Insolvency deals with companies that are unable to pay their creditors based on an overall assessment of the companies cash position. It is critical to understand that this is to be distinguished from a temporary lack of cash-flow or liquidity.
A company is insolvent, similar to a person being bankrupt as you can see from the table below alot of the processes are similar
What to do if you suspect you may be or become insolvent
You must seek professional accounting and legal advice as soon as possible, as this will increase the likelihood of the company being able to survive. Often the difference between a company that is able to survive and one that is not is only a factor of time that the director took to seek assistance.
Voluntary Administration
Voluntary Administration can assist in resolving a company’s future quickly when used correctly and at an appropriate time. Once a company is placed into voluntary administration the directors will appoint a voluntary administrator. This person takes full control of the company to determine if the business is able to be saved.
The administrator must then decide if the company can be:-
- effectively saved where, the voluntary administration end sand return the company back to the directors’ control OR
- Approve a deed of company arrangement through which the company will pay all or part thereof of its debts OR
- Wind up the company and appoint a liquidator.
Liquidation
Once a company decides or is forced to liquidate a independent liquidator takes control of the company so that its affairs can be wound up in an orderly and fair manner.
The liquidator will sell the company’s assets to pay creditors in accordance with the order of priority under a deed or the Corporations Act 2001.
Receivership
A company typically enters receivership when a receiver is appointed by a secured creditor who holds a security interest in some or all of a companies assets. The receiver’s role is to collect and sell enough of the companies property and/or stock to repay the debt.
What are some signs that a company may be insolvent?
Each company is different so it is important to seek qualified advice as soon as you think this may be an issue. Some telltale signs however include:-
- ongoing losses
- poor cash flow
- problems selling stock
- overdraft limit being reached
- unable to pay debts
- unable to pay taxes and superannuation
- special arrangements with creditors
- letters of demand
- problems obtaining finance
- inability to raise funds from shareholders
- increased debt
- irrecoverable loans
- suppliers placing your company on special terms i.e. cash-on-delivery
As a director how am I affected if my company becomes insolvent?
As a director it is part of your duty to assist the administrator.
If you have been involved in two or more companies in a seven year period that has become insolvent and paid less than 50 cents on the dollar to the creditor, ASIC can disqualify you from managing corporations for a period of up to five years.
What are some of the consequences for knowingly trading insolvent?
Civil Penalties
Contravention of the Corporations Act 2001 (Cth) can result in civil penalties against the director personally. these penalties include fines up to and including $200,000.
Compensation
Compensation for creditors are potentially unlimited and could lead to the personal bankruptcy of a director.
The personal bankruptcy of a director would preclude that person person being a director and/or managing a company in the future.
Criminal Penalties
If there is any suggestion of Fraud and/or criminal conduct the directors may be personally liable. These offences under the Crimes Act include imprisonment and/or financial penalties.
What are the possible defences for insolvent trading?
Some defences in relation to civil claims by creditors and liquidators suing the directors:
- That a director did not have reasonable grounds to suspect the company’s insolvency, and a reasonable person in a like position would not have been aware of grounds to suspect the company’s insolvency (section 588G(2)); or
- At the time the debt was incurred, the person had reasonable grounds to expect, and did expect, that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts that it incurred at that time (section 588H(2)); or
- Because of illness or for some other good reason, the director did not take part at that time in the management of the company (section 588H(4)); or
- The debts incurred were subject to the safe harbour provisions.
Additionally, under section 1317S and 1318 of the Corporations Act 2001, a court has the power to relieve a director from liability if:
- the person has acted honestly; and
- having regard to all the circumstances of the case the person ought fairly to be excused for the contravention
What is the safe harbour provisions in insolvency?
The ‘safe harbour’ applies where a director, after beginning to suspect a company may become or be insolvent, starts developing one or more courses of action that are reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator. Debts incurred ‘directly or indirectly in connection with that course of action’ are excluded from the directors’ liability for insolvent trading under the Act.