Liquidation produces no returns for creditors in Australia

In this article, we ask, does the existing liquidation process optimise returns for creditors? And if not, how might the process be reformed to produce better outcomes?

• Commonly creditors think that liquidation is a useful mechanism for getting their due from a debtor company. The evidence does not support this.
• After winding up, and the payment of liquidator remuneration and expenses, usually, there are zero cents left for the remaining unsecured creditors. 
• While there are various mechanisms in place (such as ‘reviewing liquidators’) designed to keep control of liquidator fees and expenses, they are rarely used. 
• In light of these low returns, creditors should be realistic about expecting a financial return from a standard liquidation process. 
• The new simplified liquidation process available for small businesses may be effective at reducing the cost of liquidation, but ultimately, this may have little impact on the end return to creditors. 

The run-up to liquidation 

When a debtor company owes money to a creditor, a creditor needs to decide what their best prospect is for getting that money back. A practical option for a creditor is to issue a statutory demand for payment of debt (a ‘statutory demand’). This demand can be issued where the debt is greater than $4000 and the statutory demand is in a form specified in the Corporations Act 2001 (Cth) and associated regulations. This is often a cheaper and more efficient method for the creditor to get their debt paid than pursuing a claim in court for ‘judgement debt’. The debtor company will either contact the creditor to negotiate repayment, or it will be ‘on notice’ to initiate their own winding up or liquidation (the terms ‘winding up’ and ‘liquidation’ are used interchangeably).

A statutory demand also has the added advantage that it can be the first step in proving insolvency for the purposes of a court liquidation, if it ever gets to that point. Read more about this process in our comprehensive guide to statutory demands Creditor’s Statutory Demand for Payment of Debt. 

Where the debtor company is unable to pay its debts, and directors see no viable and legal restructuring option, directors may need to initiate a creditors’ voluntary liquidation (CVL) or a voluntary administration.

Note that, despite its name, it is the members (and effectively, the directors, who convene the meeting of members), and not the creditors, that initiate a CVL. 

Unsecured creditor prospects in liquidation

In a liquidation, priority for the proceeds of the winding up goes to secured creditors. Even among secured creditors, some interests, such as a Purchase Money Security Interest (PMSI) will have ‘super-priority’ over other secured interests.

For unsecured creditors, funds are also distributed in order of priority as set out in section 556 of the Corporations Act 2001 (Cth):

• The costs and expense of the liquidation, including liquidators’ fees;
• Outstanding employee wages and superannuation;
• Outstanding employee leave of absence (including annual leave and long service leave);
• Employee retrenchment pay; and
• Remaining unsecured creditors.

Given the order or priority, what are the prospects of the remaining unsecured creditors getting a return?

• In 2017, Australian Securities and Investments Commission (ASIC) data suggested that returns to general creditors averaged 11 cents or less on the dollar in 96% of cases.
• In 2018, the prospects of creditors reduced further with 97 per cent of cases resulting in returns of zero to 11 cents.
• In 2019, the 97 percent figure held steady.  

Not only do these ASIC statistics indicate dire outcomes for creditors in most cases, in real terms these statistics overestimate outcomes for creditors. They incorporate outliers (such as 100c returns), which distort the true average.

In our experience, the expected return for the median unsecured creditor is zero cents on the dollar. As the overwhelming majority of windings up in Australia are small-sized and family businesses with a small asset base, it is perhaps not surprising that zero assets are leftover in so many cases.

Are liquidators themselves to blame? 

Are the low returns simply the result of a low initial asset base, or are excessive liquidator fees part of the equation? For a recent court decision that looked into the practice of excessive liquidator fees, consider Lock, in the matter of Cedenco JV Australia Pty Ltd (in liq) (No 2) [2019] FCA 93. In that case, the Federal Court objected to the liquidator’s rates as unreasonable (for example, $700 per hour for partners) when they were clearly out of step with market rates.

Liquidators may well seek to defend high fees on the basis that their business model is risky — they are often committed to appointments where they might not be paid in full or at all (assetless companies). However, an indefensible practice is ‘target billing’. This occurs where the insolvency practitioner loads up on billing in insolvency administrations that have assets, in order to compensate for assetless jobs. This practice is unfair and unacceptable, as it depletes dividends for creditors in asset-heavy liquidations through no fault of those creditors. 

It is also worth observing that the loss from over-the-top liquidator fees is not just a loss to individual creditors but constitutes a significant loss to taxpayers as well – the Australian Tax Office (ATO) is almost always the largest unsecured creditor, and yet, as they have no priority, they are usually unable to recover unpaid taxes.

In 2020, the Australian Small Business and Family Enterprise Ombudsman (ASBFEO) finalised an inquiry into the effect of insolvency practices on small businesses. Key findings included: 

• 93% of small businesses considered the time and cost associated with the liquidating of assets in a winding up were unreasonable.
• Small businesses consistently reported that the actual cost and duration was greatly in excess of initial estimates.
• A commonly held perception is that liquidators extend an external administration process as long as there are assets that can be realised to reimburse their fees.

One submitter to that inquiry offered the following sobering perspective (see page 13):

“[Registered liquidator] during meetings before appointment indicated that a restructure would be their primary goal and that they would provide assistance to set up a deed of company arrangement (DOCA). They estimated that their total fees would be $250,000 and that the administration would take around 6 weeks. Their fees have totalled over $1 million and continue to increase after 2 years. The liquidation is still not complete.”

Options for creditors to rein in the costs of the liquidation

In response to a perception that insolvency practitioner fees are too high, and are having a negative impact on liquidation outcomes, a range of reforms were introduced in 2016.  This included enhanced powers for creditors to approve liquidator remuneration and expenses, and the appointment of a ‘reviewing liquidator’. In the liquidation process, creditors need to consider:

• The remuneration and expenses approval process. In the case of a CVL, remuneration and fees must be approved by the creditors themselves, a ‘committee of inspection’ or the Court. If fees are not settled by either resolution of creditors or the committee of inspection, then they must be set by the Federal or Supreme Court. 
• Appointment of a reviewing liquidator. Creditors also have the option of appointing a ‘reviewing liquidator’ who is a registered liquidator appointed to review the remuneration and costs charged. The reviewing liquidator can be appointed either by a resolution of creditors (in which case, the reviewing liquidator adds to the costs). Or, it can occur without a resolution, but with liquidator consent. In that case, the individual applicant must pay for it. 

Note, the reviewing liquidator can only look into:

• remuneration approved in the prior six months; and
• costs or expenses incurred during the previous 12-month period.

It is worth noting that, as the cost of the reviewing liquidator is added to the costs of the liquidation, this can further reduce the pool of money available to unsecured creditors. If the liquidator doesn’t have sufficient funds then the creditors may be called upon to provide an indemnity.

Another option for creditors seeking to reign in excessive liquidator remuneration and expenses is to make a court application. Under section 447A of the Corporations Act 2001 (Cth), the Court has broad powers to make orders as it sees fit in relation to liquidation. This application allows creditors, others with a financial interest and directors to apply to the Court for an order:

• for a determination in relation to any matter related to the liquidation;
• an order that an individual be replaced as the liquidator; or
• remuneration orders.

As always with court proceedings, this will be an expensive and time-consuming process. 

You can read more about liquidation remuneration review tools in the Ultimate Guide to Liquidation Part 3: Responding to liquidation. 

It is worth observing that none of these tools for reducing liquidator fees appear to have been regularly used, nor do they seem to be seen as beneficial by creditors (see the ASBFEO report linked above). 

Could simplified liquidation help? 

In 2021, the Commonwealth introduced a new liquidation process, similar to a CVL but with changes made to reduce the cost of liquidations and the time spent on administering them. This ‘simplified liquidation’ is only available to companies with liabilities totalling less than $1 million.

As with a standard CVL, directors appoint a liquidator to wind up the insolvent company, to realise any remaining assets and to distribute any dividends to creditors.

The principal changes from a regular CVL are: 

• Limited ability to ‘claw back’ transactions which may have been ‘unfair preference’ payments.
• An alteration to liquidator reporting rules. Liquidators are not always required to report to ASIC about potential misconduct (see section 533 off the Corporations Act 2001 (Cth)).
• No requirement to call a meeting of creditors. Information and proposals can be put to creditors electronically.
• No committees of inspection.
• No capacity to appoint a reviewing liquidator.
• A simplified dividend and proof of debt process.
• Technology neutrality for creditor and liquidation communication.

It’s too early to say whether simplified liquidation will result in higher returns for creditors. Even though it was recommended by ASBFEO that simplified liquidations involve a strict cap on liquidator costs, no such cap was introduced. Given that simplified liquidations can only occur in relatively small businesses, it is plausible that fees will eat up any possible returns that may eventuate. 

A 2020 analysis of ASIC statistics by Professor Jason Harris of the Sydney Law School, pointed out that 78 percent or corporate insolvencies involve companies with less than $50,000 in assets and the majority (58 percent) have less than $10,000 at the point when the insolvency practitioner is appointed. In light of this, the prospects of creditor recovery from simplified liquidation are still relatively slim. 

Alternatives to liquidation for creditors

Given the poor prognosis for unsecured creditors through liquidation, what other options do they have available to them? We already mentioned in the first section of this article that creditors could consider issuing a statutory demand for payment in order to ‘scare’ the debtor company into payment.

Other possible options include:

• Voluntary Administration. This process that is usually initiated by the directors of the company. It seeks to arrive at a ‘Deed of Company Arrangement’ (DOCA) by agreement of the creditors that will provide them with a better outcome than proceeding directly to liquidation. Note, however, that the rates of return for this process are also dire for unsecured creditors. Through a DOCA, creditors receive, on average, 5-8 cents on the dollar. You can read more about the success rates of voluntary administration in the Complete Guide to Voluntary Administration.
• Pre-packs. In a ‘pre-packaged insolvency arrangement’ (‘pre-pack’), the directors of a struggling company utilise the ‘safe harbour’ from liability for insolvent trading to come up with an informal restructure. Usually, this involves the company transferring its assets to a new company (which may or may not have the same directors) for fair market value. This process is distinguished from illegal phoenix activity due to assets only being sold at market value. 
• Schemes of arrangement. These relatively uncommon arrangements, regulated under Pt 5.1 of the Corporations Act 2001 (Cth), are binding, court-approved agreements, allowing for the reorganisation of the rights and liabilities of members and creditors of a company. Note, however, that as this is a court-supervised process involving significant input from the ASIC so it is by no means a cheap or quick option. Note, a recent consultation carried out by the Treasury investigated some alterations to the current process, including a moratorium on creditor claims while the scheme is being prepared.  
• Simplified debt restructuring. This statutory process, also known as ‘small business debt restructuring’ or simply ‘restructuring’, provides another alternative to distressed companies with liabilities of less than $1 million (read more about this process here). An independent professional (known as a ‘restructuring practitioner’) is appointed by directors to come up with a plan to restructure the company’s debt (a ‘restructuring plan’). Where voting creditors of greater than 50 percent of voting value agree to the plan, it will be accepted and executed. The restructuring practitioner then supervises the implementation of the plan. As with simplified liquidation, this has only been in force since the beginning of 2021, so it is not yet clear how successful this new tool is. 

Critical comment 

Arguably, changes over the years to liquidation laws (whether 2016 changes bringing in reviewing liquidators, or the simplified liquidation of 2021) do nothing to deal with the fundamental problem in the Australian insolvency system – most liquidated companies have no assets. While attempts to turnaround businesses before the point of no return (such as the new simplified restructuring process) are laudable, it is a brute fact that most liquidated businesses will have no assets for distribution to anyone. 

Another curious fact of Australian insolvencies is that, in the overwhelming majority of cases, the Australian Tax Office (ATO) is the biggest creditor. Therefore, there is a strong public interest in efficient liquidations. 

Harris, and prominent insolvency law commentator, Michael Murray, have suggested that Australia needs a ‘Government Liquidator’ role for corporate insolvencies. This funded agent of the Government could have several core benefits: 

• Increasing the likelihood of a return to the ATO (and therefore the public purse); 
• Eliminating assetless, deregistered and dormant companies that should have been liquidated but have not been; and
• Removing/reducing the market distortion in liquidator fees caused by their ‘compensating’ for assetless liquidations. 

Conclusion

In most cases, Australian creditors have zero hope of a return from a liquidated company. In light of this, creditors may need to be realistic in their general business dealings — steer clear of bad payers and clients with poor credit. It may be worth considering credit insurance as a protection option. 

Where a business does get into considerable difficulty, the creditor’s best bet is probably a restructuring option, whether informal (such as a pre-pack) or the formal restructuring option for small businesses (simplified restructuring).