What happens if my company can't pay its debts?

In Plain English

If your company can't pay its debts, several things can happen, and there are legal avenues for both you (the company) and your creditors (those you owe money to). Here's a simplified overview:

Statutory Demand: A creditor can issue a formal demand for payment. If the company doesn't comply within a specific timeframe (usually 21 days, but it can be longer in certain circumstances), it can be used as evidence that the company is insolvent.
Winding Up: If the company can't pay its debts, a creditor (or the company itself) can apply to the court to have the company "wound up," which means it's put into liquidation.
Insolvency: The Corporations Act 2001 defines insolvency and outlines the duties of directors when a company is facing financial difficulties. Directors have a duty to prevent insolvent trading, meaning they shouldn't allow the company to incur new debts if there's a risk it can't pay them back.
External Administration: This can include liquidation, voluntary administration, or a deed of company arrangement. These processes are designed to help resolve the company's financial problems, either by restructuring the business or winding it up in an orderly manner.
Director Liability: In some cases, directors can be held personally liable for the company's debts, especially if they've engaged in insolvent trading or creditor-defeating dispositions.
Creditor-Defeating Disposition: Directors must not transfer company assets to avoid paying creditors. This is illegal phoenixing.

Detailed Explanation

When a company faces an inability to pay its debts, the legal framework provides several mechanisms for addressing the situation, as outlined in the Corporations Act 2001 and related regulations.

1. Statutory Demand and Presumption of Insolvency:

A creditor can serve a statutory demand on the company under section 459E of the Corporations Act 2001, as amended by the Corporate Law Reform Act 1992. This demand must specify the debt(s), the total amount due (which must be at least the statutory minimum, currently $4,000), and require the company to pay or secure the debt within 21 days.
Failure to comply with the statutory demand within the specified period creates a presumption of insolvency under section 459C of the Corporations Act 2001. This presumption can be used as grounds for an application to wind up the company. The company can apply to have the demand set aside under s459G of the Corporations Act 2001.

2. Winding Up:

Section 459P of the Corporations Act 2001 outlines who may apply to the Court for a company to be wound up in insolvency, including the company itself, a creditor, a director or a liquidator.
Section 468 of the Companies Act 1985 (NI) outlines the circumstances in which a company may be wound up by the Court, including if the company is unable to pay its debts.
A company is deemed unable to pay its debts if, among other things, a creditor's demand remains unpaid for the statutory period (s468(2) of the Companies Act 1985 (NI)).

3. Director's Duties and Insolvent Trading:

Section 588G of the Corporations Act 2001 imposes a duty on directors to prevent insolvent trading. This means a director must not allow the company to incur a debt if the company is insolvent or becomes insolvent by incurring that debt, and the director is aware (or a reasonable person in their position would be aware) that there are grounds for suspecting insolvency.
A director who breaches this duty may be personally liable for the company's debts. There are defences available, such as if the director had reasonable grounds to expect the company was solvent (Corporate Law Reform Act 1992).
The Treasury Laws Amendment (2017 Enterprise Incentives No. 2) Act 2017 introduced a "safe harbour" provision (section 588GA of the Corporations Act 2001) that can protect directors from liability for insolvent trading if they are taking a course of action that is reasonably likely to lead to a better outcome for the company.

4. Creditor-Defeating Dispositions and Illegal Phoenixing:

The Treasury Laws Amendment (Combating Illegal Phoenixing) Act 2020 introduced new provisions (sections 588GAB and 588GAC of the Corporations Act 2001) to deter "phoenixing," which involves transferring a company's assets to avoid paying creditors.
An officer of a company must not engage in conduct that results in the company making a creditor-defeating disposition of property. This includes situations where the company is insolvent, becomes insolvent because of the disposition, or enters external administration as a result of the disposition.
Similarly, a person must not procure, incite, induce, or encourage a company to make a creditor-defeating disposition.

5. External Administration:

If a company is insolvent, it may enter voluntary administration. An administrator is appointed to take control of the company and explore options for its future, such as a deed of company arrangement (DOCA) or liquidation.
A DOCA is a binding agreement between the company and its creditors that sets out how the company's debts will be paid.
Liquidation involves selling the company's assets and distributing the proceeds to creditors in accordance with a statutory order of priority.

6. Proof of Debt:

Creditors must lodge a formal proof of debt with the liquidator to claim their entitlements from the company's assets (Corporations Regulations 2001, Form 535).

7. Liquidator's Obligations re: Outstanding Tax-Related Liabilities:

A liquidator has obligations relating to outstanding tax-related liabilities. Within 14 days of becoming liquidator, they must notify the Commissioner of Taxation, who will then notify the liquidator of the amount required to discharge any outstanding tax-related liabilities (Taxation Administration Act 1953). The liquidator is personally liable if they contravene this section.

8. Debt Agreements:

The Bankruptcy Act 1966 allows a debtor to propose a debt agreement to creditors as an alternative to bankruptcy. If the agreement is accepted, the debtor is released from provable debts.

This information is a general overview and does not constitute legal advice. If your company is facing financial difficulties, it is essential to seek professional advice from a qualified accountant and lawyer.