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Insolvency is a critical concept company directors should understand. There are severe consequences for company directors if debts are incurred after a company has become insolvent. However, it can be difficult to know when a company has become insolvent despite the severity of insolvency. Indeed, this article will take you through the meaning of insolvency, how to tell if it is insolvent and common insolvency procedures.

Meaning of Insolvency

Insolvency refers to a company who is unable to pay its debts when due. 

The Corporations Act 2001 (Cth) defines both solvency and insolvency:

  • “a person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable”; and
  • “a person who is not solvent is insolvent”.

Notably, the courts have found that a company that is unable to pay a debt due is not necessarily insolvent. Indeed, this is because the courts recognise that a company may have a temporary lack of cash to pay its debts. For example, insolvency can further involve when a company’s:

  • current liabilities exceed its assets; or
  • net assets are negative.

How to Tell If a Company is Insolvent

Accordingly, it can be challenging to know when a company has become insolvent. However, some key indicators of insolvency are outlined in the table below:

Continuing losses

Continuously making losses is a sign that a company may be insolvent. This is because insolvency is a combination of continuing losses and insufficient funds.

No access to alternative finance

A company with insufficient funds to pay its debts on time will need to raise additional funds to remain solvent. Therefore, if a company cannot obtain finance from a bank or otherwise raise equity, it is a sign that the company may be insolvent.

Overdue tax remittance

Withholding payment of tax commitments is a sign that a company may be insolvent. This is because it is an easy way to preserve cash flow. 

Creditors issuing demands

Creditors may be demanding payment or threatening to commence legal proceedings. Indeed, in this case this should be of significant concern and needs to be closely monitored. 

Issuing post-dated cheques

Issuing post-dated checks is a sign that a company does not have sufficient funds to pay its debts. Therefore, it may indicate the company has become insolvent. 

Meeting only one or two of these indicators does not always mean a company is insolvent. However, if these issues persist or you meet more than a few, consider seeking legal advice.

Insolvency Procedures

If a company is insolvent, there are three standard insolvency procedures. These are outlined below:

1. Voluntary administration

Voluntary administration is the process that occurs when a company’s directors decide that a company is insolvent or suspected to be insolvent. Accordingly, they will decide to appoint an independent person to take control of the business. As a result, this independent, external business becomes responsible for investigating the state of the company’s financial affairs and reporting this to creditors.

Indeed, if the company is solvent, the administrator may end the voluntary administration. Alternatively, the administrator may appoint a liquidator to wind up the business.

2. Liquidation

Liquidation is the process by which a person is appointed to wind up the company’s affairs. This person, referred to as a liquidator, will see the company’s assets and operators before distributing the proceeds to creditors. 

3. Receivership

Receivership occurs when a secured creditor appoints a liquidator to act as a receiver. The receiver is responsible for collecting and selling the company’s assets to repay the debt owed to the secured creditor. 

Avoiding Insolvency

Some essential tips for companies to avoid insolvency are that you:

  • ensure adequate cash reserves;
  • devise and enforce strict debt collection procedures;
  • ensure efficient financial recording procedures; and
  • have a detailed business plan.

If you have any concerns that your company may be insolvent, you should also seek immediate external advice.

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Key Takeaways

A company is insolvent if it is unable to pay its debts when they are due for payment. For example, if it:

  • continues to incur losses;
  • lacks access to finance;
  • has overdue tax remittances; 
  • issues post-dated cheques; or
  • regularly receives demands from creditors. 

If you need assistance determining if your company is insolvent, LegalVision’s business lawyers can help. You can call them on 1300 544 755 or by filling out the form on this page.

Frequently Asked Questions

What does it mean if a company is insolvent?

Insolvency is the term used to refer to a company being unable to pay its debts when due for payment. There are three common insolvency procedures for corporations, including voluntary administration, liquidation and receivership. 

What are the signs a company is insolvent? 

Some key indicators of insolvency include incurring continuing losses, lack of access to alternative finance to pay debts, overdue tax remittance, creditors issuing demands or threatening legal proceedings and issuing post-dated cheques.

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