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Secured creditors such as banks and other charge holders are primarily paid in advance of Unsecured Creditors. Trade creditors are generally ordinary Unsecured Creditors. Both the Corporations Act 2001 and the Bankruptcy Act 1966 specify that certain classes of Unsecured Creditors are to be paid in priority to other classes, and where there are insufficient funds these groups of Creditors are to be paid pro rata.

Corporate priorities are governed by Section 556 of the Corporations Act 2001, while bankruptcy priorities are covered under Section 109 of the Bankruptcy Act 1966.

In general, the main priorities for companies are generally as follows:

• Expenses reasonably incurred on behalf of the liquidator protecting and realising the assets.
• If the Court ordered the winding up, the taxed costs of the petitioning creditor.
• The liquidator’s expenses and remuneration.
• Employee wages and superannuation.
• Compensation claims.
• Employee long service leave, annual leave and redundancy.

There are a few situations where the priorities may change, for example.

Creditors with floating (including fixed and floating) charges will only be repaid their debts after employees are paid in full.

Directors and their spouses are “excluded employees” and their priorities are limited to $2,000 and $1,500 for wages and leave entitlements, with the balance ranking as an ordinary unsecured claim.

Persons who contribute money to the company for the purpose of paying wages may also be entitled to claim priority for those monies.

In bankruptcy, the order of payment of unsecured creditor claims will generally be as follows:

1. Realisation and interest charges payable to the government.
2. Expenses reasonably incurred on behalf of the trustee protecting the bankrupt’s assets or carrying on a business of the bankrupt.
3. Other expenses paid by the Trustee in administering the estate.
4. The taxed costs of the petitioning creditor.
5. The Trustee’s remuneration.
6. Employee wages to a maximum of $3,100.
7. Workers compensation claims.
8. Employee long service leave, annual leave and sick leave.

The likelihood, quantum and timing of a dividend is specific to a particular matter. The likelihood and size of a dividend to you as a Creditor may be influenced by:

• The sum of the realisation of the matter’s assets.
• Your classifications as a creditor, i.e. employees receive a priority over unsecured trade creditors.
• The quantum of debt provable.

The timing of a dividend to you as a Creditor may be influenced by:

• Saleability of Assets and the terms of sale
• Difficulty of legal proceedings
• Timeliness of debtors paying
• Other unanticipated issues that may arise

As is often the case, directors are not always forthcoming with issues that an Administrator/Liquidator will be envisaged to encounter. As a result, this makes it difficult of the Administrator/Liquidator to be realistic in estimating a timeframe.

If you are a Trade Creditor, it is advisable that you attach copies of your outstanding invoices and a copy of your statement.

If you are an employee, it is recommended that you attach a separate schedule outlining the type of employee entitlements that you are owed (e.g. wages, superannuation, annual leave, long service leave) and the corresponding amount to each.

A proxy form that accompanies your notice will be completed specifically to that company, meeting date and time.

Director Penalty Notices are an extremely powerful and effective debt collection tool available only to the Australian Taxation Office. They allow the ATO to impose personal liability on Company Directors without the delay or expense of taking legal action. For this reason, it is essential that Company Directors act promptly if they receive a Director Penalty Notice.

However, while it is easy to conclude that Company Directors must act quickly if they receive a notice, they must choose their course of action carefully. Although paying the amount of the notice may appear to be the simplest and most direct response, as we will explain below it may actually result in a significantly larger personal liability in the future.

If a company falls behind in its payment of tax liabilities, the ATO can issue a Director Penalty Notice to any or all of the Directors. The notice takes the form of a letter from the ATO.

Once they are received, Company Directors have twenty-one (21) days to implement one of four alternatives:

• Pay the debt in full; or
• Agree and implement an instalment payment plan with the ATO; or
• Place the company into liquidation; or
• Place the company in Voluntary Administration.

If one of these four outcomes is not achieved within the twenty-one day period, then the Income Tax Assessment Act imposes personal liability on directors for the amount as set out in the notice.

Pay the debt in full

Ensuring that the company pays the debt is the most obvious way of dealing with a Director Penalty Notice – but depending on the circumstances it may not be the best alternative.

If the company is later wound up – despite the best endeavours of Directors – then the liquidator will scrutinise any payments to Creditors, and attempt to clawback any potential ‘unfair preferences.’

Unfair preferences are governed by specific provisions of the Corporations Act – but briefly, they are transactions that provide a creditor with part or full payment that is not available to all creditors, and they can be recovered or ‘clawed-back’ by a liquidator in specific circumstances. If the liquidator is able to recover unfair preferences paid to the ATO, then section 588FGA of the Corporations Act allows the ATO to seek reimbursement from the directors of the company, unless the Directors can establish one of the statutory defences. The statutory defences are similar to those available against insolvent trading claims, if a director:

• Had reason to believe that the company was solvent; or
• Had taken ‘all reasonable steps’ to stop the transaction; or
• Was not involved in the management of the company for ‘good reason’; or
• Had believed that the company was solvent because of the advice of a ‘competent and reliable person’.

Negotiate an instalment arrangement

Negotiating an instalment arrangement with the ATO will resolve the question of personal liability, to a point. However, if the company later breaches the arrangement then anyone who acted as a director between the time when the agreement was reached and the date it was breached can be made personally liable under another similar provision of the Tax Act. For that reason, instalment arrangements are only appropriate where the directors have a high level of confidence that the company will fully comply with the agreement. In practice, the longer the time period covered by the agreement, the greater the risk. If this option is under consideration, one should bear in mind that the payment arrangement must be in place before the end of the twenty-one day period, merely commencing a negotiation is not enough.

Place the company into liquidation or voluntary administration

If an instalment arrangement or paying the debt in full is not possible or appropriate, then Directors should very carefully consider appointing a liquidator or administrator. It is important to note that the company must be in liquidation within the twenty-one day period – to commence a voluntary winding up application which is finalised outside of that twenty-one day window is not enough.

A Voluntary Administration is a mechanism that allows for an insolvent or potentially insolvent company to develop a plan to deal with its debts. The purpose of a Voluntary Administration is to maximise the chances of the company, or as much as possible of its business, continuing in existence or if that is not possible, results in a better return for the company’s creditors and shareholders than would result from an immediate winding up of the company.

The Voluntary Administration period usually lasts between approximately five and eight weeks. This can be extended in some circumstances.

Unfortunately, there is no simple answer to this question because it will depend on the company’s financial position and circumstances.

However, it is clear that Directors who receive such a notice must: act quickly, make decisions based on the company’s overall financial position and viability, and choose a course of action that is viable in the long term.