McDonald Vague The Insolvency & Business Recovery Specialists

The Rights Of Creditors When A Company Fails

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When a company fails one of three things happens

• The Company is placed into receivership or;
• The company enters into a compromise with its creditors or;
• The company is put into liquidation

Receivership

The only objective of this option is to look after the debentureholder who has advanced money to the company under a debenture. That debenture gives the debentureholder security over all the assets of the company. Debentures are effectively a mortgage over all the assets of a business. Typical debentureholders are banks and lending institutions, previous proprietors who have left money in the business, and on occasion, the directors of the business who have advanced personal or family funds. The receiver looks after the debentureholder and has a duty to realise the assets of the company to repay the debentureholder. Although the receiver has a legal duty not to take any action that would affect the rights of unsecured creditors the receiver looks after the debentureholder and not the unsecured creditors. Even if the receiver has moneys surplus to the requirements of the debentureholder these must be paid back to the company. There is no power for the receiver to pay these moneys to unsecured creditors.

The only realistic option available to the unsecured creditor is to make application to the Court for a liquidator to be appointed.

Although a liquidator cannot take control of the assets of a company until the receiver has finished with them, the liquidator appointed whilst a receiver is in place can achieve the following objectives:-

• Examine the validity of the debenture under which the receiver was appointed and examine the validity of the appointment.
• Examine the acts of the receiver and ensure that the receiver obtains the best possible obtainable price for assets that are realised.
• Take those actions which are not available to a receiver
  • Voidable Preference
  • Actions against directors for reckless trading
  • Transactions for inadequate or excessive consideration with directors

It must be realised that legal action in particular can cost many tens of thousands of dollars and that in practice, where there is a receiver in place, a liquidator will need funding to bring such actions.

Compromise between creditors

Compromises between creditors are the one situation where power is technically in the hands of the unsecured creditors.

For a compromise to succeed it must be approved by 75% in number and 75% in value of each class of creditor voting for the proposal.

Creditors have the right:-

• To vote for or against a proposal
• To vote for or against amendments to the proposal

Although technically the power is in the hands of the unsecured creditors, in practice the shareholders and directors may have current accounts with the company. These accounts rank equally with the accounts of other unsecured creditors. The shareholders and directors in their capacity as unsecured creditors therefore have the ability to influence the voting.

One of the difficulties with compromises is that every compromise is different and that there is less integrity in some compromises than others. This is where the power to ask for amendments is invaluable.

Before voting, unsecured creditors will need to be satisfied that the following questions have been answered satisfactorily.

Question:
Are creditors satisfied that the proposal will give them a greater return than they would achieve in a liquidation?

To give some degree of comfort on this issue it may be necessary for an independent professional to examine the books and records of the company.

Question:
Is there a professional Compromise Manager in charge of the process?

It would seem to be relying on blind faith to assume that the director who was the architect of the company's financial difficulties can independently manage the compromise arrangement.

Question:
Is there a creditors committee to work alongside the Compromise Manager?

If creditors want to be involved with the process they must be represented.

Question:
What happens if the compromise does not work out?

Will the Compromise Manager perhaps hold a signed resolution by the shareholders to place the company into liquidation on the basis that this will be exercised if the company does not fulfil its obligations under the compromise?

Liquidation

The process of appointing a liquidator

A company is placed in liquidation by the appointment of a named person as liquidator. In practice the appointment of the liquidator is made by either the shareholders or the High Court. The shareholders choose their own liquidator. The High Court appoints the nominee of the applicant creditor.

Duties of a liquidator

The duties of a liquidator are clear. The liquidator has a duty to take possession of, protect, realise, and distribute the proceeds of realisation of the assets of the company to its creditors. The liquidator looks after the interests of all creditors.

The plight of the unsecured creditor

Unsecured creditors do not have it easy. Invariably these are too many creditors taking a share of too little money. Modern insolvency law puts unsecured creditors further and further down the ladder. Unsecured creditors rank after debentureholders, wages, holiday pay, Customs duty, GST, PAYE and a myriad of other preferential creditors such as Child Support, Student Loans, and claims under the Motor Vehicle Dealers Act. Any money left over for unsecured creditors is often then shared with the directors and shareholders who have started the company with a minimal capital, and have advanced money to the company through their current accounts.

What rights then do creditors have?

The Right to Receive a First Report

A liquidator has an obligation to prepare a report containing a statement of the company's affairs, proposals for conducting the liquidation and if practicable, the estimated date of its completion. The liquidator is absolved of this duty if he or she is satisfied that unsecured creditors are unlikely to receive more than 20 cents in the $1.00. Some liquidators however, prepare a report in all cases.

The Right to Have a First Meeting of Creditors

A liquidator is obliged to call a meeting of the creditors of the company for the purpose of resolving whether to confirm the appointment of that liquidator, or to decide upon a liquidator in place of the liquidator so appointed. Although there is a power for a liquidator to dispense with meetings of creditors the liquidator must call a meeting if a creditor gives notice in writing to the liquidator within ten working days of receiving the notice that the liquidator intends to dispense with the meeting.

The Right to Have a Liquidation Committee

At any time in the course of a liquidation the liquidator shall at the request of any creditor call a meeting of creditors to vote on a proposal that a liquidation committee be appointed to act with the liquidator, and if it is so decided, to choose the members of the committee. A liquidation committee represents creditors as a whole and assists the liquidator as appropriate in the conduct of the liquidation. The committee can also call for reports from the liquidator on the progress of the liquidation.

The Right to Call a Meeting of Creditors

A liquidator must summon a meeting of creditors forthwith when requested to do so by notice in writing, given by creditors to whom is owed not less than 10% of the total amount owed to all creditors of the company. It will be necessary in such cases to advise the liquidator of the purpose of the proposed meeting. This is because modern insolvency law provides that creditors may exercise the power to vote by casting a postal vote. The intention is that creditors should not be disenfranchised simply because they are unable to attend a meeting.

The Right to Express Views

The liquidator must regard the views of creditors. Those views might be expressed by the creditors or a liquidation committee representing the creditors.

The Right to Apply to the Court for Supervision of the Liquidator

A creditor with the leave of the Court, or a liquidation committee without such leave, can apply to the Court to supervise the liquidator. Amongst other things the Court may give directions in relation to any matter arising in connection with the liquidation. The Court may also confirm, reverse, or modify an act or decision of the liquidator.

The Right to Take Action to Make the Directors Personally Liable for the Debts of the Company

While the ability to bring civil actions against directors and others primarily lies with a liquidator, a creditor may apply directly to the Court in an effort to make recovery from company officers.

The circumstances that give rise to such proceedings are;

• Where it appears that a past or present director or manager has misapplied or retained company money or property
• Where the company has traded while insolvent
• Where the company has continued to trade when there was substantial risk of serious loss to creditors
• Where a distribution to shareholders has been made while the company could not satisfy the solvency test.

Creditors should note that any recoveries from the above actions would not generally be only for the benefit of the creditor(s) bringing the action but be for the benefit of all creditors in accordance to the normal priority rules.

Individual creditors may be successful in recovering their own losses from directors personally where a director of a company has created a legal obligation on behalf of the company and has not adequately stated the company name in the document or where there have been misrepresentations made to creditors in contravention of the Fair Trading Act 1986.

Conclusion

Creditors have many rights. If they want a return they should be aware of those rights and should take an active interest in the recovery process whatever that process might be. Creditors should be prepared to assist and pass information to any person appointed formally to act on their behalf.

DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.