Does a company owe you money or is your company facing financial hardship? Insolvency is a complex process and it is important to understand the concept of insolvency and its indicators.  If you are a director of a company, it is also important that you understand your duties as a director of an insolvent company.  In this two-part series, we will consider the basics on corporate insolvency including voluntary administration, liquidation and receivership.

Is Your Company Insolvent?

Section 95A of the Corporations Act 2001 defines solvency as if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable.  A person who is not solvent is insolvent. Corporate insolvency differs from personal insolvency.  For further information on personal insolvency, check out our article Bankruptcy and Formal Debt Arrangements – A Guide for Creditors and Debtors.

What are Some Indicators of Corporate Insolvency?

There are many telltale signs that a company is insolvent including: 

  • The company is unable to raise equity of loan capital;
  • The company is issuing post-dated cheques or cheques are dishonouring;
  • The company has disorganised, or non-existent, internal accounting procedures;
  • The company has incomplete or missing financial records;
  • The company is only paying the minimum amounts to a creditor;
  • The company has outstanding taxation obligations;
  • The company defaults on interest or loan payments;
  • The company has outstanding creditors over 90 days;
  • The company is continuing to make losses and has insufficient working capital; and
  • Creditors are requesting payment before supply.

If a company is insolvent, it is an offence if the directors continue to operate and incur more debts.

What Happens if a Company is Found to be Insolvent?

If you are a director and your company is insolvent, unless you can restructure quickly, refinance or obtain equity funding to recapitalise the company, you will generally appoint a voluntary administrator or a liquidator. The three most common insolvency procedures are:

  1. Voluntary Administration,
  2. Liquidation, and
  3. Receivership.

I am a Director of a Company.  What Happens if the Company Becomes Insolvent?

Under the Corporations Act, if your company is insolvent, you cannot continue to trade and allow it to incur further debt. Directors face serious consequences for insolvent trading including criminal charges, civil penalties and compensation proceedings.  You also risk disqualification as a director, losing your job, losing your home and assets to pay the debts.

As a director, you must be aware of your company’s financial position and have a positive duty to prevent insolvent trading.  

Other director’s duties include:

  • Exercising your powers and duties with care and diligence. This involves taking steps to remain informed about your company’s financial position and ensuring it doesn’t trade insolvent. 
  • Exercising your powers and duties in good faith in the company’s best interests and for a proper purpose;
  • Not using your position to gain improperly an advantage for yourself or someone else, or cause detriment to the company; and
  • Not using information obtained through your position as a director to gain an advantage for yourself or someone else, or cause detriment to the company.

Conclusion

In our next article, we consider what happens when your company is insolvent. In the meantime, if you have any questions, please get in touch! LegalVision’s experienced corporate lawyers would be delighted to assist you.

Lauren Moroney

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