An extract from The Insolvency Review, 9th Edition

Insolvency law, policy and procedure

i Statutory framework and substantive law

The Corporations Act 2001 (Cth) (the Corporations Act) is the primary legislative reference for, among other things, the registration, insolvency and reorganisation of companies incorporated in Australia. In the context of insolvency, the Corporations Act prescribes the manner in which an Australian company can enter into a formal insolvency process and how its assets are ultimately distributed to creditors.

The legislative framework for personal insolvency is set out in the Bankruptcy Act 1966 (Cth) (the Bankruptcy Act), which prescribes the manner in which an individual may enter into a personal insolvency agreement, debt agreement or a formal bankruptcy process. Unlike some other jurisdictions, bankruptcy in the Australian context refers to the insolvency of an individual only.

Despite the regulation and rules governing corporate and personal insolvency being contained in two separate and distinct pieces of legislation, the Australian government has introduced legislative reform by way of the Insolvency Law Reform Act 2016 (Cth), intended to align, to the extent possible, the Bankruptcy Act and the Corporations Act and create common rules for both corporate and personal insolvency processes.

For the purpose of this chapter, however, we have focused on the statutory framework and substantive law for corporate insolvency processes only.

The broad aim of insolvency law is to balance the interests of the primary stakeholders in an insolvent estate, these being debtors and creditors. A number of formal procedures are available under the Corporations Act in the event of insolvency. These include receivership (private and court-ordered), voluntary administration, deeds of company arrangement, provisional liquidation, liquidation (voluntary and involuntary, and solvent and insolvent), and schemes of arrangement (court-sanctioned).

The Australian test for solvency is set out in Section 95A of the Corporations Act, which provides that: 'A person is solvent if, and only if, the person is able to pay all the person's debts, as and when they become due and payable. A person who is not solvent is insolvent.'

The courts have not applied Section 95A as a rigid rule but rather as a factual question to be determined as a matter of commercial reality and in light of all the surrounding circumstances. The Section has been applied in a wide and varied manner. Despite its broad reading, courts have highlighted certain key issues that must be considered when faced with the question of assessing a company's solvency at a particular point in time. These key issues relate to the cash flow test and prospective considerations.

The key test of solvency in Australia is the 'cash flow' test, rather than the 'balance sheet' test. That is to say, a company must have sufficient cash flow available to it to meet its debts as and when they fall due. The balance sheet analysis is not immaterial, however, because courts have held that it is often relevant in providing background and context for the proper application of the cash flow test.2

ii PolicyThe Australian government's response to the covid-19 pandemic

In response to the covid-19 pandemic, the Australian government enacted the Coronavirus Economic Response Package Omnibus Act 2020 (Cth), which came into effect on 25 March 2020. This legislation provided temporary economic and other relief to ensure continuity for Australian businesses and jobs and aimed to provide 'breathing space' to reduce the number of businesses entering into formal insolvency processes. While the temporary relief measures ended for most businesses on 31 December 2020, the relief was extended for incorporated businesses with liabilities of less than A$1 million that appointed a restructuring practitioner before 31 March 2021. This is to align with the insolvency reforms for small businesses that came into effect on 1 January 2021.

The temporary relief measures include:

  1. relief for directors and holding companies from trading while insolvent where new debts are incurred in the ordinary course of business;
  2. increasing the threshold at which creditors can issue a statutory demand (from A$2,000 to A$20,000) and increasing the time companies have to respond to such demands (from 21 days to six months); and
  3. the ability for the Treasurer to provide targeted relief for classes of persons from provisions of the Act (by legislative instrument) to deal with unforeseen events and government actions resulting from the pandemic.
Safe harbour and ipso facto reforms

There has been a historical view, propounded by some, that Australia's insolvency regime is focused more on punitive measures than on the rehabilitation of debtor companies. This is in contrast to other jurisdictions where insolvency laws, many consider, better promote restructuring, innovative reorganisations and value preservation.3 To seek to address some of these perceived issues, on 18 September 2017, the Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Bill (the TLA Act) received royal assent. The TLA Act brought into operation two fundamental changes to Australia's insolvency laws:

  1. a new safe harbour from civil liability for insolvent trading for directors seeking to restructure financially distressed or insolvent companies, without commencing a formal insolvency process such as voluntary administration or liquidation,4 (i.e., a safe harbour); and
  2. a legislative stay on the enforcement of certain ipso facto rights (i.e., an automatic stay on the enforcement of clauses that allow one party to terminate or modify the operation of a contract upon the occurrence of a specific event, such as an insolvency event, regardless of the continued performance by the counterparty).

The safe harbour provisions introduced Section 588GA into the Corporations Act. Under this Section, a director will not be liable for debts incurred by a company while it is insolvent if 'at a particular time after the director starts to suspect the company may become or be insolvent, the director starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company' than the 'immediate appointment of an administrator or liquidator to the company'. To assess this 'better outcome' test (noting the relevant director bears the evidential burden if he or she seeks to rely on this defence), Section 588GA(2) sets out the steps that a director could take, including developing and implementing a plan for restructuring to qualify for safe harbour. A director cannot rely on the provision if, at the time the debt is incurred, the company has failed to pay employee entitlements or comply with certain reporting or taxation requirements. Further, the provision is not intended to protect directors against statutory and general breach of duty claims.

Since its introduction, the courts have only once examined the safe harbour provision,5 and anecdotal evidence as to its efficacy is limited. In 2019, an industry survey found that 48 per cent of respondents consider safe harbour to have had no impact on the turnaround industry in Australia.6 Further, a 2019 survey of members of the Australian Restructuring Insolvency and Turnaround Association (ARITA) found that respondents: (1) had limited experience with safe harbour in terms of being engaged by a client to develop a safe harbour plan; (2) considered strongly that the reform is best suited to large companies; and (3) believed the reform was not achieving its objectives, being to achieve more successful restructurings outside of formal insolvency and to promote entrepreneurship.7 A government review of safe harbour was expected during 2019 but has been delayed due to the covid-19 pandemic.

The second recent development, the introduction into the Corporations Act of an automatic stay on the enforcement of ipso facto provisions, came into effect from 1 July 2018. Broadly, the automatic stay operates to preclude a party from enforcing certain rights (including terminating a contract or accelerating a debt) simply because the company has entered into certain formal insolvency processes. The reforms apply to: (1) voluntary administration;8 (2) receivership (for managing controllers);9 and (3) creditors' schemes, where the scheme is proposed to avoid liquidation.10 However, the automatic stay will not apply to:

  1. receiver or controller appointments that are not over the whole or substantially the whole of the company's assets;
  2. entry by a company into a deed of company arrangement (DOCA);
  3. liquidations (including provisional liquidation), other than those immediately following a voluntary administration or where the company is fully wound up in connection with a scheme of arrangement;
  4. rights or self-executing provisions arising under contracts entered into prior to 1 July 2018;
  5. rights or self-executing provisions in syndicated loan agreements; and
  6. certain contract types and rights prescribed in the Regulations and Ministerial Declaration as being exempt from the automatic stay.

Pursuant to the new Sections 415E, 434K and 451F of the Corporations Act, a court may lift the automatic stay if the court is satisfied that it is in the interests of justice to do so, or if the stay relates to a relevant scheme of arrangement, that scheme is found not to be for the purpose of avoiding being wound up in insolvency.

Strengthening protections for employee entitlements

On 5 April 2019, the Corporations Amendment (Strengthening Protections for Employee Entitlements) Bill 2018 (Cth) (the SPE Act) received royal assent. The amendments to the Corporations Act brought about by the SPE Act are intended to strengthen enforcement and recovery options to deter behaviours that prevent, avoid or significantly reduce the recovery of employee entitlements in insolvency. The most significant changes include:

  1. an extension of the existing criminal offence provision to capture a person recklessly entering into transactions to avoid the recovery of employee entitlements;11
  2. enhanced personal liability consequences by introducing a new civil penalty for such action with an objective reasonable person test;12 and
  3. the ability for a liquidator, in certain circumstances, to seek compensation for loss or damage suffered because of a contravention of the civil penalty provision, among other things.13

The SPE Act further introduced a Division 8 to Part 5.7B of the Corporations Act dealing with contribution orders for employee entitlements, whereby a court may order an entity within a 'contribution order group' to contribute, in certain circumstances, to the payment of the employee entitlement liabilities of an insolvent company in the same contribution order group.14 Those able to apply to the court for an order are a liquidator, the Australian Tax Office, the Fair Work Ombudsman and the Department administering the Fair Entitlements Guarantee Act 2012 (being a scheme of last resort for the payment of employee entitlements).

It may take some time before the reforms are properly considered by the courts. A contravention of Section 596AB has only been considered once since its implementation in Connelly v. Commonwealth of Australia, Australian Road Express Pty Ltd (Receivers and Managers Appointed) (in liq) [2018] FCA 1429. This case concerned an unsuccessful attempt to have the defendant's claim for a contravention of Section 596AB(1) struck out. However, the alleged contraventions did not proceed to trial for substantive determination because the parties discontinued the proceedings.

Combating illegal phoenixing

As part of the 2018–2019 Federal Budget, the Australian government announced a series of reforms to combat illegal phoenix activity, being transactions that take place when a company is nearing insolvency and is intended to defeat creditors.

The Insolvency Practice Rules (Corporations) Amendment (Restricting Related Creditor Voting Rights) Rules 2018 (Cth) (the Rules) took effect on 7 December 2018 and amended the Insolvency Practice Rules (Corporations) 2016 (Cth) by, in effect, preventing phoenix operators from 'stacking' votes at creditors' meetings by assigning debts without consideration to related creditors who then vote to appoint, and keep in place, a 'friendly' liquidator or voluntary administrator (who will in turn fail to properly investigate the phoenix activity that has occurred). The Rules provide, in respect of debt assigned to a related creditor, that:

  1. the related creditor will only be allowed to vote up to the value it paid for the debt; and
  2. an external administrator must ask all related creditors who have been assigned a debt for written evidence of the assignment and the consideration paid for the assignment for voting purposes.

In addition, the Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 (the Illegal Phoenixing Act) provides a power for liquidators to recover property that is the subject of creditor-defeating dispositions (in line with their existing legislated ability to claw back voidable transactions).

The Illegal Phoenixing Act commenced on 18 February 2020 and resulted in the introduction of a new Section 588FE(6B) of the Corporations Act, which provides that creditor-defeating dispositions of company property are voidable if they are made while a company is insolvent or if they cause the company to become insolvent or enter external administration within 12 months of the disposition. The new Section 588FDB of the Corporations Act defines a creditor-defeating disposition as a disposition of company property for less than its market value (or the best price reasonably obtainable) that has the effect of preventing, hindering or significantly delaying the property becoming available to meet the demands of the company's creditors in winding up.

The Illegal Phoenixing Act enhances the personal liability consequences for illegal phoenix transactions by introducing both a civil penalty regime and criminal liability (with recklessness being the fault element) for creditor-defeating behaviour conducted by directors or facilitators (e.g., pre-insolvency advisers).

The Illegal Phoenixing Act also introduces a new Section 203AA of the Corporations Act to prevent the backdating of director resignations when such resignations are reported to the Australian Securities and Investments Commission (ASIC) more than 28 days after their purported occurrence. It also provides that if a resignation would result in the company having no other directors, it will have no effect unless the company is being wound up. This seeks to address illegal phoenix practices relating to backdating the effective date of director resignations to escape liability for a company's actions following the effective date.

iii Insolvency proceduresFormal procedures

The formal insolvency procedures available under Australian law are:

  1. receivership (both private and court-appointed);
  2. voluntary administration;
  3. a DOCA;
  4. provisional liquidation;
  5. liquidation (both solvent (known as a members' voluntary liquidation (MVL)) and insolvent (known as a creditors' voluntary liquidation (CVL) or court-appointed);
  6. special purpose liquidation;
  7. a court-sanctioned scheme of arrangement between creditors and the company; and
  8. small business restructurings and simplified liquidations.

For all insolvency processes, other than a MVL, the individual appointed must be a registered liquidator.

Receivership

The main role of a receiver is to take control of the assets of a company (subject to the security pursuant to which the receiver is appointed) and realise those assets for the benefit of the secured creditor. One or more individuals may be appointed as a receiver or a receiver and manager of the assets. Despite some historical differences, in practice, it is difficult to distinguish between a receiver and a receiver and manager.15 Receivers are not under an active obligation to unsecured creditors on appointment, although they do have a range of duties under statute and common law.

A receiver can be appointed to a debtor company pursuant to either (1) the relevant security document granted in favour of the secured creditor when a company has defaulted and the security has become enforceable; or (2) an application made to the court.16 The latter is far less common and, as such, this chapter focuses on privately appointed receivers.

The security document itself will set out the secured party's rights to appoint a receiver (usually effected by way of a deed of appointment, and the secured creditor will often but not always indemnify the receiver by way of a deed of indemnity). Once appointed, the receiver will ordinarily (by way of contract) be the agent of the debtor company (not the secured creditor) and will have wide-ranging powers, including the ability to operate the business, sell assets or borrow against the secured assets. Those powers are set out in the underlying security document and are supplemented by the receiver's statutory powers set out in Section 420 of the Corporations Act.

On appointment, a receiver will immediately take possession of the assets subject to the security. Once in control of the assets, the receiver may elect to run the business and may engage in a sale process. When engaging in a sale process, a receiver has a statutory obligation under Section 420A of the Corporations Act to obtain market value or, in the absence of a market, the best price reasonably obtainable in the circumstances. This duty has traditionally presented a significant stumbling block to the adoption of pre-packaged restructuring processes through external administration widely used in the UK market (colloquially referred to as pre-packs).17 This is because of the inherent concern that a pre-pack involving a sale of any asset without testing the market could be seen as a breach of the duty under Section 420A.18 Pre-packs are likely to become more common in circumstances where the value of assets held are demonstrably less than the secured debt. Australia's creditor-friendly insolvency regimes and strict independence requirements for insolvency practitioners have also hindered the use of pre-packs.

Once a receiver has realised the secured assets and distributed any net proceeds to the secured creditor (returning any surplus to the company or later-ranking security holders), he or she will retire in the ordinary course.

Voluntary administration

Voluntary administration, unlike receivership for example, is entirely a creature of statute. The purpose and practice is outlined in Part 5.3A of the Corporations Act. While voluntary administration has often been compared to the Chapter 11 process in the United States, it is not a debtor-friendly process like Chapter 11. In a voluntary administration, the administrator and creditors control the final outcome to the exclusion of management and members.

The object of Part 5.3A is to:

  1. maximise the chances of the company, or as much as possible of its business, to remain in existence; or
  2. if the first option is not possible, achieve a better return for the company's creditors and members than would result from an immediate winding up of the company.19

There are three ways an administrator (often called a voluntary administrator) may be appointed under the Corporations Act:

  1. by resolution of the board of directors that, in their opinion, the company is, or is likely to become, insolvent;20
  2. a liquidator or provisional liquidator of a company may, in writing, appoint an administrator of the company if he or she is of the opinion that the company is, or is likely to become, insolvent;21 and
  3. a secured creditor that is entitled to enforce security over the whole or substantially the whole of a company's property may, in writing, appoint an administrator if the security interest is enforceable.22

An administrator has wide powers to manage the company to the exclusion of the existing board of directors. Once an administrator is appointed, a statutory moratorium is activated, which restricts the exercise of rights by third parties under leases and security interests23 and the continuing of litigation claims. This moratorium is intended to give the administrator the opportunity to investigate the affairs of the company to either implement change or realise value, with protection from certain claims against the company.

There are two meetings during the course of an administration that are critical to its outcome. Once appointed, an administrator must convene the first meeting of creditors within eight business days. At this first meeting, the identity of the voluntary administrator is confirmed, the initial remuneration of the administrator is approved and a committee of creditors may be established. The second creditors' meeting is normally convened 20 business days after the commencement of the administration, but this may be extended by application to the court. At the second creditors' meeting, the administrator must provide a report on the affairs of the company to the creditors and outline their view on the best option available to maximise returns to creditors. There are three possible outcomes that can be put to the meeting: enter into a DOCA with creditors (discussed further below), wind up the company, or terminate the administration by returning the business to directors as a going concern24 (this last outcome is rare as it would only occur when the company is actually solvent).

The administration will terminate following the outcome of the second meeting. The automatic stay on ipso facto provisions (see Section I.ii,) will not apply when the company enters into a DOCA; however, if the company is to be wound up, the automatic stay will apply.

A secured creditor that was previously estopped from enforcing a security interest because of the automatic stay becomes entitled to take steps to enforce that security interest unless the reason for the termination is the implementation of a DOCA approved by that secured creditor.25

DOCA

A DOCA is effectively a contract or compromise between a company and its creditors. Although closely related to voluntary administration, it is a distinct regime, as the rights and obligations of the creditors and company differ from those under administration.

DOCAs are flexible. The terms of a DOCA may provide for, inter alia, a moratorium of debt repayments, a reduction in outstanding debt and the forgiveness of all or a portion of the outstanding debt. They may also involve the issuance of shares (subject to certain conditions), and can be used as a way to achieve a debt-for-equity swap through the transfer of shares either by consent or with leave of the court.26 There has also been an increase in the use of 'holding DOCAs', which do not provide for a distribution of the company's property to creditors but rather allow the deed administrators more time to effect a restructuring of the company or a sale of its assets.27 For a debtor company to enter into a DOCA, a bare majority of creditors, both by value and number, voting at the second creditors' meeting in the administration must vote in favour of the company executing a DOCA. If there is a voting deadlock, for example when there is a majority in number but not in value or vice versa, pursuant to Rule 75-115(3) of the Insolvency Practice Rules (Corporations) 2016 (Cth), the chairperson of the meeting (usually the administrator) may exercise a casting vote to pass, or not to pass, a resolution.

Once executed, a DOCA will bind the company, its shareholders, directors and unsecured creditors in respect of claims arising before the date specified in the DOCA. Secured creditors can, but do not need to, vote at the second creditors' meeting, and typically only those who voted in favour of the DOCA at the second creditors' meeting are bound by its terms.28 Unlike a scheme of arrangement, court approval is not required for a DOCA to be implemented, provided it is approved by the requisite majority of creditors.

Upon execution of a DOCA, the voluntary administration terminates. The outcome of a DOCA is generally dictated by the terms of the DOCA itself. Typically, once a DOCA has achieved its stated aims, it will terminate. If a DOCA does not achieve its objectives, or is challenged by creditors, it may be terminated by the court or in accordance with its terms. Further, the court has the power to terminate a DOCA if it is oppressive to creditors or contrary to the interests of the creditors as a whole.29

Provisional liquidation

A provisional liquidator may be appointed by the court at any time after the filing of a winding up application and before the making of a winding up order in a number of circumstances.30 The most commonly used grounds include:

  1. insolvency;
  2. when an irreconcilable dispute at a board or shareholder level has arisen that affects the management of the company; or
  3. if the court is of the opinion that it is 'just and equitable' to do so.

There must be a reasonable prospect of the company being wound up. A creditor, a shareholder or the company itself has standing to apply for the appointment of a provisional liquidator, although in most cases a creditor will be the applicant.

The effect of the appointment is to give interim control of the company to a liquidator to the exclusion of the directors. A provisional liquidator will normally only be appointed by the court if there is a risk to the assets and affairs of a company prior to a company formally entering liquidation. As such, a provisional liquidator is normally only given very limited powers (i.e., to take possession of the assets), and the main role of the provisional liquidator is to preserve the status quo.

A court determines the outcome of a provisional liquidation, and may order either that the company move to a winding up (with the appointment of a liquidator) or that the appointment of the provisional liquidator is terminated. The automatic stay on ipso facto provisions (see Section I.ii) does not apply to provisional liquidation.

Liquidation

Liquidation is the process whereby the affairs of a company are wound up and its business and assets are realised. A company may be wound up voluntarily by its members if solvent (MVL) or, if it is insolvent, by its creditors (CVL) or compulsorily by order of the court.

Special purpose liquidator

The appointment of a special purpose liquidator (SPL) has historically been used where there is an actual or perceived conflict of interest or lack of independence on the part of the liquidator that may jeopardise the liquidator's ability to carry out a significant function in the liquidation – usually an investigation. More recently, however, courts have been open to the appointment of an SPL where a creditor seeks a preferred, alternative liquidator to carry out a legitimate investigation and agrees to fund only that liquidator and no other.31 In this case, the SPL appointment will co-exist with the existing liquidation.

Voluntary liquidation (members and creditors)

The members of a solvent company may resolve that a company be wound up if the board of directors is able to give a 12-month forecast of solvency (i.e., an ability to meet all the company's debts in the following 12 months). If not, or if the company is later found to be insolvent, the creditors take control of the process and it converts to a creditor's voluntary liquidation.

Creditors may also resolve at a meeting of creditors to wind up the company and appoint a liquidator (this may take place at the second meeting of creditors during an administration). If the requisite approvals are obtained in either a members' voluntary winding up or a creditors' voluntary winding up, a liquidator is appointed.

Involuntary liquidation

The most common ground for a winding up application being made to the court is insolvency. This is usually indicated by the company's failure to comply with a statutory demand issued by a creditor for payment of a debt. Following a successful application by a creditor, a court will order the appointment of a liquidator.

In both a voluntary and an involuntary winding up, the liquidator will have wide-ranging powers, including the ability to challenge voidable transactions and take control of the assets of the company. Most likely, a liquidator will not run the business as a going concern, unless that will ultimately result in a greater return to stakeholders. During the course of the winding up, the liquidator will realise the assets of the company for the benefit of its creditors and, to the extent of any surplus, its members. At the end of a winding up, the company will be deregistered and cease to exist as a corporate entity.

Scheme of arrangement

A scheme of arrangement is a restructuring tool that sits outside a formal insolvency process; that is, the company may become subject to a scheme of arrangement whether it is solvent or insolvent. A scheme of arrangement is a proposal put forward (with input from management, the company or its creditors) to restructure the company in a manner that includes a compromise of rights by any or all stakeholders. Creditors whose rights are affected are required to participate in the scheme. The process is overseen by the courts and requires approval by all classes of creditors. In recent times, schemes of arrangement have become more common, in particular for complex restructurings involving debt-for-equity swaps, in circumstances where the number of creditors within creditor stakeholder groups may make a contractual and consensual restructure difficult.

A scheme of arrangement must be approved by at least 50 per cent in number and 75 per cent in value of creditors in each class of creditors. It must also be approved by the court to become effective (it requires court involvement at two stages). The test for identifying classes of creditors for the purposes of a scheme is that a class should include those persons whose rights are not so dissimilar as to make it impossible for them to consult one another with a view to a 'common interest'. Despite this long-standing proposition, recent case law has suggested that courts may be willing to stretch the boundaries of what would ordinarily be considered the composition of a class and, in doing so, may agree to put creditors in classes even where such creditors within the class appear to have objectively distinct interests.32

The outcome of a scheme of arrangement is dependent on the terms of the arrangement or compromise agreed with the creditors but, most commonly, a company is returned to its normal state upon implementation as a going concern with the relevant compromises having taken effect.

The key advantages of a scheme of arrangement are its flexibility and ability to bind secured and unsecured financial creditors and members, keep management in place and bind creditors' rights against third parties (provided there is a sufficient nexus between the scheme and the rights).33 The disadvantages of schemes include cost, complexity of arrangements, uncertainty of implementation, timing issues (because a scheme must be approved by the court and is subject to the court timetable, although the courts have demonstrated an increased willingness to move swiftly in recent times)34 and the overriding issue of court approval (a court may exercise its discretion to not approve a scheme of arrangement, despite a successful vote, if the court is of the view that the scheme of arrangement is not fair or equitable). These factors explain why schemes of arrangement tend to be undertaken only in large corporate restructures and in situations where timing is not fatal to a restructure.

Small business insolvency reforms

On 1 January 2021, after a brief period of consultation, amendments to the Corporations Act introduced a new regime for the restructuring of small businesses.35 The reforms, which comprise the largest changes to insolvency law in almost three decades, implement a new small business restructuring process (the SBR process) and simplified liquidation process for small businesses (the SL process) and are intended to reduce the costs of external administration for small businesses and the compliance burden for insolvency practitioners. The SBR process implemented under new Part 5.3B of the Corporations Act provides a framework for eligible companies to work with a restructuring practitioner to develop and propose to creditors a debt restructuring plan that, if accepted, will bind the company and certain of its creditors. The process is available to companies: (1) that have total liabilities of less than A$1 million; (2) that are substantially compliant with their obligation to pay employee entitlements and make tax lodgements; (3) whose directors (or previous directors within the preceding 12 months) have not engaged in the SBR process or SL process for another company within the past seven years (subject to a carve out for group restructurings run together); and (4) that have not used the SBR process or SL process within the past seven years. While the SBR process follows the structure and many of the key aspects of voluntary administration under Part 5.3A, a key difference is that it is a 'debtor-in-possession' model whereby the directors remain in control of the company.

The SL process is intended to provide a less complex, faster and lower cost liquidation for small businesses. The SL process may be commenced if: (1) the directors determine that the company is insolvent and should be wound up; (2) an MVL is initiated (whereby a declaration of solvency is required), but the liquidator appointed determines that the company is in fact insolvent; (3) the company has been subject to administration, or a DOCA, and the creditors elect to initiate a CVL; or (4) ASIC appoints a liquidator where it forms the view that the company has been abandoned. The eligibility criteria for the SL process is broadly the same as the SBR process, including that the company must have total liabilities of less than A$1 million.

The reforms have seen a very slow uptake since implementation. Reasons for this may include the fact that the A$1 million liability cap is too low,36 and that insolvency practitioners and other industry professionals will require time to get up to speed on what is a fairly complex piece of legislation.

iv Starting proceedings

The Federal Court of Australia and the Supreme Courts of each Australian state and territory have jurisdiction to hear matters relating to the insolvency of a corporation (including both civil and criminal offences arising from insolvency proceedings).

Matters pertaining to debt recovery and monetary compensation can also be dealt with by other courts, such as district courts, county courts and magistrates' courts, within their jurisdictional limits. The judicial institutions have discretion to transfer matters between them if considered appropriate.

It is generally only the Federal Court and the Supreme Courts that have jurisdiction to wind up a company. Interestingly, two of the more common forms of insolvency process – voluntary administration and receivership – often have no court involvement.

v Control of insolvency proceedings

For administrations and liquidations, the relevant insolvency practitioner has control of the company itself to the exclusion of the directors.37

In a CVL (an insolvent winding up), the members lose any right to management of the company. The liquidator is vested with wide powers of investigation and inquiry as well as the power to recover and gather in and secure the company's property. Liquidation does not interfere with the rights of a secured creditor who is able to retain and enforce the security and recover the full amount for the debt owed.

In a voluntary administration, the creditors control the final outcome to the exclusion of management and members, and ultimately decide on the outcome of the company.

Upon execution of a DOCA, the voluntary administration will terminate. Once the DOCA has been executed, a director's powers are no longer suspended, but they can only exercise their powers consistently with the provisions of the DOCA.

When the powers granted to a receiver are expressed broadly, as they usually are, the receiver will control the management of the company and its business to the exclusion of the directors and administrators.

Following the implementation of a scheme, often a scheme administrator (who must be a registered liquidator) will be appointed to implement the terms of the scheme, and this role ceases once the scheme is implemented. This is not a requirement under the Corporations Act but is often used in large and complex creditors' schemes.

vi Special regimes

As noted in Section I.i, the Corporations Act is the primary legislative instrument for corporate insolvency and restructuring in Australia and governs the insolvency proceedings of all companies incorporated in Australia and companies incorporated or possessing separate legal personality in foreign jurisdictions that carry on business in Australia, as well as building societies, credit unions and managed investment schemes.

The provisions of the Corporations Act do not govern the potential insolvency proceedings for:

  1. government agencies;
  2. state or federal corporate bodies; or
  3. entities created by statute that are not companies.

The individual statutes creating these bodies will normally provide for their dissolution or winding up. As a general comment, there is no precedent in Australia for a government-owned enterprise becoming insolvent.

The Personal Property Securities Act 2009 (Cth) is the primary legislation that governs personal property security and is therefore an integral part of restructuring and insolvency law in Australia.

vii Cross-border issues

Australian courts will cooperate with foreign courts and insolvency practitioners in two principal ways.

First, under Section 581 of the Corporations Act, Australian courts have a duty to render assistance when requested by a foreign insolvency court and may also request a foreign court to provide assistance to an Australian liquidator in respect of an external administration matter (being the winding up of an Australian company, body corporate or Part 5.7 body (including a foreign company carrying on business in Australia)). Australian courts are obliged to assist the bankruptcy courts of prescribed countries, including the United Kingdom and United States. For all other countries, whether the Australian court will offer assistance is discretionary.

Insolvency practitioners may also seek assistance under the Cross-Border Insolvency Act 2008 (Cth) (the Cross-Border Act) which implements the UNCITRAL Model Law on Cross-border Insolvency (the Model Law). For those jurisdictions that have adopted it, the Model Law provides a process for creditors and their representatives to request and receive assistance from foreign courts in relation to foreign insolvency proceedings.

The Cross-Border Act allows for the recognition of foreign proceedings in Australia under Chapter 5 of the Corporations Act (with the exception of receiverships and solvent liquidations).38 Whether an Australian court is required to recognise a foreign proceeding depends on the location of the debtor's centre of main interest (COMI).

Recognition of a foreign proceeding as a 'foreign main proceeding' (being a proceeding taking place where the debtor's COMI is located) will automatically stay actions of individual creditors against the debtor and of enforcement proceedings concerning the assets of the debtor in all non-main jurisdictions, suspend the debtor's right to dispose of its assets and allow clawback proceedings in respect of antecedent transactions to be commenced by the foreign representative.39 The scope of the stay that applies is the same as that which would apply under the analogous Australian procedure in Chapter 5 (other than Parts 5.2 and 5.4A) of the Corporations Act. For example, if the foreign proceeding is a 'debtor-in-possession' corporate rescue or restructuring proceeding involving a plan requiring creditor approval, the most analogous Australian procedure would be voluntary administration under Part 5.3A.40 If the Australian court recognises the foreign proceeding as a 'foreign non-main proceeding' (being a foreign proceeding taking place where the debtor has an 'establishment' rather than its COMI), then an automatic stay will not apply, however the court does have the discretion to grant appropriate relief.

Under the Cross-Border Act, there is a rebuttable presumption that a corporate debtor's COMI is its registered office. The Model Law provides no further guidance on the standard required for COMI determination and, to that end, Australian courts have applied the general test established in Re Eurofood IFSC Ltd41 that a debtor's COMI should be assessed by criteria that are both objective and ascertainable by third parties.42

In considering where the COMI of a debtor or group of companies exists, the court will consider a number of factors, including the location of debtor's headquarters, books and records, financial and operational centre, primary assets, the majority of the debtor's creditors or a majority of creditors who would be affected by the proceedings, administration, payroll, accounts payable or cash management activities, tax authority and the jurisdiction which applies to most disputes.43

In 2018, UNCITRAL published the final version of the UNCITRAL Model Law on Recognition and Enforcement of lnsolvency-Related Judgments (MLREIJ) which seeks to complement and clarify uncertainties arising from the Model Law by providing a framework for the domestic recognition and effectuation of 'insolvency related judgments' issued by the courts of a foreign jurisdiction and reducing the prospect of conflicting judicial decisions and auxiliary proceedings. The MLREIJ has not yet been adopted in Australia (or elsewhere).

Lastly, the Foreign Judgments Act 1991 (Cth) creates a general system of registration of judgments obtained in foreign countries but will only apply to judgments pronounced by courts in countries where, in the opinion of the governor general, substantial reciprocity of treatment will be accorded by that country in respect of the enforcement in that country of judgments of Australian courts. Notably, due to a lack of reciprocity, judgments of US courts cannot be enforced under this legislation.

Insolvency metrics

Australia's economic bounce-back from the effects of the covid-19 pandemic has defied all expectations. While the recovery was initially expected to be slow, uneven and prolonged, highly effective economic policies and support programmes implemented by the federal and state governments have proved instrumental in providing stability and have resulted in the Australian economy performing strongly by international standards.

Australia's strong economic recovery has resulted in record low numbers of insolvencies and limited restructuring activity (although many debtors are seeking covenant waivers and debt extensions to avoid defaults). Each quarter, ASIC publishes insolvency statistics outlining the total number of companies that have entered into external administration (that is administration, liquidation or receivership) during that quarter and a comparative analysis of the previous quarter and a 12-month comparison. For the quarter ending March 2021, a total of 973 companies entered into external administration, which represents a drastic decrease from the 1,747 in the same quarter in 2020.

Notwithstanding the low number of insolvencies in the past 12 months, a number of sectors continue to suffer particular distress. These include retail, mining and mining services, property and construction, higher education, hospitality and tourism. In recent times, Australia has seen a number of household names enter into formal insolvency processes, including department store Harris Scarfe, clothing and accessories retailers Seafolly, Tigerlily, Jeanswest, Colette, Bardot and Kikki.K and aviation giant, Virgin Australia.

Since the handing down of the final report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry (Royal Commission) in February 2019 (the Final Report), there has been increased media attention (especially social media) on the behaviour of banks, which has resulted in reputational risk becoming a primary concern for management and general counsel. A key outcome of the Royal Commission was a renewed focus on regulation, with the Final Report recommending greater collaboration between ASIC and the Australian Prudential Regulatory Authority.