When a company cannot pay its debts when they are due, it is said to be trading insolvent. One of the most important duties of a company director is making sure their company does not trade when it is insolvent. If you breach this duty as a director, you can face serious penalties, including steep fines and criminal charges. It is crucial that as a director, you understand when your company is trading insolvent. This article will set a few warning signs you can look out for and some practical steps you can put in place for your company to avoid trading while insolvent.

What Is Insolvent Trading?

Your company is trading insolvent when it cannot pay its debts when they fall due for payment. That sounds simple, but working out the exact point at which your company is trading insolvent is a complex matter and determined by a number of different factors. The state of your company’s balance sheet and its cash flow is only one indicator. You should not rely on this alone. There may be underlying issues that reveal a deeper problem.

For example, assets that appear solid on the balance sheet but cannot be liquidated (turned into money) to pay debts may be a red flag.

Determining insolvency often takes further investigation and a broader consideration of whether the company either has the assets or can raise the money in a reasonable time to pay its debts.

Directors’ Duties and Insolvent Trading

Ensuring that a company does not trade insolvent is a key legal obligation of all company directors. A director’s duty to prevent insolvent trading extends to where there are any reasonable grounds for suspecting that the company is insolvent or would become insolvent. As a director, you will breach the duty if:

  • you allow the company to incur debt at the time the company is insolvent; or
  • the company becomes insolvent as a result of that debt.

Lack of knowledge is not a defence. A director can breach his duty to prevent insolvent trading if a reasonable person in his or her position would be aware the company was trading insolvent. For directors, the consequences are severe. Penalties include fines as high as $200,000, up to five years in jail and civil claims for compensation.

The Warning Signs

There are many warning signs that can indicate a company is headed for insolvency. As a director, you should look out for:

  • ongoing losses;
  • poor cash flow;
  • absence of a business plan, cash-flow forecasts and other budgets;
  • liabilities greater than assets;
  • problems selling stock or collecting debts;
  • creditors paid outside usual terms;
  • solicitors’ letters, demands and other court documents relating to unpaid debts;
  • difficulties obtaining finance;
  • return of dishonoured cheques;
  • overdue taxes and superannuation liabilities;
  • suppliers changing terms to cash-on-delivery only;
  • expectations that future business will solve cash flow issues; and
  • issues with directors, the board or management staff.

Tips to Avoid Insolvent Trading

Directors are responsible for monitoring performance and staying informed about their company’s true financial position. There are steps you can take as a director to ensure you do not breach your duty to prevent insolvent trading. They include:

  1. keeping informed. Regularly review financial records and be familiar with your company’s balance sheet and trading practices;
  2. investigating. If you have any concerns about your company’s solvency, take steps to investigate more closely and assess the situation;
  3. seeking advice. Seek expert advice sooner rather than later to assist with your company’s trading difficulties, including whether or not it is possible to keep trading; and
  4. moving quickly. Your duty to prevent trading means moving quickly to get help and acting on advice to address any trading issues in the company.

Key Takeaways

Working out when a company is trading insolvent can be difficult, but for directors it is an essential undertaking. Preventing your company from trading insolvent is a key director’s duty and breaching this duty can have serious consequences. It is essential that directors continually take steps to monitor a company’s trading health closely and move quickly to get advice and improve trading issues before they become a serious problem. If you have any questions about insolvent trading and directors’ duties, get in contact with LegalVision’s insolvency lawyers on 1300 544 755 or fill out the form on this page.

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