To be or not to be [insolvent]: That is the question
25 February 2016
Insolvency is not always immediately obvious. It can be difficult for a Director to ascertain if the company is experiencing short term liquidity problems or if the company has crossed the line and is insolvent. Understanding this difference is critical as this is where the personal risk to a Director becomes real. If a Director allows their company to incur debts at a time when it is insolvent, and the company fails with those debts remaining unpaid, the liquidator (and in certain cases creditors themselves) can pursue the Director personally for unpaid debts. The Director faces personal liability and risks the loss of personal assets including the family home.
ASIC Regulatory Guide 217 – Duty to prevent insolvent trading: Guide for Directors sets out ASIC's position on directors meeting their obligations to prevent insolvent trading. This is based on four key principles:-
1. Directors must remain informed;
2. Directors should investigate financial difficulties;
3. Directors should obtain advice; and
4. Directors should act in a timely manner.
When does financial difficulty become insolvency?
There are many warning signs that a company is experiencing financial difficulty. They are varied and will be different for each business. These warning signs include ongoing losses, poor cashflow, unpaid creditors outside usual trading terms and problems obtaining finance. The warning signs point to an increased likelihood that a company is insolvent or will become insolvent. ASIC Regulatory Guide 217 – Duty to prevent insolvent trading: Guide for Directors sets out further indicators of potential insolvency as follows:
1. The company has a history of continuing trading losses.
2. The company is experiencing cash flow difficulties.
3. The company is experiencing difficulties selling its stock, or collecting debts owed to it.
4. Creditors are not being paid on agreed trading terms and/or are either placing the company on cash-on-delivery terms or requring special payments on existing debts before they will supply further goods and services
5. The company is not paying its Commonwealth and State taxes when due (e.g. pay-as-you-go instalments are outstanding, goods and services tax (GST) is payable, or superannuation guarantee contributions are payable).
6. Cheques are being returned dishonoured.
7 Legal action is being threatened or has commenced against the company, or judgements are entered against the company, in relation to outstanding debts.
8. The company has reached the limits of its funding facilities and is unable to obtain appropriate further finance to fund operations – for example, through: - negotiating a new limit with its current financier; or
- refinancing or raising money from another party.
9. The company is unable to produce accurate financial information on a timely basis that shows the company's trading performance and financial position or that can be used to prepare reliable financial forecasts.
10. Company directors have resigned, citing concerns about the financial position of the company or its ability to produce accurate financial information on the company's affairs.
11. The company auditor has qualified their audit opinion on the grounds there is uncertainty that the company can continue as a going concern.
12. The company has defaulted, or is likely to default, on its agreements with its financier.
13. Employees, or the company's bookkeeper, accountant or financial controller, have raised concerns about the company's ability to meet, and continue to meet, its financial obligations.
14. It is not certain that there are assets that can be sold in a relatively short period of time to provide funds to help meet debts owed, without affecting the company's ongoing ability to continue to trade profitably.
15. The company is holding back cheques for payment or issuing post-dated cheques.
There is a significant risk that a company experiencing one or more of these indicators is insolvent and that the company's directors will face personal liability for trading while insolvent if the company fails.
To minimise the risk of personal liability, and to fulfil their duties as a Director, it is critical that a Director acts promptly if any of the above warning signs are identified. Prompt action also maximises the chance of the successful restructure of the company and the continuation of the business.
In these circumstances, a Director should take the following steps:
1. Read ASIC Regulatory Guide 217 – Duty to prevent insolvent trading: Guide for Directors and ASIC Information Sheet 42 – Insolvency: A guide for directors in full;
2. Ensure that the financial information the directors are relying on to assess the affairs of the company is accurate;
3. Remain informed as to the financial position of the company, ensuring that the company maintains proper financial records and prepares relevant financial information;
4. Make all reasonable inquiries to enable them to have an understanding of the financial position and cash flow requirements of the company at all times;
5. Immediately investigate any financial difficulties;
6. Contact Rodgers Reidy for independent, professional advice in relation to their specific business circumstances; and
7. Act in a timely manner on the advice obtained.
If you have any queries in relation to the above and would like to take advantage of the guidance and assistance of an independent advisor who is experienced in advising and working with businesses in financial difficulty, call Rodgers Reidy now for a confidential discussion in relation to your specific business circumstances.
1. ASIC Regulatory Guide 217 – Duty to prevent insolvent trading: Guide for Directors
2. ASIC Information Sheet 42 – Insolvency: A guide for directors