trading while insolventtrading while insolvent

A Guide To Insolvent Trading

  • September 19th, 2021
  • Domenic Calabretta

Where there’s smoke there’s fire, and the impact of financial distress on a company should never be underestimated. Many organisations may appear to be in a position of financial strength but are in fact trading insolvent. This guide provides information on important aspects of insolvent trading including director duties, indicators of insolvency, legal implications, and the most appropriate courses of actions to take.

What does insolvent trading mean?

Insolvent trading is when a company or person is unable to meet financial commitments (pay debts on time) and continues to incur debt. It is essential to first note the difference between corporate insolvency and bankruptcy. The former relates to incorporated companies while bankruptcy is the legal process taken by individuals that cannot pay off their debts. We will focus on companies, and more specifically, the roles and responsibilities of Directors.

What are the most common indicators of insolvency?

On the surface, many indicators of insolvency are clearly identifiable and obvious. Unfortunately, it is common for Directors to ignore these signs as it often means a realisation that they have been unable to place their company in a position of success. This highlights the importance of taking an objective view as a Director when assessing key aspects of your company including its financial position, accounting procedures, organisational issues and equity status. Some of the most common indicators of insolvency are:

  • Financial Position: Unpaid creditors, cash flow problems, company debts outweigh assets, declining profits, assets sold off, continuing losses, payment plans with creditors, and pending legal proceedings against the company.
  • Accounting: Overdue taxes, inconsistent records, errors in paying employees, unable to generate accurate reports.
  • Organisational issues: Management communication breakdown, reduced employment benefits, bad workplace culture, rising number of employees leaving the company.
  • Equity: Unable to borrow additional funds from current lender, no access to alternative financing, incapable of raising equity capital.

If there are signs that your business is in trouble do not ignore them. Acting early as a director will provide your company with the best prospects of returning to a position of financial stability.

Who is personally liable?

The structure of a company is unique as they are recognised as a separate legal entity. Companies share the same rights as a person in that they can accrue debt, commence legal proceedings, and be held legally accountable. Limited liability applies to companies and there are circumstances where Directors may be personally liable for any debt accumulated by a company. They include the following:

Insolvent Trading: It is illegal to trade while insolvent and preventing this from occurring is one of the fiduciary duties of a Director. If it is determined that a Director allowed a company to continue trading while insolvent, they may be held personally liable for any debts incurred.

  • Loans and Guarantees: If personal assets have been used as security, they be used to pay off any outstanding company debts. Similarly, a Director will be liable for any personal or Director guarantees that were signed.
  • Tax Implications: Directors should always be abreast of any tax debts. This includes any unpaid PAYG, superannuation contributions or Director Penalty Notices that have not been dealt with accordingly.

Director Responsibilities and insolvency

There are numerous fundamentals that Directors must adhere while carrying out their roles as a Director of a company. Some of the key Director responsibilities outlined by ASIC are to:

  • Make decisions in good faith
  • Not have a material interest in decisions
  • Assess the financial impact of decisions on the company’s performance
  • Ensure company can bay any outstanding debts on time
  • Seek out and get professional advice when required.

What is insolvent trading in Australian law?

The Corporations Act 2001 sets out the laws for business entities and the way they operate in Australia. Its application is universal and applies at both federal and state levels. The legislation covers all business entities including companies and partnerships. The Corporations Act also specifies the duties and responsibilities of Directors along with the penalties for any breaches.

The Act also gives power to the Australian Securities Investment Commission (ASIC) for its administration. They are an independent government body who are the financial services regulator. Part of ASIC’s role is to provide key information about companies to the public and enforce the law - taking action where necessary.

Understanding insolvent trading and the Corporations Act can be complex and one of the major reasons why businesses should invest in legal advice. There have been significant changes to insolvency laws, and it is a key responsibility of a Director to be aware of their implications. You can also use our resource centre to stay up to date with the latest insolvency news.

What are the penalties for trading insolvent?

The penalties for insolvent trading can be severe. The consequences may include criminal charges including substantial financial penalties, civil implications, and compensation proceedings.

Criminal Charges: A Director may be subject to criminal proceedings if it is determined that their dishonest actions were a contributing factor to insolvent trading. The penalties are up to 5 years imprisonment and 2,000 penalty units which equates to $444,000 as of 1 July 2020.

Civil Penalties: Breaches of the insolvent trading provisions of the Corporations Act can result in civil penalties against Directors up to the amount of $200,000.

Compensation Proceedings: Unpaid creditors can initiate compensation against Directors personally. The amount of compensation is unlimited and may lead to the personal bankruptcy of a Director. There are associated implications with personal bankruptcy including disqualification from continuing as a director. There are a series of recommended steps that can be taken for those looking to recover from bankruptcy.

What should I do if my company is insolvent?

If you have recognised that your company is trading while insolvent you must act immediately. There are a range of options available including restructure and turnaround, liquidation, voluntary administration, and receivership.

Restructure and Turnaround: This may be a viable option for some companies and involves changing the financial/organisational structure to address financial difficulties. The process may involve debt consolidation, cost reduction, or organisational restructure. Acting early will increase the prospects of a successful restructure and turnaround.

Voluntary Administration: Company administration could provide your company with the breathing space required to devise a plan for growth. The process does not have to be a costly exercise and can prevent your business from being forced into liquidation.

Receivership: If you have mounting debts owed to a secured creditor, you may be faced with the prospects of receivership. A receiver and manager may be appointed by a creditor or court. They will conduct a thorough analysis of the company before beginning the process of collecting, selling, and distributing assets.

Liquidation: When a company is trading insolvent and no longer viable, liquidation is in many instances the most appropriate course of action. There are a variety of liquidation options including creditors’ voluntary liquidation (CVL), members’ voluntary liquidation (MVL), provisional liquidation and simplified liquidation for small businesses.

As you can see, identifying that you are trading while insolvent is just the first step. Determining the most appropriate course of action will determine the future of a company, and in many instances, its Directors. Australian Debt Solvers specialise in all aspects of corporate insolvency and offer expert business advisory services that will help ensure that you carry out your responsibilities as a company Director.

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