Personal bankruptcy and business liquidation

On August 8, 2022, the Australian Financial Security Authority (AFSA), the Australian Securities and Investments Commission (ASIC) and the Australian Restructuring Insolvency and Turnaround Association (ARITA) released a joint guide detailing how personal bankruptcy and liquidation of a company can interact. The guide was first published in 2017 and has since been updated in July 2022.

The joint publication provides guidance for corporate directors and other business people to help them understand their rights and responsibilities in the event of personal bankruptcy and business liquidation. It provides useful information to advisers regarding the potential consequences and options available if their client is a director or shareholder of a company in financial difficulty. The guide also emphasizes the importance of seeking competent professional advice and acting on that advice.

More specifically, the guide states:

1. where a party may be liable for the debts of its business,

2. what happens if someone goes bankrupt, including the impact on their business

3. what happens if an individual’s business goes into liquidation, including the impact on their personal debts, and

4. practical advice on how to avoid unreliable advisers and how to receive correct advice.

Personal liability for professional debts

It is important to understand what is involved in both bankruptcy and liquidation and how they interact.

Many people operate their business through a corporation. This is so to avoid personal liability for business debts of the business and to protect their personal assets in the event of business bankruptcy. This is because the corporation owns the assets of the business and is liable for all debts incurred in the course of operating that business. The individual, as a director or shareholder, is generally not personally liable for trade and other debts of the business. However, if the business and the individual cannot pay their debts as they come due, the business may go into liquidation and the individual may go bankrupt.

Individuals may also become personally liable for director sanctions if their company fails to:

• respond to a pay as you go (PAYG), goods and services tax (GST) or superannuation guarantee charge (SGC) in full, or

• file tax returns by the required due date.

Banks or financial providers may also require individuals to post a personal guarantee against any unpaid liabilities of a business. This means that if the company cannot pay, the individual becomes legally responsible for the debts of the company. When a business goes bankrupt, it can lead to increased pressure from creditors demanding payment. If a company continues to carry on business after becoming insolvent and incurs debts that it cannot pay as they come due, the person may become personally liable for those debts if the company goes into liquidation, whether that person provided or not a personal guarantee. .

If a person operates the business in their own name or in partnership with another person, rather than through a corporation, then that person will be personally liable for the debts of the business and may go bankrupt if they do not is unable to pay these debts.

Consequences of personal bankruptcy

An individual can go bankrupt in 2 ways:

1. by their own choice via a debtor’s petition – known as voluntary bankruptcy, or

2. because a court orders an individual to declare bankruptcy at the request of one or more of his creditors — via a creditor’s petition.

A trustee in bankruptcy — a qualified licensed professional responsible for administering the bankrupt’s estate — is appointed.

What happens to a bankrupt’s business?

If an individual goes bankrupt, he cannot continue as a company director. Any shares they hold in the company will pass (or vest) to their trustee in bankruptcy who can manage them as they see fit. The trustee can choose to liquidate the company or sell shares in order to use the funds to pay creditors. The bankrupt has an obligation to assist an appointed liquidator in the liquidation process, including providing the liquidator with information regarding the activities, assets, affairs and financial condition of the company.

Alternatively, the trustee may choose to take no action if the company has no assets or if there is little or no value in the company. If this happens, a creditor can ask the court to put the company into liquidation and appoint a liquidator.

Consequences of the liquidation of an individual’s business

A company can be put into liquidation in 2 ways:

1. By resolution of shareholders — known as voluntary liquidation, or

2. Because a court orders the liquidation of a company, usually based on a creditor’s request for liquidation — known as judicial liquidation.

If an individual’s business goes into liquidation, a liquidator — a qualified licensed professional to administer the liquidation of the business — is appointed. Other options or processes may help a person deal with their company’s debts and may enable them to continue trading. These options include small business restructuring or voluntary administration.

Impact on an individual’s personal liabilities

If an individual’s business goes into liquidation, responsibility for the administration of the business passes to the liquidator. The person, as a director, must assist the liquidator and provide him with information regarding the affairs, property, business and financial situation of the company. However, the individual no longer has control of the business; rather, it is the liquidator who decides how the liquidation should proceed. Unless the individual is bankrupt, he remains liable:

• their separate personal debts — for example, their personal credit card,

• the social debts they have guaranteed,

• any debts they owe the business — for example, to repay a loan received from the business,

• unpaid employer pension contributions,

• certain tax debts, and

• any debts incurred if the company continued its activities while it was insolvent.

The liquidator will investigate the affairs, property, business and financial condition of the company. This includes determining whether there are any assets worth recovering for the benefit of creditors. The liquidator will also investigate the existence of a claim against the person as director or shareholder, in particular for:

• not prevent the company from negotiating and incurring debt while it is insolvent, and/or

• breaches of duties by directors.

If an individual does not go bankrupt, the liquidation of the company only resolves the obligations of the company to its creditors; it does not resolve the individual’s separate personal debts or guarantees, for which the individual will always remain liable.

Practical steps

The joint publication by AFSA, ASIC and ARITA also offers practical advice for business owners facing financial difficulties, to seek qualified professional advice and act on that advice.

Consult a qualified lawyer

Business failure can lead to complicated legal outcomes, including asset recovery actions and penalties against the offending individual, if they fail to meet their legal obligations. In addition, declaring bankruptcy can have serious consequences.

Therefore, a person who may encounter financial difficulties in their business is advised to consult a qualified lawyer as soon as possible. Other professionals to consult may include a registered trustee or liquidator. Many trustees are also liquidators; however, by law, they cannot act in both capacities at the same time for an individual and their business. Once appointed, a trustee or liquidator acts for the benefit of the creditors of an individual or company and not for the benefit of an individual personally.

Beware of unreliable advisors

Some advisers may target individuals or business owners whose businesses or individual circumstances may be facing financial difficulties and are therefore likely to take actions that may be illegal. Such actions can result in serious consequences for individuals and business executives, including heavy fines or jail time. It is important that individuals know what they are paying for and that advice received does not result in a breach of law or duty. Warning signs of an untrustworthy advisor include:

• contact a person unexpectedly,

• remain reluctant to provide advice in writing; a written record of advice is always recommended,

• presenting himself as a “friendly” fiduciary or liquidator,

• suggest the transfer of assets belonging to an individual or his company to another party or company without that party or company paying the full value of these assets; such action could harm the individual’s claims or those of the company’s creditors, and

• advising a person to withhold or delay the transmission of his business documents to his fiduciary or the transmission of the books and records of the company to its liquidator; it is an offence.

Sources: ASIC, Personal Bankruptcy and Liquidation of a Company, August 8, 2022, accessed September 10, 2022.

AFSA, Updated Personal Bankruptcy and Business Liquidation Guidelines, August 8, 2022, accessed September 10, 2022.

ARITA, Personal Bankruptcy and Business Liquidation Guidance Document, August 8, 2022, accessed September 10, 2022.

ASIC, Information Sheet 42 (INFO-42), Director Insolvency, accessed 10 September 2022.

CCH Pinpoint ®, Bankruptcy, accessed September 10, 2022.

CCH Pinpoint ®, Insolvency Law Reform, accessed September 10, 2022.

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