This article is for directors of financially distressed or potentially insolvent companies. An insolvent company cannot pay its debts as and when they fall due.
Financial distress rarely arrives without warning. In most cases, the signs have been visible for weeks or months. Most directors who appoint a Registered Liquidator too late were optimistic. The next contract was almost signed, that debtor was going to pay on time, or the Australian Taxation Office (ATO) had been patient before and allowed a repayment plan over two (2) years. In a healthy business, optimism is a virtue, but when the company is insolvent, it becomes one of the most expensive habits a director can carry.
Two directors can face the same cash-flow pressure and reach very different outcomes depending on when they seek advice. One director calls us before creditors take formal action and still has time to consider restructuring, Voluntary Administration or an orderly Liquidation. The other director waits until a statutory demand, Director Penalty Notice (“DPN”) or winding-up application is issued. By then, the question may no longer be which option is best, but which options are still legally available.
Consulting a Registered Liquidator is not the same as appointing one. A formal appointment is a step with immediate legal consequences. The right time to seek advice is well before an appointment of a Registered Liquidator feels unavoidable as early advice may preserve options that may disappear once a statutory demand, DPN, or winding-up application is on foot. When your company is insolvent, timing has option value. The longer directors wait without a plan, the more those options become constrained by creditors, lenders, statutory deadlines and the company’s deteriorating cash position.
What are indicators of insolvency?
Insolvency can show up in financial and non financial ways.
The below list is an indication, but not substantive list of what insolvency may look like:
- Continued losses;
- Current assets are not sufficient to pay current liabilities;
- Continued negative net asset position;
- High related party debt;
- External lenders unwilling to continue or to provide credit;
- Overdue State and Federal taxes;
- Suppliers ceasing supply or changing credit terms to cash on delivery;
- Aging of accounts payable;
- Inability to collect debtors;
- Repossession or assets;
- Debt collection enforcement or disclosure of non payment to credit reporting agencies;
- Delaying the provision of financial information amongst directors;
- Director/Shareholder disputes; and
- Untidy company premises.
If your company is experiencing any of the above indicators, you should consider seeking immediate advice from HM Advisory.
Where are you in the process?
| Phase | What it looks like | What to do |
|---|---|---|
| Pressure but potentially solvent | Cash flow is tight, creditors are overdue, but there is still a credible plan to pay debts on time | Get cash-flow and restructuring advice |
| Suspected insolvency | There are reasonable grounds to doubt whether debts can be paid as they fall due. ATO is unwilling to enter a repayment arrangement. Lender refuses to increase overdraft or loan against property. Financial accounts are not being prepared on time or are delayed. | Contact HM Advisory urgently before incurring further debt |
| Trigger event | A statutory demand, DPN or winding-up application has been received | Immediately contact HM Advisory to discuss options |
Directors often delay seeking advice because they are worried about employees, reputation, future directorships, or what becomes publicly available. Those concerns are best addressed with early advice, when more options remain for managing each one.
When the law expects you to act
Australian law takes the Company to be insolvent when it cannot pay its debts as and when they fall due. A business can hold real estate, equipment, or receivables that exceed its total debts and still be legally insolvent if it cannot convert that value to cash quickly enough to meet obligations as they arise.
Financial distress becomes legally dangerous when the company continues incurring new debts despite a real question about whether those debts can be paid on time or at all. At that point, the issue also becomes one of a directors’ conduct and potential civil and criminal offences that may arise.
A director has the duty to prevent insolvent trading. Under the Corporations Act 2001, a director must consider whether there are reasonable grounds to suspect the company is insolvent, or will become insolvent, before allowing it to incur a new debt.
The Corporations Act 2001 also places a positive obligation that a company director make decisions for the benefit of the company and display care and diligence in decision making. It will be expected that directors seek advice at the earliest point when insolvency is suspected.
What you face if you do not act
A director who allows an insolvent company to keep incurring debts can be held personally liable through a civil claim tied to the loss or damage suffered in relation to debts incurred during the relevant period of insolvency. Exposure can be substantial. Available defenses are limited and difficult to rely on where directors have not stayed properly informed about the company’s financial position. Where a breach involves dishonesty or recklessness, further criminal consequences may apply.
Directors who dispose of company assets with the intention to defeat creditors, including through illegal phoenix activity, face their own criminal penalties, which the Australian Securities and Investments Commission (“ASIC”) pursues as a distinct and serious matter.
ASIC, a Liquidator, or in certain circumstances a creditor can all commence proceedings against a director for insolvent trading regardless of whether the company’s failure was intentional.
Directors should also consider personal guarantees. Insolvency advice does not remove guarantees given to lenders, landlords, suppliers or financiers, but it can help directors understand how those exposures interact with liquidation, administration, restructuring and creditor enforcement.
The pathways available to you
Liquidation is one of several formal responses to insolvency. Which pathway is appropriate depends on the company’s circumstances and how early the assessment is made. An example of the type of formal appointment that may be recommended is below:
Voluntary administration (“VA”) may be appropriate where the business or asset base has value worth preserving and creditors may receive a better outcome through a Deed of Company Arrangement than in Liquidation.
Small Business Restructuring (“SBR”) may be available to eligible companies where directors can remain in control of the Company while a Restructuring Practitioner assists with a repayment plan to creditors.
Creditors’ Voluntary Liquidation (“CVL”), where directors convene a shareholders’ meeting who then appoints a Registered Liquidator, The Registered Liquidator undertakes an orderly wind up of the company. Acting voluntarily can allow directors to manage the timing of the appointment, nominate an appropriate Registered Liquidator and demonstrate that they responded before creditors or the court forced the issue.
The earlier directors act when the company is facing financial distress, the more likely they are to retain influence over which pathway is pursued and the timing of a formal appointment.
What early advice usually involves
Early advice does not necessarily mean an immediate appointment. It usually begins with an initial conversation to review of the company’s cash flow, creditor position, tax status, employee entitlements, secured debt, asset values, director exposure and restructuring prospects.
A Registered Liquidator can then identify whether the company has a viable turnaround path, and whether Voluntary Administration or Small Business Restructuring should be considered. Alternatively, whether Liquidation is the most orderly way to bring the company’s affairs to a close.
The appropriate course depends on the company’s particular circumstances, including its cash flow, assets, liabilities, secured creditors, employee entitlements, tax position and prospects of restructuring. If any of the following apply, get urgent insolvency advice today:
- The company is consistently missing payments to suppliers, employees, or the ATO;
- Tax, BAS, PAYG, GST or superannuation reporting is overdue;
- There are reasonable grounds to suspect the company cannot pay its debts as they fall due;
- A statutory demand has been served;
- A Director Penalty Notice has been received; and
- A creditor has threatened or filed a winding-up application.
Early advice does not force liquidation. Waiting too long can remove every alternative.
If you suspect your company is insolvent, contact us at HM Advisory for an initial confidential and free consultation.