The personal consequences of insolvency for directors continue to deepen. Set out below are some indicators of when you should be taking advice on your potential exposures.
Duty to Prevent Insolvent Trading
Directors have a duty to prevent insolvent trading under section 588G of the Corporations Act 2001 (Cth) (the Act). But just what is ‘insolvent trading’, and how can you tell whether your company is insolvent?
Insolvent Trading – A definition
Section 95A of the Act defines ‘solvency’ and ‘insolvency’. You are ‘solvent’ if, and only if, you are able to pay all your debts, as and when they become due and payable. If you are not solvent, then you are ‘insolvent’.
Indicia of Insolvent Trading
The section 95A definition is not particularly helpful for businesses to assess whether they are insolvent (or solvent) in a practical sense. However, in the case of ASIC v Plymin (2003) 46 ACSR 126, the court discussed practical indicators that point towards a company being insolvent that provide some practical guidance for directors. These factors are where the company has:
- Overdue commonwealth and/or state taxes
- Poor relationship with present bank, including inability to borrow further funds
- No access to alternate finance
- Inability to raise further equity capital;
- Continuing losses
- Liquidity ratios below ‘1’
- Suppliers placing company on cash on delivery (or COD) or otherwise demanding special payments before resuming supply
- Creditors unpaid outside trading terms
- Issuing of post dated cheques
- Dishonoured cheques
- Special arrangements with selected creditors
- Solicitors’ letters summonses judgements or warrants issued against the company
- Payments to creditors or rounded sums which are not reconcilable to specific invoices
- An inability to produce timely and accurate financial information to display the company’s trading performance and financial position and make reliable forecasts
When questioning whether the company is insolvent or solvent, directors should consider the factors above, and seek legal advice.
