Lecture 11_Chapter 16

Insolvency and Liquidation

©2018 John Wiley & Sons Australia Ltd

 Learning objectives

After studying this presentation you should be able to:

16.1 Describe the meaning of insolvency and identify the
requirements imposed on an administrator of an insolvent
company
16.2 Identify the legal requirements for the winding up of a
company by the court
16.3 Compare a voluntary winding up with a winding up by
the court
16.4 Describe the duties and powers of a liquidator
16.5 Describe the different accounts that a liquidator is
required to keep
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 Learning objectives

16.6 Determine how a company’s debts are proven for

liquidation
16.7 Determine the order of priority of payment of the
company’s debts in liquidation
16.8 Determine the rights and obligations of
contributories on liquidation
16.9 Prepare accounting records necessary for the
liquidation of a company
16.10 Describe the role of a receiver appointed by a
secured creditor.

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 Introduction

• The legal requirements are contained in Chapter 5 —

External Administration of the Corporations Act 2001,
which adopts the policy of doing everything possible to
keep a company in existence.
• The Act contains several provisions in relation to
̶ Arrangements and reconstructions (Part 5.1)
̶ Appointment of receivers and other controllers for
satisfaction of certain creditors’ claims (Part 5.2)

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 Introduction

̶ Appointment of an administrator of a company’s affairs

with a view to executing a deed of arrangement with
creditors, without liquidation of the company (Part
5.3A).
• If these fail, then liquidation is inevitable, and the
requirements for liquidation are contained in Parts 5.4–5.6
of the Act in relation to companies.

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 Insolvency and administration

• The main intention of the Corporations Act 2001 is to treat

liquidation of a company as a last resort.
• In an attempt to avoid liquidation, Part 5.3A deals with the
topic of appointing an administrator to a company
whenever the directors believe that the company may be
insolvent.
• According to s. 95A of the Corporation Act:
̶ 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.
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 Insolvency and administration

• The onus of responsibility for insolvency falls squarely on

the directors of a company, and the directors may be
liable for prosecution under the Act if they allow the
company to continue to trade while it is insolvent.
• An administrator may be appointed also by a liquidator if
the liquidator believes that the company will become
insolvent (s. 436B), or by a person who is entitled to
enforce a charge on the whole, or substantially the whole,
of a company’s property (s. 436C).

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 Insolvency and administration

• According to ASIC, administration is designed to resolve

the company’s future direction quickly.
• An independent and suitably qualified person — the
administrator — takes full control of the company in an
attempt to save either the company or the company’s
business.

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 Insolvency and administration

Role and powers of the administrator

• Section 437A(1) sets out the role of an administrator:
• While a company is under administration, the
administrator:
̶ Has control of the company’s business, property and
affairs
̶ May carry on that business and manage that property
and those affairs
̶ May terminate or dispose of all or part of that business,
and may dispose of any of that property

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 Insolvency and administration

Role and powers of the administrator

̶ May perform any function, and exercise any power, that
the company or any of its officers could perform or
exercise if the company were not under administration.
• According to ASIC’s website and s. 438A of the Act, the
administrator, after taking control of the company, must
investigate and report to creditors information as to the
company’s business, property, affairs and financial
circumstances, and on the three options available to
creditors.

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 Insolvency and administration

Role and powers of the administrator

• The options available to creditors are to:
1) End the administration and return the company to
the directors’ control
2) Approve a deed of company arrangement through
which the company will pay all or part of its debts
and then be free of those debts
3) Wind up the company and appoint a liquidator.
• The administrator must give an opinion on each option
and recommend which option is in the best interests of
creditors (s. 439A).
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 Insolvency and administration

Role and powers of the administrator

• According to s. 438B(1)–(3):
• As soon as practicable after the administration of a
company begins, each director must:
̶ Deliver to the administrator all books in the director’s
possession that relate to the company, other than
books that the director is entitled, as against the
company and the administrator, to retain
̶ If the director knows where other books relating to the
company are — tell the administrator where those
books are
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 Insolvency and administration

Role and powers of the administrator

• Within 5 business days after the administration of a
company begins or such longer period as the administrator
allows, the directors must give to the administrator a
statement about the company’s business, property, affairs
and financial circumstances.
• A director of a company under administration must:
̶ Attend on the administrator at such times

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 Insolvency and administration

Role and powers of the administrator

̶ Give the administrator such information about the
company’s business, property, affairs and financial
circumstances; as the administrator reasonably
requires.
• Shareholders do not get to vote on the future of the
company.
• Under s. 443BA, the administrator of a company is also
liable to pay to the Commissioner of Taxation amounts
payable under the Income Tax Assessment Act.

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 Insolvency and administration

The administrator’s accounts

• According to s. 438E of the Act, an administrator is
required to keep proper accounting records and to submit
a statement of receipts and payments each six months.
• Section 438E states:
̶ The administrator of a company under administration
must, within one month after
̶ A person who ceases to be the administrator of a
company under administration must, within one month
after the cessation, lodge an account that

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 Insolvency and administration

The administrator’s accounts

̶ If an account is lodged under subsection (1) or (2), ASIC
may cause the account to be audited by a registered
company auditor.
̶ The auditor must prepare a report on the account.
̶ For the purposes of the audit under subsection (3), the
administrator or former administrator must give the
auditor such books and information as the auditor
requires.
̶ If ASIC causes an account to be audited under
subsection (3)
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 Insolvency and administration

The administrator’s accounts

• ASIC must give the administrator or former
administrator a copy of the report by the auditor
• Subsection 1289(5) applies in relation to the report
prepared by the auditor as if it were a document
required to be lodged.
̶ The costs of an audit under this section are to be fixed
by ASIC and form part of the expenses of
administration.

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 Winding up in insolvency and by the court

• Liquidation or winding up is a process whereby a

company is dissolved, at which point the company ceases
to be a legal entity.
• There are two modes of winding up a company:
1. Winding up in insolvency and by the court — Parts
5.4 to 5.4B and 5.6 of the Act
2. Voluntary winding up by members or creditors —
Parts 5.5 and 5.6 of the Act
• The accounting entries are the same in both cases.

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 1) Winding up in insolvency and by the
court
• A contributory is defined in s. 9 and basically refers to the
holders or immediate past holders of shares in the
company.
• Once an application is made, the court may order the
insolvent company to be wound up (s. 459A).
• The Court may order the winding up of a company if:
i. The company has by special resolution resolved that it
be wound up by the Court
ii. The company does not commence business within
one year from its incorporation or suspends its
business for a whole year
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 1) Winding up in insolvency and by the
court
iii. The company has no members
iv. The Court is of opinion that it is just and equitable
that the company be wound up.
• Once a company commences winding up, be it by a court
order or voluntarily, the company is required in every public
document and in every negotiable instrument of the
company to include the words ‘in liquidation’ after its name
(s. 541).

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 1) Winding up in insolvency and by the
court
• The liquidator’s task is as follows:
̶ Take possession of the company’s assets under s. 474(1)
̶ Realise the assets or carry on business as necessary for
the beneficial disposal of the assets (s. 477(1))
̶ Determine the creditors and order of priority of
payment
̶ Pay the creditors
̶ Bring about the dissolution of the company.

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 1) Winding up in insolvency and by the
court
• The aim of the report as to affairs is to provide information
concerning the company’s estimated realisable values of
assets and any expected surplus or deficiency of assets
after deducting creditors’ claims.
• Once the liquidator has received the report as to affairs, he
or she is required under s. 476 to lodge a preliminary report
with ASIC, normally within 2 months, containing the
following details:
̶ In the case of a company having a share capital — the
amount of capital issued, subscribed and paid up

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 1) Winding up in insolvency and by the
court
̶ The estimated amounts of assets and liabilities of the
company
̶ If the company has failed — the causes of the failure
̶ Whether, in the liquidator’s opinion, further enquiry is
desirable regarding the promotion, formation or
insolvency of the company or the conduct of the
business of the company.
• When the order is made that the company be deregistered
under s. 481(5), ASIC must deregister the company and the
company ceases to exist (ss. 601AC and 601AD).

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 2) Voluntary winding up

• A company may be wound up voluntarily at the instance of

either the members or the creditors.
• In the case of a members’ voluntary winding up, the
company is wound up by the members passing a special
resolution to that effect.
• A members’ voluntary winding up can occur only if the
company is solvent.
• A liquidator is appointed by the company in general
meeting (s. 495(1)).

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 2) Voluntary winding up

• In a members’ voluntary winding up, where there has been

a declaration of solvency, and the liquidator forms the
opinion that the company will not be able to pay its debts
in full within the period stated in the declaration, the
liquidator must do one of the following, under s. 496(1):
̶ Apply under s. 459P for the company to be wound up in
insolvency
̶ Appoint an administrator of the company under s. 436B
̶ Convene a meeting of the company’s creditors.

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 2) Voluntary winding up

• Where a creditors’ voluntary winding up occurs — basically

where there is no declaration of solvency — the winding up
is under the control of both members and creditors. As s.
497(1) states:
• The liquidator of the company must cause a meeting of
the company’s creditors to be convened within 11 days
after the day of the meeting of the company at which
the resolution for voluntary winding up is passed.

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 Powers of the liquidator

• In the case of a company being wound up by the court, the

powers of the liquidator are specified in s. 477.
• Subsection (1) states that the liquidator may:
̶ Carry on the business of the company so far as is
necessary for its beneficial disposal or winding up
̶ Pay any class of creditors in full
̶ Make compromises or arrangements with creditors or
people claiming to be creditors
̶ Enter into legal proceedings on behalf of the company

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 Powers of the liquidator

̶ Appoint a solicitor to help with the duties

̶ Sell/dispose of property of the company
̶ Exercise the court’s powers under s. 483(3) in relation to
making calls on contributories
̶ Deal with bills of exchange or promissory notes on
behalf of the company
̶ Obtain credit where necessary
̶ Appoint an agent to do what the liquidator cannot do in
person.

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 Powers of the liquidator

• In the case of a voluntary winding up, the liquidator’s

powers are specified in s. 506.
• The liquidator can:
̶ Exercise the power under s. 478 of a liquidator
appointed by the court to settle a list of contributors
̶ Exercise the court’s powers under s. 483(3) in relation to
making calls on contributories
̶ Exercise the power of the court of fixing a time when
debts and claims must be proved.

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 Powers of the liquidator

• The liquidator must then pay the debts of the company and
sort out the rights of the contributories (s. 506(3)).
• The liquidator is required as well to keep proper records in
which entries and details of proceedings of meetings must
be made.
• Creditors and contributories, or their agents, are entitled to
inspect these records, unless the court orders otherwise (s.
531).

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 The liquidator’s accounts

• Section 539 deals with the preparation of a liquidator’s

statement of receipts and payments:
• In this section: ‘liquidator’ includes a provisional liquidator.
̶ A liquidator must, within 1 month after the end of the
period of 6 months from the date of his or her
appointment and of every subsequent period of 6
months during which he or she acts as liquidator and
within 1 month after he or she ceases to act as
liquidator, lodge:

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 The liquidator’s accounts

̶ ASIC may cause the account and, where a statement of

the position in the winding up has been lodged, that
statement to be audited by a registered company
auditor, who shall prepare a report on the account and
the statement (if any).
̶ For the purposes of the audit under subsection (2) the
liquidator must give the auditor such books and
information as the auditor requires.

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 The liquidator’s accounts

̶ The liquidator shall give notice that the account has

been made up to every creditor and contributory when
next forwarding any report, notice of meeting, notice of
call or dividend.
̶ The costs of an audit under this section shall be fixed by
ASIC and form part of the expenses of winding up.

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 Proof of debts

• The actual procedures to be followed if proof of debts is

required by the liquidator are provided in Corporations
Regulations 5.6.39 to 5.6.57 inclusive.
• Debts may be admitted by the liquidator without formal
proof; however, if a formal proof is requested the creditor
must complete Form 535 in Schedule 2 of the Regulations
(s. 553D).
• The size of any debt is calculated for the purposes of the
winding up as at the relevant date (s. 554), which is defined
in s. 9 as the day on which the winding up is taken to have
begun, in accordance with ss. 513A–513C.
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 Priority of payment of debts

• The general principle regarding priority of payment of debts

in liquidation is stated in s. 555 of the Act: Except as
otherwise provided by this Act, all debts and claims proved
in a winding up rank equally and, if the property of the
company is insufficient to meet them in full, they must be
paid proportionately.
• Four different categories of creditors can be identified:
1. Secured creditors
2. Preferential unsecured creditors
3. Ordinary unsecured creditors
4. Deferred creditors.
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 Priority of payment of debts

1) Secured creditors
• In effect, two types of secured creditor are recognised
under the Act, namely:
̶ A creditor secured by a non-circulating security
interest (formerly known as a specific charge), such as
a mortgage, lien, or bill of sale.
̶ A creditor secured by a circulating security interest
(formerly known as a floating charge), which commonly
occurs with debentures.

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 Priority of payment of debts

1) Secured creditors
̶ Creditors secured by a non-circulating security interest
• The advantage to a secured creditor of choosing the
second option is that the property covered by the non-
circulating security interest does not pass through the
liquidator.
̶ Creditors secured by a circulating security interest
• The security in this case does not relate to a specific
item of property but relates to all assets of the
company; that is, it ‘floats’ over whatever assets the
company has at a particular time.
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 Priority of payment of debts

2) Preferential unsecured creditors

• Note the following with respect to the list in s. 556:
̶ The definition of ‘excluded employee’ in s. 556(2)
applies to directors, their spouses and their relatives,
thus limiting preferential payments to these people to a
maximum of $2000 per person under s. 556(1A) and (1)
(e), and $1500 per person under s. 556(1B) and (1)(g).
̶ In s. 556(1A) and 1(e), any amount greater than $2000
for excluded employees may be claimed with other
unsecured, non-preferential debts.

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 Priority of payment of debts

3) Ordinary unsecured creditors

• These debts have no preferential treatment and are the
last to be paid before funds are returned to contributories.
• Unsecured creditors include trade creditors, rent payable,
audit fees payable, directors’ fees payable, telephone and
internet bills, goods and services tax, rates, fringe benefits
tax, and PAYG income tax instalments payable to the
Australian Government.

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 Priority of payment of debts

4) Deferred creditors
• Deferred creditors are, in effect, certain debts payable to
the contributories of the company ahead of repayments of
capital to those contributories.
• Depending on the constitution of the company, arrears of
preference dividends whether declared or otherwise, any
ordinary dividends payable, and any calls paid in advance
by contributories may be paid ahead of any returns of
capital.

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 Priority of payment of debts

Summary of priority of payment of creditors (assuming

insolvency)
• In relation to the previous summary, note the following.
̶ Although creditors such as electricity authorities and
telecommunications companies are unsecured, they
often obtain preferential payment by threatening to
withdraw their services.
̶ Local government Acts and State Land Tax Acts may
empower the authority to charge the land for unpaid
rates and taxes.

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 Rights of contributories

• In respect of a limited company, a contributory is defined in

s. 9 of the Act as follows: contributory means:
• In relation to a company (other than a no liability
company):
̶ A person liable as a member or past member to
contribute to the property of the company if it is
wound up
̶ For a company with a share capital — a holder of fully
paid shares in the company; and

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 Rights of contributories

̶ Before the final determination of the persons who are

contributories because of sub-­paragraphs (i) and (ii) — a
person alleged to be such a contributory.
• There are three possible situations that can arise in relation
to contributories’ claims:
̶ Insufficient funds exist to pay creditors, requiring calls to
be made on contributories
̶ Sufficient funds exist to meet creditors’ claims, but not
to repay all share capital
̶ Surplus funds exist over and above creditors’ claims and
share capital.
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 Rights of contributories

Insufficient funds for creditors

• If there are insufficient funds to pay the creditors and
partly paid shares exist, the court is empowered, in a
winding up by the court, to issue an order to make calls on
all or any of the contributories to the extent of their
liability, to be paid into a bank account kept by the
liquidator (s. 483(3) and (4)).
• Once all shares have been paid in full, any deficiency of
funds must be borne by creditors in the reverse order of
priority of payment.

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 Rights of contributories

Sufficient funds to pay creditors, but not to repay share

capital
• A constitution may give preference shareholders priority
claim over ordinary shareholders as to return of capital.
• The requirements of companies’ constitutions as to return
of capital vary.
• Any distribution calculations then are approved by a
special resolution of members.
• In the absence of agreement among shareholders, some
liquidators in practice may refer the ultimate distribution
decision to ASIC.
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 Rights of contributories

Sufficient funds to pay creditors, but not to repay share

capital
• Any deficiency of funds on the winding up of a company is
to be borne by each shareholder in accordance with the
number of shares held, irrespective of the issue price of
those shares.
• If any shares are partly paid, the amount unpaid on those
shares is to be treated as property of the company.

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 Rights of contributories

A surplus of funds
• As with the sharing of any deficiency and repayment of
funds to contributories, the rights of contributories to
participate in a surplus of funds should be specified in the
constitution.
• Preference shareholders may or may not be entitled to
share in a surplus with ordinary shareholders, depending
on the constitution.
• Any provision in the constitution that gives preference
shareholders a prior claim as to return of capital does not
automatically give them a right to participate in a surplus.
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 Rights of contributories

Calls in advance and arrears of dividends

̶ Calls in advance
• The constitution may deal with this situation; however,
in the absence of such guidance, calls in advance with
related interest will be repaid before any payments are
made to shareholders, and after all payments have
been made to creditors.
• Calls in advance are effectively deferred claims.

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 Rights of contributories

Calls in advance and arrears of dividends

̶ Arrears of dividends
• If there is no guidance in the constitution, and if the
dividend is a legal debt but not paid, those
shareholders have a prior claim over other returns of
capital to shareholders but rank after unsecured
creditors; that is, dividends so declared are deferred
creditors.

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 Accounting for liquidation

• In terms of accounting requirements, there are five main

tasks to be performed:
i. Preparation of a report as to affairs and, in addition, in
a creditors’ voluntary winding up, a summary of
affairs and, in a members’ voluntary winding up, a
declaration of solvency
ii. Realisation of the assets
iii. Possession of assets by secured creditors
iv. Payment to the creditors in order of priority
v. Return of capital and surplus (if any) to contributories
(shareholders).
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 Accounting for liquidation

(i) The report as to affairs

• The basic format used in this book for illustrative purposes
is the format specified in ASIC’s Form 509, entitled
‘Presentation of summary of affairs of a company’ referred
to as a ‘Summary of affairs’.
• This form is used on the grounds of simplicity for teaching
purposes, as use of Form 509 avoids preparation of
detailed schedules required with Form 507.

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 Accounting for liquidation

(ii) Realisation of the assets

• The realisation of assets is accounted for in the company’s
records using a Liquidation account.
• First, the carrying amounts of all assets (except cash and
assets subject to a security interest) and all contra-asset
accounts are transferred to this liquidation account.
• Second, on realisation of the assets by the liquidator, the
Cash account is debited and the Liquidation account
credited.

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 Accounting for liquidation

(iii) Possession of assets by secured creditors

• Assets over which a non-circulating security interest (or
specific security) is held are commonly taken into
possession by the secured creditor and sold.
• Any net proceeds after payment of the security are then
handed over to the liquidator.
• The adjustment to the Liquidation account represents the
gain (or loss) on disposal of the secured asset after
payment of the security.

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 Accounting for liquidation

(iv) Payment to other creditors in order of priority

• The liquidator pays off the remaining creditors in strict
order of priority from the cash balance, which includes the
proceeds of sale of the assets and any proceeds from calls
necessary on contributories.
• In the course of determining a list of creditors, the
liquidator is likely to find certain liabilities that were not
recorded on the company’s records — for example,
liquidation expenses and remuneration, and unrecorded
interest payable.

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 Accounting for liquidation

(iv) Payment to other creditors in order of priority

• Such unrecorded liabilities, in effect, increase the
loss/reduce the gain on liquidation, and are best
accounted for by debiting the Liquidation account and
crediting the appropriate liability accounts in order for
payment to proceed.
• In some cases, certain creditors may be willing to settle for
an amount lower than the carrying amount of the debt.

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 Accounting for liquidation

(v) Return of capital to contributories

• The accounting procedures to return capital to
contributories are as follows.
̶ Calculate the appropriate distribution of funds for each
class of shareholder in accordance with the rights of
contributories as discussed in section 16.8.
̶ Make any necessary calls on the various classes of
shareholders.
̶ Transfer share capital to a Shareholders’ Distribution
account.

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 Accounting for liquidation

(v) Return of capital to contributories

̶ Transfer all reserve accounts (including any forfeited
shares surplus from the previous step and retained
earnings) to the Liquidation account.
̶ Pay any appropriate capital distribution to the various
classes of shareholders by crediting the Cash account
and debiting the Shareholders’ Distribution account.
̶ Transfer the balance of the Liquidation account
(representing the deficiency or surplus) to the
Shareholders’ Distribution account.

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 Accounting for liquidation
/ FVC by acquirer

Accumulated losses XXX

Loss on disposal of secured asset
XXX
Gain on liquidation XXX

Cash given up by the acquirer XXX

Gain on liquidation XXX

Equity instruments issued by acquirer XXX

58 Debt instruments issued by acquirer XXX
Non-cash items given by acquirer XXX
 Receivership

• A receiver or a receiver and manager or controller may be

appointed by a court or by creditors — for example,
debenture holders, according to the terms of the
agreement — in order to protect the security of those
creditors.
• The power of a court to appoint a receiver is given by
statute, and the court will make such an appointment when
it perceives that it is just and convenient that such an order
be made.

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 Receivership

• In most cases, a receiver and manager are appointed.

• The main effect of appointing a receiver (and manager) is
that relevant property can be sold in order to repay the
debt of the secured creditor.
• The receiver is responsible to the secured creditor, not to
the company.
• A court-appointed receiver needs the permission of the
court to sell property of the company.

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 Receivership

• A receiver is required to open his or her own special bank

account (s. 421(1)) and, in accordance with s. 432, to lodge
every 6 months an account of the receiver’s receipts and
payments.
• One problem a receiver may face is if he or she has been
appointed under a circulating security interest.
• The debts having priority are listed in s. 433(3).
• Note that neither State nor Commonwealth governments
are entitled to any particular priority under these
provisions.

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 Receivership

• The receivership still continues, and the receiver may be

appointed as the liquidator.
• If a separate liquidator is appointed, the receiver is entitled
to remain in control of the property on which the security is
based.
• In accounting for the assets sold by a receiver prior to the
company going into liquidation, the sale of each asset may
be treated separately.

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