Unfortunately, sometimes companies on the Australian stock exchange become insolvent and investors risk their capital in that company. However, this is not a usual occurrence but may have negative implications to the investor.
What does insolvent mean?
A situation of insolvency in a company occurs when the organisation cannot pay off its debt obligations and bills. This mean the firm’s liabilities exceed the assets that the company currently owns. It is a criminal offence for a company to trade insolvent so company directors need to place it into administration when they see the company will be unable to pay their debts.
Differences between insolvency vs bankruptcy
Insolvency is different from bankruptcy. This is because insolvency involves finding solutions to paying off debts and bills whereas bankruptcy is a court order that outlines how the insolvent company will pay their unpaid debts.
Options for the insolvent company
When a company becomes insolvent there are three options the company can take:
- Voluntary administration – This means an independent voluntary administrator has been appointed to conduct a review of the business and ascertain whether it is best for the company to continue trading and restructure or to sell the business.The administrator takes control of the company and deals with outstanding creditors. The main purpose of the administrator is help achieve a better outcome for the creditors than winding up the company. They may recommend to creditors a plan for debt repayment or the appointment of a liquidator.
- Liquidation – Shareholders or creditors can vote for the liquidation. A company may liquidate which means selling company’s asset and distributing the proceeds to creditors and other outstanding unpaid bills/salaries. If there is anything left after that, then the shareholders will receive the rest.
- Receivership – This occurs when a secured creditor appoints a receiver to sell the company’s asset to repay the debt owed.
Implication to shareholders
Shareholders are ranked last on the list when a company is insolvent. If there is any money left after secured, unsecured creditors, and unpaid bills are made then share holders may get something back.
However, shareholders in companies which are in liquidation or in administration can realise a capital loss if the company declares in writing they believe there is no likelihood shareholders will receive any distribution for their shares. Shareholders can use the cost of what they paid for the shares and offset it against any capital gains made to reduce the tax payable.
Lauren Hua is a private client adviser at Fairmont Equities.
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