Winding up

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Contents

Required Reading

Redmond, Paul Corporations and Financial Markets Law 6th ed, 2013, LBC, pp. [8.140]-[8.175]; [3.185]-[3.215].

Introduction

[1] Winding-up (also known as external administration or liquidation) refers to the dissolution of a company. This usually happens during or right before insolvency (ie, when the company is no longer able to pay all of its debts when they are payable: s 95A (2)). It often involves selling all of the companies’ assets and the closure of its operation. Sometimes, portions of the business are resurrected after the process.

There are other methods of closing up a company (sometimes named ‘insolvency regimes’) which may be used to avoid the finality of winding-up:

  • Voluntary administration.
  • Receivership.
  • A creditor’s scheme of arrangement (this is not limited to insolvency or loan default).

Voluntary administration

Voluntary administration (VA) is where the company decides to initiate its own winding-up procedure. It does not require court approval, although the court exercises a supervisory jurisdiction over the conduct of the administration. VA is provided for in Part 5.3A of the Corporations Act 2001.

  • Administrators should be appointed by the company if the company is insolvent or likely to become insolvent: s 436A.
    • Note that if directors allow an insolvent company to trade and incur debts, they may be personally liable for losses sustained by creditors: ss 588G, 588FA.
  • VA seeks to maximise the chance of survival for the company, or if survival is not possible, to maximise return for creditors: s 435A.
  • Possible outcomes:
    • Company will resume but with a deferred or reduced debt burden under a deed of company arrangement approved by creditors (ie, the creditors agree between them to only accept a percentage of what they are owed).
    • A secured creditor will appoint a receiver, disposing of assets.
    • The creditors, unsatisfied with the administration, will vote to put company into liquidation (ie, normal winding-up).

While a company is under administration, the administrator has control of the company’s property and business: s 437A

  • The powers of other corporate officers including directors are suspended (not removed) and may not be exercised without written approval from the administrator: s 437C(1).
  • The administrator:
    • Must be a registered liquidator who is independent of the company: ss 448B, 448C
    • May be appointed by the liquidator (s 436B) or a substantial secured creditor (s 436C).

Process:

The process of VA is roughly as follows:

  • No later than the next business day, the administrator must notify a secured creditor of his appointment: s 450A (3).
  • Within 10 days, a substantial creditor may enforce its charge, usually by appointing a receiver or agent - if it chooses to do so, it effectively supplants the administration: s 442D (1).
    • All or nothing rule - when overriding powers of administration, the charge must be enforced in relation to all of the property of the company, not a portion s 441A (1) (b).
    • If there is no substantial creditor or they choose not to enforce the charge, there is a general moratorium (investigation and collective assessment of options) upon actions against the company and its property by creditors and owners/lessors of property used by company: ss 440A, 440B, 440C, 440D, 440F.
    • Administrator is personally liable for debts incurred (ss 443A, 443B) but has a right to indemnity out of company assets (s 443D) ranking in priority to other debts secured by lien over property assets (ss443E, 443F).
    • During VA, there is a stay of enforcement of guarantees by directors and relatives of a liability of the company without leave of Court: s 440.

As soon as possible, the administrator must investigate the company’s business, property and financial circumstance (s 438A) and convene two meetings of creditors:

  • Meeting 1 - Within 5 days, to determine whether to appoint a committee of creditors to consult the administrator (ss 436E, 436F) or replace the administrator with a qualified other (s 436E(4)).
  • Meeting 2 - Within 21 days, to decide the company’s future (s 439A), administrator must report to creditors about company’s business, property and financial circumstances, and may resolve to:
    • Execute a deed of arrangement
    • VA should end and company returned to directors
    • The company be wound up: s 439C
    • Administrator must state their opinion on each option: s 439A(4)

Deeds

There are two types of deeds:

  • Moratorium deeds - in which company is granted an extended period in which to repay its debts.
  • Compromise deeds - creditors agree to receive less than their full debts.
    • May have combination of these two.

Deeds bind all unsecured and secured creditors, owners and lessors of property used by the company who voted for the deed, the company and its officers and shareholders: ss 444D, 444G.

  • The court may order those who didn’t vote for the deed are nonetheless bound by it where enforcement of their rights would have a material adverse effect on the deed’s purposes and their interests would be adequately protected: s 444D(2), (3), 444F.
  • If a deed provides for distribution among creditors significantly different from the order of application of assets under winding up, court may terminate it: s 445D.
  • VA ends once company becomes subject to deed: s 435C(1)(b), (2)(a)
  • Court may consider deed void if not compliant with Pt 5.3A, or validate it despite contravention, by powers in s 445G.

Powers of court

The court has substantial powers to intervene in VA, including:

  • To terminate the deed because Pt 5.3A powers are being abused, or company is solvent: s 447A(2)
  • May wind up company for insolvency: Pong Property Development Pty Ltd v Sleiman (2004)
  • Power of supervision of a company under administration or deed: s 447E
  • These are broad and plenary power to be exercised in public interest: Cawthorn v Keira Constructions Pty Ltd (1994)

Disadvantages of VA

Voluntary administration still contains the following draw backs:

  • Administrator does not have powers of liquidator to set aside transactions and pursue remedies against directors and other officers.
  • The tightness of time limits on administrator precludes a thorough investigation a liquidator may take.
  • This has led many to believe administrators are set up to avoid liquidation. However courts may exercise power to intervene where abuse of Pt 5.3A: see also Blacktown City Council v Macarthur Telecommunications Pty Ltd (2003)

Receivership

Securities given by companies to lenders commonly grant lender a right upon default to appoint a person to take possession and control either a particular asset, group of assets or whole property, and may deal with such in any way necessary to obtain repayment of the debt. These persons are called receivers, and when this process occurs, it is called receivership.

  • Primarily associated with floating charges (ie, secured debts).
  • Administrators are subject to the powers of the receiver.

Strictly speaking, the receiver has powers to receive property and income but not to undertake the management tasks such as asset disposal that may be necessary for this purpose. However, the reality is that most security instruments include powers of management to supplement the other powers of the receiver. When a reciver is appointed by a court (s 1323(1)(h)), they usually only have power to receive and not manage.

Power of Directors

Where a receiver is appointed under private instrument, directors’ powers are displaced but only to extent of inconsistency with receiver’s powers (ie, if only to particular asset(s): Hawkesbury Development Co Ltd v Landmark Finance Pty Ltd (1969)

  • Even if control is over the whole company, directors retain the power to sue in company’s name to challenge validity of charge and receiver’s appointment or to claim damages for wrongs done to company by holder of charge: Ernst & Young v Tynski Pty Ltd (2003).
  • Where a receiver is appointed by court order to company property, director’s powers are suspended and revived only upon termination of receivership: Reid v Explosives Co Ltd (1887)

Liability of Receivers:

  • If appointed by private instrument, must be careful not to exceed their powers or statutory augmentation under s 420, otherwise they could be exposed to tort and other liabilities for going beyond their powers.
  • Even though receiver is appointed and answerable to chargee, private instruments usually provide the receiver acts as agent of company with the intention that the company is responsible for receiver’s acts, and not the chargee.

Schemes of arrangement

Schemes of arrangement are initiated by an application to the court for an order that a meeting of creditors be convened for approval of an explanatory statement to be sent to creditors with the notice of meetings: ss 411, 412.

  • This binds creditors only if it is approved by a majority of creditors in each class, who between them, hold 75% of total debt present in person/by proxy - the compromise must also be approved by court after application to it: s 411(4).

The complexity, formality and delay inherent in this procedure explain its lack of appeal and displacement in favour of voluntary administration.

Winding-up

Winding up is the process leading up to the liquidation of the company and termination its registration and existence. It can be initiated in two ways:

  1. By voluntary decision by members/creditors; or
  2. Upon order of court (compulsory liquidation)

Voluntary winding up:

A company may be wound-up voluntarily so long as it is still solvent: s 491(1).

  • Voluntary liquidation must be decided upon by a resolution: ss 491, 497
  • Creditors appoint liquidator and control liquidator’s conduct: s 499
  • At the second meeting of voluntary administration stage, the company may be moved into voluntary winding up procedure - liquidation doesn’t affect secured creditors, as they often appoint a receiver: s 466A.
  • A court order may be made on application of members of solvent company complaining of unfairness of oppression in conducts/affairs, or that it is just and equitable that the company be wound up: s 459P (c). These are usually in context of shareholder or management disputes.

Compulsory winding up

On an application under s 459P, or on its own under s 461, the court may order that insolvent company be wound up in insolvency. This section cannot be used to wind up solvent companies and thus should not be used by creditors to put commercial pressure on corporate debtors to repay debts

  • Those who can make an application for winding up are found in s 459P(1):
    • The company
    • A creditor (even if creditor is secured creditor, or is only a contingent or prospective creditor)
    • A contributory (refers to members of the company)
    • A director
    • A liquidator/provisional liquidator of co
    • ASIC
    • A prescribed agency
  • Those who can make an application for winding up with leave include (s 459P(2)):
    • Person who is a creditor only because of contingent or prospective debt;
    • A contributory
    • A director
    • ASIC

These applications usually rely upon presumed insolvency arising from non-compliance with a statutory demand (a statutory demand is one made in the prescribed form requiring payment by the company of a debt of $2000 minimum value that is presently due): s 459E.

  • The company is insolvent if within 21 days after service of demand the company fails to pay or apply to have demand set aside: s 459C.
  • Opposing the Application:
    • If winding-up application is made because of failure to comply with statutory demand, the company is precluded from opposing the application by contesting the debt on a ground it has previously relied on in other proceedings.
    • If the company wishes to dispute the debt or raise an offsetting claim, it must apply to have the demand set aside within 21 days of its service.
    • If not, it may oppose winding up by proving solvency at hearing of application: s 459S.

Directors’ powers

Directors’ powers are brought to an end by winding-up order. They can no longer make decisions about company assets or conduct of business.

  • After winding up, all subsequent transfers of property or shares are invalid, other than by liquidator: s 468(1).
  • Powers vest with liquidator, who may carry on business only so far as necessary for its beneficial disposal: ss 471A, 477.
  • Winding up automatically terminates contracts of employment.

The order of application of company assets

After the liquidator realizes the assets, the funds are used to discharge the funds of creditors. The fundamental rule is the pari passu principle, that all debts and claims in a winding up rank equally, and if property of company is insufficient, all debts must be paid (ie, reduced) proportionately: s 555.

The principle is displaced in these situations:

  • Secured creditors are issued first, however certain preferential unsecured funds may be discharged first via charged assets: s 561.
  • Certain unsecured claims are given priority in that they must be paid sequentially and each in full before others are paid, such as for expense of liquidation, voluntary administration and employee entitlements for wages, superannuation contributions, claims for injury compensation and retrenchment: ss 556, 558.
    • Sons of Gwalia - acase where shareholder purchased via misrepresentation in which the HC held you can be a shareholder, but also a claim as a creditor.

Recovering property and compensation for the benefit of creditors

The liquidator may recover property and funds passing under voidable transactions and seek compensation from directors and other officers for losses sustained through breach of duty: Pt 5.7B.

  • If transaction is voidable, the liquidator can seek orders including for the recovery of money and property by the company, disgorgement and tracing of benefits received, releasing company from debt and varying terms of agreements/declaring them to be void: s 588FF
  • An order cannot be made against a creditor if it is proved they received no benefit from transaction or they received the benefit in good faith and without reasonable grounds for suspecting the company was insolvent: s 588FG(1) - or if they became party to a transaction in good faith, had no reasonable grounds to suspect insolvency, and provided valuable consideration under the transaction or changed its position in reliance: s 588FG(2)

Pt 5.7B void transactions include:

  • Insolvent transactions: transactions that give an unfair preference and uncommercial transactions of the company, made within 6 months of commencement of winding up and where preference of transaction contributes to company’s insolvency: ss 588FE(2), 588FC
  • Unfair preference arises where creditor receives from company in respect of unsecured debt, a greater sum than they would receive if they had to provide for payment along with other unsecured creditors: s 588FA(1)
  • An uncommercial transaction is measured objectively by reference to respective benefits and detriments of parties: s 588FB

Clawback periods:

  • Two year clawback period - Where transaction satisfies both unfair preference and uncommercial transaction, there is an extended clawback period of two years rather than 6 months: s 588FE(3)
  • Four year clawback period, when:
    • Insolvent transaction with a related entity to which the company is a party: s 588FE(4)
    • Unreasonable direct-related transactions (ss 588FE(6A), 588FDA) measured objectively from benefits and detriments of parties involved
  • Ten year clawback period:
    • Insolvent transaction made with purpose of defeating delaying or interfering with the right of creditors in winding up: s 588FE(5)

Unfair loans voidable whenever made (s 588FE(5)), and unfair if interest rate or loan charges are or have become extortionate by reference to specified considerations: s 588FD

Grounds for compulsory liquidation

Section 461 (1) lists the general grounds on which a company may be wound up by a Court:

  • (a) special resolution by the company
  • (c) the company does not commence business within one year from its incorporation or suspends its business for a whole year;
  • (d) the company has no members; or
  • (e) directors have in their own interests rather than the company; or
  • (f) affairs of the company are being conducted in a manner that is oppressive or unfairly prejudicial some members or in a manner that is contrary to the interests of the members as a whole; or
  • (g) an act or omission by or on behalf of the company, or a resolution, or a proposed resolution, of a class of members of the company, was or would be oppressive or unfairly prejudicial to, or unfairly discriminatory against, a member or members or was or would be contrary to the interests of the members as a whole; or
  • (h) ASIC has stated in a report prepared under Division 1 of Part 3 of the ASIC Act that, in its opinion:
    • i. the company cannot pay its debts and should be wound up; or
    • ii. it is in the interests of the public, of the members, or of the creditors, that the company should be wound up; or
  • (k) the Court is of opinion that it is just and equitable that the company be wound up

A company must lodge a copy of a special resolution referred to in paragraph (1)(a) with ASIC within 14 days after the resolution is passed

Standing for compulsory liquidation

s 462 (1) specifies who has standing to request the court to liquidate the company (this is not limited to insolvency like s 459P):

  • (a) the company; or
  • (b) a creditor (including a contingent or prospective creditor) of the company; or
  • (c) a contributory; or
  • (d) the liquidator of the company; or
  • (e) ASIC pursuant to section 464; or
  • (f) ASIC (in the circumstances set out in subsection (2A)); or
    • (2A)(a) the company has no members; and
    • (2A)(b) ASIC has given the company at least 1 month's written notice of its intention to apply for the order.
  • (g) APRA.

Subsection (4) states that the Court must not hear an application by a person being, or persons including, a contingent or prospective creditor of a company for an order to wind up the company unless and until:

  • (a) such security for costs has been given as the Court thinks reasonable; and
  • (b) a prima facie case for winding up the company has been established to the Court's satisfaction.

Compulsory liquidation remedies

Statutory remedies fall into two categories:

  1. Compulsory liquidation remedies
    • Permits the court to make an order for the winding up of the company on application if the factors in s 461 are satisfied.
  2. Remedies for oppression and injustice
    • Allows for a wide range of orders to be made.
    • Any member of a company who believes that its affairs or transactions are within the formalities many apply for an order.

The just and equitable ground of winding up: s 461 (k)

History and scope of the remedy

The principle modern application of the clause is with companies that are in nature of incorporated partnerships or quasi-partnerships. Other categories and illustrations under the clause arise:

  1. Where the company has abandoned its main objects or has entered upon activities beyond the general intention of its corporators (the failure of substratum).
  2. Where the company is unable to carry on business because of deadlock in its management.
  3. Where the company’s management or control is characterized by fraud, misconduct or otherwise gives rise to a justifiable lack of confidence by shareholders.
  • May also be invoked with leave of court by ASIC:s 459P (1) (f), (2) (d)
    • “There must be misconduct sufficient to destroy a reasonable shareholder’s confidence that the business, if left in the hands of the respondents, will be conducted completely and honestly and in the interests of the shareholders, including the petitioners”: International Hospitality Concepts v National Marketing Concepts
    • May be that this ground is an essential remedy only in instances of irreconcilable differences between the parties: McMillan v Toledo Enterprises International, or of other applications of the quasi-partnership principle: Thomas v Mackay Investments
    • It is a well-established practice of the court, that before making such an order on this ground, to adjourn or suspend its order to enable parties to reach a compromise before making final order (Re City Meat Co) - demonstrates extreme reluctance of court to wind up solvent companies
    • Note this reluctance also demonstrated by s 467(4) below.

This was discussed in Re Tivoli Freeholds Ltd:[2]

  • Facts: Company managed theatres which had been damaged by fire. These were sold and theatrical activities were ceased. Company funds were then employed in corporate raiding activities - 93% of minority shareholders (42% of issued capital) opposed current direction of company policy
  • Held (Menhennitt J): Under s 461 (k), the court has a wide discretion and the facts satisfying this ground cannot be resolved into an exhaustive set of categories. Failure of the substratum of a company is a recognised ‘category’ – occurs when company engages in acts which are entirely outside what can fairly be regarded as having been within general intention and common understanding of the members when they became members
    • This is not evidenced by a mere discontinuance of business activities even for a lengthily period so long as it does not evidence a final and conclusive abandonment of business.
    • Even if taking up some other business which if successful will enable capital to be secured to carry out main objective, still really involves an abandonment of primary objective and involves shareholders contributing to venture different altogether from that to which they have subscribed
    • Prime source for ascertaining general intention or common understanding of members is company’s memorandum of association which among other things states its objects - the company’s course of conduct may be relevant but could not prevail against conclusion drawn from memorandum but may be useful to remove ambiguity.
    • As the company’s main objects were concerned with entertainment, and funds had been applied for a wholly foreign purpose to objectives and intention of members, it was just and equitable for the company to be wound up.

And also in Ebrahimi v Westborne Galleries Ltd:[3]

  • Facts: N and E formed a private company to sell carpets. Both were directors. Ns son later joined the company, becoming a director and shareholder. Good profits were made, distributed as remuneration rather than dividends. N and his son passed a resolution removing E as a Director.
  • Held (Lord Wilberforce): winding up the company was just and equitable in the circumstances - in this case, N’s refusal to acknowledge E as a director effectively repudiated the relationship. E lost his right to a share in the profits through remuneration, and was at the mercy of N to receive dividends. Moreover E couldn’t dispose of his interest without consent of N’s.
    • Section 461 (k) enables the court to subject the exercise of legal rights to equitable considerations, that is, considerations arising between one individual and another which may make it unjust or inequitable to insist on legal rights
    • Court drew an analogy between small closely held companies and partnerships - this recognized that it is the essence of the relationship that mutual confidence be maintained. If this is ended, so that they can no longer work together in the way originally contemplated, the relationship should be ended
      • However, a loss in trust and confidence is insufficient in itself to justify dissolution on a “just and equitable” ground, and requires more.
      • It is irrelevant if the power is exercised in the bona fide interests of the company
    • The question whether it is equitable to allow one or two to make use of their legal rights to the prejudice of his associate
    • Held that some of the following elements are necessary:
      • An association formed/continued on basis of a personal relationship, involving mutual confidence (often found where a pre-existing partnership has been converted into a limited co)
      • An agreement/understanding that all/some of shareholders shall participate in conduct of business
      • Restriction upon transfer of members’ interest in the co – so if confidence lost/1 member removed from management, he cannot take out his stake and go elsewhere
    • Right course in this case is to dissolve the company and wind up

The Australian application of the quasi-partnership analogy

Picks up scenarios which are in similar category which may subject legal rights to “equitable considerations” arising from understanding between corporators:

  • Existence at outset of understanding of interest
    • Re Caratti Holdings: The constitution gave power to governing director to acquire shares of other members at par value. Although exercise of power was formally valid, to permit the director to acquire the shares compulsorily at gross undervalue was contrary to a clear understanding that existed from the outset that the shareholder would have 10% “partnership” interest in the business
    • Kokotovich Constructions v Wallington: The minority shareholder was granted at formation, holdings as recognition of pre-existing emotional and business relationship. Due to the continued animosity between the parties, and risk of oppression and limited nature of co’s activities, winding up was granted.
  • Inheritance cases
    • Re City Meat Co: Shareholders were members of a family who acquired their shares through inheritance. Trading generated few profits and rarely paid dividends. The majority shareholder and MD received income but ignored the “rights, expectations and obligations” of other shareholders, justifying winding up.
  • State of animosity or no way to continue
    • Re Dalkeith Investments: Shares were divided between former spouses and daughter, and it was held the family company was in substance a “partnership in a corporate form”. Because of divorce, there was a loss in mutual trust and confidence and it was no longer possible for members to work together for the common good or to rely, for the protection of interests and investment in the company. Therefore, winding up permitted.

Management deadlock

Winding up may be permitted where neither party is oppressing the other, but incompatibility, and inability to reach agreement, is such that the company is in a state which could not have been contemplated by them when the company was formed: Re Yenidje Tobacco Ltd.

Directors acting in their own interests: s 461(e)

Allows making of winding up order where directors have acted in affairs of company in their own interests rather than in interests of members as a whole/in any other manner whatsoever that appears to be unfair/unjust to other members

  • Although not widely used, its utility derives from, breadth of its language
  • Posits an objective standard: whether directors have acted in their own interests etc/otherwise unfairly/unjustly
  • This standard avoids the problems which have plagued law on directors’ duties in defining subjective notions of good faith/equitable fraud as criteria for relief
  • This ground is complimented by ss 461(f), (g) which parallel terms in oppression remedy in Pt 2F.1.

This was discussed in Re Cumberland Holdings Ltd:[4]

  • Acting in “own interests”: Directors do this if they have acted in the interests of another company of which they are also directors/shareholders
  • Acting not in the interests of the company “as a whole”: Where directors are shown to have preferred their own interests to the interests of a significant section of the company’s members ie, in a way that is unfair or unjust to other members (oppressing the minority)
    • Conduct does not have to be shown to be unfair or unjust to the members as a whole - sufficient if shown it is unfair or unjust at least to any significant body of other members, and perhaps to any other member
  • “Directors”: not limited to whole board acting unanimously/effective majority acting in own interests/interests of 1+ of those members, or even where 1 D somehow causes his will to be carried into effect by board
  • “Affairs of the company”: not limited to trade/business matters, but encompass capital structure, dividend policy, voting rights, consideration of takeover offers and indeed all matters which may come before board for consideration
  • Section 461 (e) applies where it is shown that the directors have acted in the affairs of the company in any other manner whatsoever which appears to be unfair to the other members - sufficient to show that the conduct is unfair or unjust to any significant body of other members, and perhaps to any other member

And also in Re Weedmans Ltd:[5]

  • Facts: Sportscraft secured voting control of W. Took steps to facilitate takeover bid by S. Bid at very unfair price. S misinformed and misled the minority shareholders in material respects
  • Held (Lucas J): Looking at the whole history of the matter it seems the board were concerned more with the interests of S than with the interests of W. Failed to observe “requisite standard of commercial morality” - was unfair and unjust to other members.
    • If allotment of shares stood in isolation, no doubt there would have been another remedy but it doesn’t stand in isolation and the petitioners did not rely on this alone
    • They have no other remedy other than winding up

End

This is the end of this topic. Click here to go back to the main subject page for Business Associations.

References

Textbook refers to Redmond, Paul Corporations and Financial Markets Law 6th ed, 2013, LBC.

  1. Textbook, [3.185].
  2. [1972] VR 445.
  3. [1973] AC 360.
  4. (1976) 1 ACLR 361.
  5. [1974] Qd R 377.
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