The law about insolvency, solvency and insolvent trading is contained in the Corporations Act 2001. Definitions of solvency and insolvency are found at section 95A of the Corporations Act. A company, or person, is solvent if they can pay their debts when they become due and payable. A person, or company, is insolvent if they cannot pay their debts as and when they become payable. Insolvent trading by a company can attract both civil and criminal penalties.
Civil penalties and criminal offence
Section 588G of the Corporations Act 2001 concerns insolvent trading. Directors, or persons acting in a position like a Director even if they are not named a Director (shadow directors), can be liable to pay a civil penalty or even be charged criminally if their company trades while insolvent. More specifically, the penalties that can apply to a director for insolvent trading include:
- Disqualification from managing a company;
- A civil penalty of up to $200,000;
- Orders to compensate the company for an amount owed to creditors
- A criminal sentence of up to five years imprisonment (where a director is found to have acted dishonestly) or a fine of up to 2,000 penalty units or both
As a director of a company, you are responsible for making sure that your company does not trade while insolvent. This is a responsibility that is added to your other duties as director that include:
- To act with due care and diligence;
- To act in good faith;
- To act in the best interests of the company; and
- To not use your position improperly for personal gain.
If you are charged as a director of a company either civilly or criminally for insolvent trading, there may be some defences available to you. These include:
- That you believed the company was solvent and had reasonable grounds for believing so;
- That you were not taking part in the management of the company at the relevant time and had a good reason for this; and
- That in order to stop the company incurring the debt, you took reasonable steps.
So how can I tell if my company is insolvent trading?
One place to start to determine whether your company may be insolvent trading is the company’s balance sheet and cash flow. However, it may be difficult to determine whether your company is insolvent trading just from these things. Some other telltale signs that your company may be trading while insolvent include the following:
- The assets of the company are less than its liabilities;
- Assets on a balance sheet for a company cannot be liquidated to pay debts;
- The company is experiencing difficulties selling its product or stock and recovering its debts;
- Customers are departing from the company, and the revenue of the company is decreasing;
- Creditors are not allowing your company to extend a debt facility it has with them;
- Suppliers are not delivering stock or product due to payments not being made or only providing delivery for cash exchanged at the time of delivery;
- Your company has taxes that are overdue or requirements to pay superannuation entitlements that have not been met;
- Your company is receiving letters of demand from solicitors or companies requesting unpaid debts;
- Your company is experiencing problems obtaining finance;
- Your company has hope or expectation that the next big project will save the company;
- There are difficulties with or among the executives of the company, including directors, management and the board.
What should I do if I am a Director of a company that I suspect is insolvent trading?
If you are a director of a company that you suspect is insolvent trading, what do you do? Firstly, you should obtain independent professional advice. Registered liquidators can review your company’s position to determine whether it is solvent. If he or she finds that your company may be insolvent trading, then he or she can outline the different options available. These options may include restructuring the business, making changes to the activities of the company, refinancing or appointing an external administrator. If an external administrator is appointed, they take control of the affairs of the company and its property and determine the next direction of the company or wind up the company.
What if I am a creditor of a company and suspect that it is insolvent trading?
If a company owes you money and you suspect that it is in financial difficulty, you could first raise your concerns directly with the company. If this approach is not effective, then you can obtain independent legal advice on your options to recover the money owed to you. If a company goes into liquidation, creditors are paid in a specific order. This is:
- The liquidator’s professional costs;
- Secured creditors – those creditors that hold security over assets owned by the company;
- Priority unsecured creditors. E.g. employees who are owed wages;
- Unsecured creditors such as contractors, customers and supplies; and
If you require legal advice or representation in any legal matter, please contact Armstrong Legal.