Construction companies across Australian states are currently facing an unprecedented wave of insolvencies. According to ASIC statistics, in the 2022-2023 financial year, 2,213 construction companies entered external administration. When a company becomes insolvent, are shareholders required to use their personal assets to repay debts? And how can creditors protect their rights?

Must Shareholders Use Personal Assets to Repay Debts?

Under the law, a company is an independent legal person, holding all the same rights as a natural person. In Australia, once registered with ASIC, a company is independent of its shareholders and founders, and the company’s assets are separate from those of its shareholders — this is known as the separate entity principle. Therefore, after a company becomes insolvent, shareholders are not required to use their own assets to repay the company’s debts. However, shareholders remain liable to the company to the extent of their capital contribution or subscribed shares.

However, for sole traders and partnerships, owners bear unlimited liability (except for limited partnerships). That is, if the business assets are insufficient to fully cover the debts, personal assets must be used to repay the balance.

How Creditors Can Take the Initiative

Receivership

Receivership typically requires a secured creditor to appoint an independent third party as receiver, who takes possession of the secured property and sells it to pay off the secured debt, or continues to operate the business until the risk to the security is removed.

The receiver may take possession of and control the property, lease or dispose of the company’s assets, borrow against the assets as security, insure the assets, repair, renovate or expand the assets, sell assets to finance the company, and hire or dismiss employees. The advantage of receivership is that the receiver can maximise protection of the secured creditor’s interests. The time required for receivership depends primarily on the risk profile of the assets.

Creditor’s Scheme of Arrangement

A creditor’s scheme of arrangement refers to a rearrangement of a company’s affairs when it faces financial difficulties, resulting in an arrangement that binds all creditors. Creditor’s schemes of arrangement are rarely used as a means of insolvency resolution, mainly due to the high costs and the complex, slow procedure; in addition, a creditor’s scheme of arrangement must first be applied for through the court.

Liquidation (Winding Up)

If the debt is not less than AUD 4,000, a creditor may apply to the court for compulsory liquidation and issue a statutory demand requiring the debtor to repay the debt by the date specified. If the company fails to repay within 21 days of receiving the statutory demand, reach a repayment arrangement satisfactory to the creditor, or apply to the court to set aside the statutory demand, the company will be deemed insolvent.

Creditors may also initiate a voluntary liquidation, but this requires the company to be insolvent and a meeting of members and creditors to be convened. Creditors may appoint a liquidator, who must convene a company meeting and, within ten business days after the resolution for voluntary liquidation is passed, send every creditor a summary of affairs and a list of creditors.

Liquidation is time-consuming — it can take years — and expensive, but it allows for the pursuit of insolvent trading claims.

Voluntary Administration

Voluntary administration is primarily aimed at understanding the company’s financial position and determining, as quickly as possible, the course of action that best protects creditors’ interests. While the company is in voluntary administration, the administrator has control over the company’s assets and operations.

A creditor with a security interest in the company may appoint an independent liquidator as administrator, and the company’s directors may not exercise their powers without the administrator’s written consent. The first meeting of creditors must be held within 8 business days after the administration begins, and creditors have the right to replace the administrator. The second meeting of creditors must be held within 25 business days after the administration begins, at which creditors decide matters such as commencing liquidation or ending the administration. Both meetings must be completed within 30 business days of the administration beginning.

In addition, during the administration period, no proceedings against the company or its property may be commenced or continued (other than criminal proceedings), except with the administrator’s written consent or the court’s leave.

The benefit of voluntary administration is that it gives the company an opportunity to turn itself around, and the process is relatively short — usually within 4 weeks — although the administrator may need several years to prepare a Deed of Company Arrangement (DOCA).

Final Thoughts

Corporate insolvency and liquidation often involve the allocation of rights and order of priority among multiple stakeholders. The procedures are complex and the amounts involved can be substantial, making professional legal assistance all the more important in order to properly protect the rights of different parties. If you are facing company insolvency issues — whether as a shareholder, director, creditor, or employee — you are welcome to contact NS Legal for advice. Our experienced lawyers can help you navigate the relevant issues.