In the current economic situation, it’s not unusual for businesses to experience financial uncertainty. But what if it reaches a point where the liabilities outweigh the assets? Is ‘closing’ the business the only way forward?
What is Insolvency?
Under the Corporations Act 2001 (the Act), a person or company is considered insolvent if they are unable to pay all of their debts when they fall due for payment.
How to Determine Business Insolvency
The Act’s definition of insolvency is quite vague. It is often unclear when a company becomes insolvent.
In the case of ASIC v Plymin (2203) 46 ACSR 126; VSC 123 [paragraph 386], also known as the “water wheel case”, Justice Mandie listed relevant factors that are indicias of insolvency:
- Continuing losses
- Liquidity ratio below 1
- Overdue taxes
- Poor relationship with bank
- No access to alternative finance
- Inability to raise further equity capital
- Suppliers placing company on cash on deliver (COD) or otherwise demanding special payments before resuming supply
- Creditors unpaid outside trading terms
- Issuing post-dated cheques
- Dishonoured cheques
- Special arrangements with selected creditors
- Solicitors’ letters, judgments, or warrants issued against the company
- Payments to creditors of rounded sums that are not reconcilable to specific invoices
- Inability to produce timely and accurate financial information to display the company’s trading performance and financial position, and make reliable forecasts
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How Insolvency Affects You
If you are a director…
As a company director, you have a duty to avoid insolvent trading. Under section 588G (1) of the Act, elements of prohibition of insolvent trading can be summarised as follows:
- A person is a director at the time when the company incurs a debt;
- At that time, the company is insolvent or becomes insolvent by incurring that debt;
- At that time, a reasonable person would have grounds to suspect that the company was insolvent or would become insolvent by incurring that debt; and
- The director is aware at the time the debt is incurred that there are reasonable grounds for suspecting the company is insolvent, or a reasonable person in a similar position would be so aware.
If you are an investor or shareholder…
Generally, shareholders do not participate in the day to day running of a company. Being insolvent does not change that. It will, however, affect the dividend distributions or how you and the other shareholders will receive your investments back.
If you are an employee…
In most cases, a company entering liquidation terminates its employees.
Employees generally have the right to be paid their outstanding entitlements before other unsecured creditors are paid (priority claims). Employee entitlements are generally paid in the following order:
- outstanding wages and superannuation
- outstanding leave of absence (e.g. annual leave and long service leave)
- retrenchment pay
Employees owed certain entitlements after losing their job because their employer went into liquidation may be able to get financial help from the Australian government. This help is available through the Fair Entitlements Guarantee (FEG).
If you are a creditor…
In its simplest form, there generally two kinds of creditors: a secured creditor and an unsecured creditor. A secured creditor has a security interest over company assets; an unsecured creditor doesn’t and is generally only paid on a pari passu basis if there is any money left.
If you are a liquidator…
If you are a registered liquidator and have been appointed by an insolvent company, you can basically take control of the insolvent company’s affairs, money, and other assets. Some of your tasks include but are not limited to:
- Collecting debtor company’s property (section 478 of the Act)
- Keeping various books and accounts as stated in division 70 of the Insolvency Practice Rules (Corporations)
- Report to ASIC on possible breaches of the law (section 533 of the Act)
- Acting as “officer” bound by sections 180 to 184 of the Act
What to Do if Your Company is Insolvent
If your company is experiencing financial distress, make sure you speak to someone.
Insolvency does not necessarily mean all is lost for your company. You just have to act quickly, cautiously, and decisively to maximise all available options in turning things around. With the right professional intervention, you can increase your chances of surviving instead of incurring more debt.
Our bankruptcy and insolvency lawyers act for both companies and insolvency practitioners, as well as secured and unsecured creditors. Schedule a consultation with us by calling 03 9052 3214. You can also leave us a message via our Contact Us page.
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