Insolvent Trading – What are the implications?
This article discusses the implications of not being able to pay debts as they become due and payable.
What is ‘insolvency’?
Insolvency’ is the term used to describe the situation where a company or person is not able to pay its debts as they become due and payable.
Personal Insolvency: Personal Insolvency describes the situation where a person cannot pay their debts as they become due and payable.
Corporate Insolvency: Corporate Insolvency describes the situation where a company cannot pay its debts as they become due and payable.
When is a corporation insolvent?
The Corporations Act 2001 (Cth) is used in determining solvency and insolvency. Specifically, the Corporations Act sets out at section 95A that:
- “A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable.” And;
- “A person who is not solvent is insolvent.”
Various court cases have discussed this definition of insolvency and it has been widely accepted that it means a company must meet all current debts and liabilities, as and when they become due.
This definition is often referred to as the ‘cash-flow’ test or the ‘balance sheet’ test.
Corporate insolvency and ‘Insolvent Trading’
The director or directors of a company have a positive duty to prevent the company from incurring debt if the company is insolvent or, after incurring the debt, would be insolvent.
Implications of corporate insolvent trading
There are serious implications, both corporate and personal, if a corporation incurs debt while the company is insolvent or incurs debt making the corporation insolvent.
- Corporate implications
Should a company become insolvent, the Corporations Act 2001 (Cth) provides for the ‘Winding up’ of the company.
Broadly, the ‘Winding up’ of a company is the shutting down of the company.
The process involves the deregistration and liquidation of the company with the proceeds being distributed to those who the company owes debts with any remains distributed to shareholders.
This is a complex process that involves significant expertise and experience.
- Personal implications
Should a director, or directors, of a company fail to comply with their duty to prevent insolvent trading they may receive a civil penalty which could include being:
- personally liable to pay compensation to the company;
- personally liable to pay up to $200,000 as a penalty to the Commonwealth; and
- disqualification as a director for a period of time.
On top of these civil penalties, the court can order that the director, or directors, have committed a criminal offence which can include:
- a penalty of up to 2,000 penalty units, which equates to $220,000 (at the current scale at time of publication); and
- imprisonment up to 5 years.
How to avoid insolvent trading?
There are various duties and responsibilities that directors of companies must comply with in order to avoid insolvent trading.
The Australian Securities and Investment Commission (‘ASIC’) is the body that regulates and investigates companies in Australia and recommends that:
- Directors should remain informed about the financial position of their company.
- This includes overseeing budgets, such as profit and cash flow budgets, managing accounts, monitoring actual and budget expectations, and monitoring debts, creditors, and funding.
- The information required and processes involved in the director remaining informed will depend on the company and a range of other factors, such as size, complexity, industry etc.
- Directors should investigate financial difficulties.
- This includes taking positive steps to confirm the company’s financial position
- Directors should obtain advice.
- This includes timely seeking advice both internally and externally to best deal with financial difficulties.
- Directors should act in a timely manner.
How Ramsden Lawyers can help
Insolvency matters are complex and have serious implications if not handled correctly. The proper handling of insolvency matters requires expertise and experience.
Here at Ramsden Lawyers we are experts in insolvency matters.
We can assist you whether you are a director of a company, a shareholder, or simply interested in obtaining further information.
“For more information and advice about this topic, please call our office to speak with one of our experts in this area”.
By John Ramsden, Lawyer and Managing Director of Ramsden Lawyers
21 May 2013