Unfortunately, LegalVision see an increasing number of companies in financial distress, struggling to keep up with payments to suppliers and other third parties. But what can you do if your company can’t pay its debts? It’s important to know what options are available where your company may be (or is) insolvent.

When is a Company Solvent?

A company is solvent if it can pay all its debts as and when they fall due for payment. If you are a company director, you have a duty to inform yourself of the business’ financial position and take appropriate action. Continuing to trade while insolvent is a breach of your directors’ duties and can result in both civil and criminal liability of up to $220,000 in fines or imprisonment for five years.

Winding Up Where the Company May Be Insolvent

If you are a sole director, you have a duty to prevent insolvent trading. Failure to do so could result in serious civil penalties, compensation proceedings and criminal charges. Liquidation is winding up an insolvent company (i.e. the company can’t pay its debts when they fall due or fails to satisfy a creditor’s statutory demand). The company can be liquidated in the following circumstances:

  1. Court order: Creditors can apply to the courts to wind up the company. They must first prove the company is insolvent and the court will then appoint a liquidator.
  2. Voluntary Administration: If during voluntary administration, the creditors decide to put the company into liquidation, the administrator will become the liquidator and sell the company’s assets.
  3. Creditors: If company directors appoint a liquidator after becoming insolvent, creditors may hold a meeting within 18 days of the resolution to wind up the company and change the liquidator.

During liquidation, the company will cease to operate, and the liquidator will sell its assets to satisfy the company’s debts to creditors. Any remaining funds would then be distributed to the shareholders. The liquidator then applies to ASIC to deregister the company, after which point the company no longer exists.

Voluntary Administration Where the Company May Be Solvent

If it is not possible to restructure or refinance the company, a director can appoint a voluntary administrator or liquidator. Administrators are appointed so companies in financial distress can develop a restructuring plan with creditors (deed of company arrangement or DOCA) or plan for an asset sale. During this period, creditors cannot make claims against the company unless permitted by the courts.

The process for voluntary administration is as follows:

  1. Company directors decide, in writing, to appoint an administrator through a board meeting/resolution.
  2. After the board passes the resolution, the company goes into voluntary administration.
  3. Unless the courts allow an extension of time, creditors must meet within eight business days of the administrator’s appointment. At this first meeting, creditors can vote to either replace the administrator or create a committee of creditors.
  4. The administrator investigates the company’s affairs and reports back to the creditors.
  5. Creditors must meet within 25 or 30 business days of the administrator’s appointment and decide to either:
    1. Return the company to the directors;
    2. Accept a DOCA; or
    3. Put the company into liquidation.
  6. If creditors accept a DOCA, then the company should sign a deed within 15 business days, and deed administration begins.
  7. If the creditors decide to put the company into liquidation, then the administrator becomes the company’s liquidator.

Prohibited Phoenix Activities

Phoenix activities or ‘rebirthing’ occurs where a business intentionally transfers its assets from an indebted company to a new company to avoid paying creditors, tax or employee entitlements. The old company is usually placed into administration or liquidation, leaving no assets to pay creditors, while the same directors create a new company to continue the business.

Phoenix activity is illegal and can result in company directors and secretaries facing criminal penalties including imprisonment. Directors should not attempt to transfer any company assets (e.g. current contracts or intellectual property) to another company as there is a risk that you would be personally liable as a director.

Potential Liability for Company Directors

Although a company’s limited liability largely protects directors, there are some cases in which the court can “pierce the corporate veil” to hold directors personally liable, including:

  • Insolvent trading;
  • Company losses caused by a breach of director’s duties;
  • Illegal phoenix activity; and
  • Certain outstanding tax obligations of the company under the ATO’s Director Penalty Regime.

Under the ATO’s Director Penalty Regime, a director has personal liability for any unpaid Pay As You Go (PAYG) withholding or Superannuation Guarantee Charge (SGC) amounts that the company fails to pay. If the company is wound up, you should ensure the business maintains enough assets to satisfy its PAYG and SGC liabilities.

Key Takeaways

If your company is in financial distress and struggling to pay its debts as and when they fall due, you should take immediate steps to obtain financial advice from an accountant. Following this, you can then make a determination on what steps you should take as a director. Importantly, understand that there are significant consequences for directors who breach their duties including financial sanctions and criminal penalties. If you have any questions, get in touch with our insolvency lawyers on 1300 544 755 or fill out the form on this page.

Emma George

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