outside the liquidation and realise their securities independently of it.

 

But this general rule applies only to secured creditors whose security is good against claims by the liquidator. The most common forms of invalid securities are:

 

     1.   Unregistered charges.

 

     2.   Floating charges created within 6 months before the special resolution and at a time when the company was insolvent. (Such charges are valid to the extent of moneys paid to the company on or after creation of the charge and a small, set rate of interest on those moneys.)

 

     3.   Charges created within 6 months before the special resolution, at a time when the company was insolvent and with the effect of giving the creditor a preference over other creditors.

 

     4.   Charges in favour of certain persons: for example, officers of the company.

 

If a security is not valid, the liquidator will disregard it and realise the "charged assets" " for the benefit of all creditors. If the "secured" creditor realises those assets before the liquidator is appointed, the liquidator would almost certainly recover from the creditor the amount realised.

 

Chapter 13 (Remedies Outside Liquidation) looks at the various remedies that might be available to unsecured and secured creditors. The remedies discussed in the section on secured creditors are:

*    civil proceedings;

*    petition to wind up;

*    payment;

*    taking possession; and

*    appointing a receiver.

Some of these remedies can be utilised even if the security is not valid. Others only exist where the security is valid, the remedies are authorized by the security document (or the law) and the necessary default has occurred.

 


4.4    EFFECTS ON EXISTING CONTRACTS

 

The following comments, taken from a book entitled "The Law of Company Liquidation" by B.H. Mc Pherson and J. O'Donovan, outline the effects which liquidation may have on contracts with the company:

 

“It is impossible to generalise about the effect of winding up upon contracts to which the company is a party, since each case depends upon the nature and terms of the contract in question and the circumstances affecting the winding up.  Liquidation may have no effect at all upon the existence of contracts made with the company or it may give rise to a state of affairs which terminates the contract. If the former, the contract continues until repudiated or disclaimed by the liquidator. If the latter, then the winding up operates to discharge the contract in one of two ways: either by frustration - in which case the obligations of both parties are at an end - or by breach, in which case the other party will be entitled to prove for damages in the winding up.”

 

Chapter 14 (Continuing Supplies of Goods, Services and Property) examines this topic in more detail, looking in particular at the following contracts:

*    sale of goods;

*    employment;

*    services;

*    hire purchase and lease; and

*    rental.

As will be seen, the two distinct events - notice of insolvency and special resolution - can have different effects.

 


4.5     EFFECTS ON NEW CONTRACTS

 

Whether or not a creditor/supplier should enter into a new contract with the company during the transition period or after the special resolution depends above all on the prospect of an adequate profit on the transaction. And in evaluating that prospect the supplier should, as usual, look beyond the contract price and canvass the issue of payment; for there is no statutory guarantee of payment for goods, services and property supplied during the transition period or after a liquidator is appointed.

 

Another ingredient in calculating whether or not a creditor should trade with an insolvent company is the prospect of an increased dividend on the pre-liquidation debt. Often the value of a company's assets can be preserved only if it continues to trade and sells its business as a going concern. Therefore by continuing to supply the company, creditors stand to benefit by sharing in a higher return on the company's assets.

 

That, at least, is the theory. But a higher dividend depends not only on a better price being achieved (a result which creditors should not take for granted) but also, for example, on the size of amounts owing to secured or preferential creditors. Where such priority creditors exist all or most of the benefit of the improved price may go to them.

 

Both of these issues - payment and dividend - are examined in Chapter 14 (Continuing Supplies of Goods, Services and Property).

 


4.6     NOTICE OF INITIAL MEETING OF CREDITORS

 

At least 7 days before the meeting creditors must receive written notice of the creditors' meeting together with certain documents.  The notice will probably refer to the section of the Companies Code under which the meeting is called - Section 398 - and/or employ the phrase "creditors voluntary winding up". 

 

Creditors who do not receive a notice - perhaps learning of the planned meeting through an advertisement or from other creditors - should contact the convenor of the meeting or the company and request a copy of the package of documents sent to creditors.

 

The documents creditors must receive are:

(a)  a notice, advising the date, time and place of the meeting;

 

(b)  a form (known as a Summary of Affairs) revealing the nature and value of the company's assets and the amounts owing to secured, preferential and ordinary unsecured creditors;

 

(c)  a list displaying the names and addresses of all creditors and the amount owing to each one; and

 

(d)  a proxy form.

 

In this package creditors should also receive a form on which they can enter particulars of their debts.

 

Those creditors whose debts do not exceed $200 might not receive a list of creditors (item (c) above).  But if they don't, their "packages" must contain advice as to where the list can be obtained.

 

The notice of meeting (item (a) above) must explain the purpose of the meeting and should include the agenda.  The matters to be decided at the creditors' meeting are:

1.    Election of a person to chair the meeting.

2.    Whether the meeting has been held at a date, time and place that is convenient to the majority, in value, of creditors.  (This decision is made by the chairman.)

3.    Whether a committee of inspection should be appointed and, if so, who should be on it.

4.    Who will be liquidator.

 

The meeting of creditors will also receive from the directors a form containing details of the company's assets and liabilities (a Report as to Affairs) and creditors will be given the chance to question a director and a secretary of the company about the company's affairs and the circumstances leading up to the winding up.

 

Also, the creditors might be asked to decide certain other matters, such as:

  • The liquidator's remuneration. 

  • Whether to give the liquidator power to pay any class of creditor in full.  (This proposal usually refers to a debt incurred by the company in obtaining assistance with convening the members' and creditors' meetings.)

  • Whether to give the liquidator power to make a compromise or arrangement with a creditor.

These three agenda items (for example) are optional rather than mandatory because they are dealt with by the creditors only if they decide not to appoint a committee of inspection.  Naturally, if a committee is appointed it will decide these issues.  (There is more on the powers of a committee of inspection later in this chapter.)

 


4.7    BEFORE THE CREDITORS' MEETING

 

Having received notice of the meeting it is then time for each creditor to make decisions.

 

First, there is the decision whether or not to take part in the meeting.  If the answer is no, there is nothing more for the creditor to do until after the meeting.  But creditors who want to take part will need to address these issues:

1.    Appointment of a proxy.

2.    Particulars of the debt or claim.

3.    Appointment of a chairperson.

4.    Choosing a liquidator.

5.    To have or not to have a Committee of Inspection.

6.    How the liquidator is to be remunerated.

7.    What questions to put to the directors.

 These issues are analysed in this chapter.  But first, there are some comments on the value of creditors talking to one another.

 

4.7.1    Discussions with other creditors

 

A creditor who wants to maximise his/her or its impact on the meeting should get in touch with other creditors as soon as possible after receiving the notice.  The advantages of doing so include:

 

1.    A possible increase in voting power.  If other creditors had not intended taking part in the meeting they might be prepared to appoint the creditor as their proxy.

 

2.    An agreement on several issues.   For example, who should chair the meeting, whether the members nominee for liquidator is acceptable (and, if not, who the creditors should nominate) and whether a Committee of Inspection should be formed.

Of course, before these discussions take place it will be necessary to know who the members intend nominating as liquidator.  This might be mentioned in the notice of meeting, but if it isn't the creditor should find out by asking a director of the company or the person organising the meeting.

 


4.8    APPOINTMENT OF A PROXY

 

Any creditor who is entitled to attend and vote at a meeting has the right to appoint a natural person (over 18 years of age) as a substitute to attend and vote at the meeting on the creditor's behalf.  For obvious reasons, a creditor that is a company must appoint a proxy.

 

The person who is appointed to act as proxy must bring to the meeting or forward to the convenor beforehand (whichever is specified in the notice) evidence of his/her authority to act.  As a rule this evidence will be the proxy form received by the creditor with the notice of meeting and subsequently completed.  For more on this see Chapter 13.

 

If a proxy is to be appointed the question of who to appoint must be carefully considered.  Unfortunately many creditors simply put the words "the chairman" or "the liquidator", which is almost equivalent to deciding not to take part in the meeting at all.   What creditors should seek in a proxy holder is someone who knows the creditors' rights, knows how the meeting should be conducted and, above all, will act on their behalf.

 

A proxy holder can be given specific powers - such as to vote on certain resolutions in certain ways - or a general power to vote on all matters that arise as he/she thinks fit.

 


4.9    PARTICULARS OF DEBT OR CLAIM

 

The only creditors entitled to vote at a meeting are those who have lodged particulars of their debts or claims with the chairperson of the meeting or the person named in the notice as the one who may receive those particulars.  Hence, this requirement should not be overlooked or treated lightly.

 

Naturally the amount of the debt or claim must be stated.  If it is contingent or, in the case of a claim which is before the court, has not been assessed or quantified, an estimate of its value must be made.  Either way, details must be given of how the debt arose; for example, "goods sold and delivered on (date/s) as per invoice (number/s)".  For comments on which types of debts are provable see Chapter 13.

 


4.10    APPOINTMENT OF A CHAIRPERSON

 

Creditors have the right to appoint the person who will preside over their meeting.  The person they appoint must be either the director who is required to attend the meeting or a creditor or a person acting as proxy for a creditor.

 

4.10.1    The "nominated liquidator" as chairperson

 

The "nominated liquidator" is the person who has been nominated by the members for the job of liquidator.  He/she is their candidate.

 

Often in practice creditors appoint the nominated liquidator as chairperson.  (To be eligible for election as chairperson he/she must hold at least one proxy from a creditor.) This person is said to be the logical choice because of his/her knowledge of the rules and laws to be followed at the meeting.

 

But creditors should bear in mind two other factors:

(1)  The person elected to chair the meeting is given a number of important powers, such as the power:

  • to admit or reject a proof of debt or claim for the purposes of voting;

  • to decide whether the meeting has been called for a date, time and place convenient to the majority in value of creditor;

  • if the vote is tied, to have a casting vote;

  • to prepare minutes of proceedings at the meeting.

(2)  On election that same person collects what frequently amounts to substantial voting power through being appointed as proxy by those creditors who give their vote to "the chairperson".  At times throughout the meeting creditors might find that having these powers in the hands of the members' candidate is a drawback.


 

  4.11    CHOOSING A LIQUIDATOR

 

One of the most important powers given to creditors is the right to choose who will be the liquidator (although their choice can be challenged - see 4.1).  By choosing the best person for the job creditors increase their chances of getting a good return on their debts and have the comfort of knowing a thorough job will be done.  In fact a successful liquidation depends more on the quality of the liquidator than anything else.

 

The obvious factors to consider in choosing a liquidator are the candidate's skills, knowledge and ability and his/her scale of fees.  (For more on the subject of fees see 4.13 - Liquidator's Remuneration and Chapter 13.) Less obvious, but also important, is the experience and ability of his/her support staff, as it is they who will do most of the day to day work.

 

Just as essential as expertise and cost are integrity and independence.  The last thing creditors need is a liquidator who is a "puppet" of directors of the insolvent company.  Any investigation carried out by such a liquidator is not likely to discover assets which might have been diverted to a director's private use, or preferential payments directors might have received or offences they might have committed.  Even a liquidator who, prior to his/her appointment, has had no more than a brief professional acquaintance with the members or directors of a company might find it hard to act independently if he/she owes his/her appointment to them.

 

If creditors want as liquidator a person other than the one put forward by shareholders, they must obtain from their candidate his/her written consent to act.  A pro forma written consent to be completed and forwarded to the candidate can be found at, although this might not be necessary because most eligible candidates have their own.  Whichever form is used it must be obtained before the meeting of creditors and should be delivered or handed to the chairperson.

 

To be eligible for appointment as a liquidator a person must first and foremost be a registered liquidator.

 

Note: Lists of the names and addresses of registered liquidators are kept by the Australian Securities and Investments Commission.  Click here to go to ASIC's web page where a search may be conducted.

 

As well as this positive requirement, there are several things that a candidate for appointment as liquidator must not be.  These restrictions come from provisions in both insolvency law and ethical rules promulgated by accounting and insolvency organisations. 

 

Note: All registered liquidators should be aware of these restrictions.  Hence a creditor who is asking a registered liquidator to consent to appointment should only have to tell him/her the name of the company that is about to go into liquidation and the liquidator will know whether or not he/she can act. 

 

Later in this chapter (4.13) the remuneration of the liquidator is discussed.  As that discussion will show, many variations exist in the way remuneration can be calculated and paid, and a decision on this question is not finally made until the committee of inspection or the creditors meet.  However, this issue will need to be addressed when a potential liquidator is being sought because the manner in which he/she is to be remunerated is likely to be foremost in his/her mind.

 


4.12     COMMITTEE OF INSPECTION ?

 

Creditors have the right to decide whether to appoint a committee of inspection.  If they want to have one, they also determine its size and make-up, usually ensuring that a clear majority of the positions are taken by persons representing creditors rather than shareholders.

 

4.12.1    Powers

 

The main tasks of a committee of inspection are to advise, assist and supervise the liquidator.  It is both a guide dog and a watch-dog.  It cannot compel the liquidator to comply with its wishes, because the liquidator has a duty to use his/her own discretion.  But the liquidator is required to have regard to any direction given by the committee.

 

Apart from this general role, the committee has certain specific powers, such as the power to:

1.    Fix the liquidator's remuneration.

2.    Give the liquidator certain additional powers.  For example, the power to pay any class of creditors in full, to make any compromise or arrangement with creditors and to compromise any debts of more than $20,000 due to the company.

3.    Approve the continuance of any powers of the directors.

4.    Allow, or refuse to allow, the books of the company and the liquidator to be destroyed before the expiration of the otherwise minimum period of 5 years from the date of dissolution of the company.

5.    Direct the liquidator to invest surplus funds in an authorised trustee investment, on the short term money market or on deposit at interest with a bank.

6.    Grant the liquidator power to receive for the sale of company property, shares etc.  in a company.

Although these powers are given to a committee, they are not lost if creditors fail to appoint a committee.  In that event powers 1 to 4 (but not 5 and 6) can be exercised by creditors as a whole or, failing that, all of these powers may be deployed or granted by the court on the application of the liquidator. 

 

4.12.2    Advantages

 

If creditors as a whole can utilise most of the powers given to a committee of inspection the question which must be answered is why have a committee.

 

The answer, in part, is that a committee, being a much smaller group than the general body of creditors, can exercise those powers and carry out the role of guide dog/watch-dog cheaper and more efficiently. 

 

Take meetings for example.  First, to call meetings the liquidator does not have to give the 14 days notice required for meetings of creditors.  Secondly, the cost of calling a meeting is cheaper because only committee members are given notice and meetings do not have to be advertised.  And finally, decisions at a committee meeting are made by a simple majority (show of hands) rather than by the cumbersome "majority in number and in value" method which might be required at a creditors' meeting. 

 

This sort of freedom means, for example, that in the early stages of a difficult or complex winding up the liquidator could consult the committee every week, or even daily, if he/she thought it appropriate. 

 

But apart from comparisons of cost and the speed at which meetings can be brought about, there is the question of who may call meetings.  With meetings of creditors (other than annual meetings and the final meeting which are discussed later in this chapter) the decision on when to call them rests with the liquidator.  In contrast, a meeting of a committee of inspection  can be called by any committee member.  This right gives creditors, through their representatives, an important advantage because meetings are a very effective way of obtaining information and exercising supervision.

 

4.12.3    Disadvantages

 

As will be obvious from the above, being a member of a committee of inspection carries with it an obligation to attend meetings, which means a commitment of time.  And, unfortunately for the member, this will be time for which he/she is not entitled to any remuneration from the company.  In other words, it is an honorary position.

 

It is also a position of trust.  This means that a member must act in the interests of the party he/she represents and is not, unless the court gives its permission, allowed to receive a direct or indirect benefit from his/her position.  Specifically, a member of a committee cannot

  • Purchase any property of the company.

  • Derive any profit or advantage from a transaction, sale or purchase for or on account of the company.

  • Derive any gift, profit or advantage from a creditor.

  • Receive or accept from the company or any other person, in connection with the winding up, a gift, remuneration or any consideration or benefit.

 

A transaction which contravenes these rules may be set aside by the court on the application of a creditor or member of the company.

 

As these prohibitions only apply to a person while he/she is acting as a member of the committee, an option available to any member who wants, for example, to purchase property of the company is resignation from the committee.  The resignation must be by notice in writing signed by the member and delivered to the liquidator.  The vacancy thereby created can be filled at a meeting of creditors.  If not filled that way, it can be filled at a committee meeting.  Even if the vacancy is not filled, the committee can continue to act as long as there are at least 2 members.

 

4.12.4    Qualification of Members

 

To be able to represent creditors on a committee of inspection a person must be either:

  • a creditor of the company;

  • the attorney of a creditor by virtue of a general power of attorney; or

  • a person authorized in writing by a creditor to be a member of the committee of inspection.

Only individuals (natural persons) can be appointed to a committee.

 

4.12.5    Number of Members

 

As mentioned earlier, there must be at least two members on the committee.  (There is no upper limit.) However, in practice a committee with only two members (or, indeed, any even number) might sometimes find itself unable to act, since decisions must be made by a majority in number.

 

For that reason, the committee should consist of no less than three members.  But, to be  safe, at least five members should be appointed.  This number overcomes another problem which frequently occurs: the absence of members.  Because a committee can act only when a majority of its members are present, a committee of three has very little margin for absenteeism. 

 

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