Posted on 10th March 2017 by Christabelle Harris

What is Insolvency?

Insolvency is the point at which the organisation or individual can no longer meet its financial obligations with its lenders/creditors as their debts fall due. Common signs that your company/business may be in financial difficulty may include:

  • Continued losses
  • Poor cash flow
  • Incomplete financial records or disorganised internal accounting procedures
  • Increasing debt (liabilities becoming greater than assets)
  • Creditors unpaid outside usual terms
  • Overdraft limits reached or defaults on loans and interest payments
  • Overdue tax and superannuation liabilities

What are my duties as a Director?

Generally, as a director your fiduciary duties are to your company’s shareholders and to ensure compliance within the laws of the company operations. However, if your company is insolvent, or there is a real risk of insolvency, your duties expand to include creditors (including employees with outstanding entitlements).

In addition it is the director’s duty not to be trading whilst being insolvent. This means that before you incur a new debt, you must consider whether you have reasonable grounds to suspect that the company is insolvent or will become insolvent as a result of incurring the debt.

An understanding of the financial position of your company only at the time you sign off on the yearly financial statements is insufficient. You need to be constantly aware of your company’s financial position.

Your company must keep adequate financial records to correctly record and explain transactions and the company’s financial position and performance. A failure of a director to take all reasonable steps to ensure a company fulfils this requirement breaches the Corporations Act.

For the purposes of an insolvent trading action against a director, a company will generally be presumed to have been insolvent from the point where it can be shown to have failed to keep adequate financial records. This highlights the importance of having accurate and timely financial records.

What are the Consequences of Insolvent Trading for Directors?

The Corporations Act does provide certain statutory defenses for directors. However, directors may find it difficult to rely upon these if they have not taken appropriate steps (as mentioned above) in order to keep themselves adequately informed about the company’s financial position.

Civil penalties

Breaching the insolvent trading provisions of the Corporations Act can result in civil penalties against directors with penalties of up to $200,000.

Compensation proceedings

Compensation proceedings for amounts lost by creditors can be initiated by ASIC, a liquidator or a creditor against a director personally. A compensation order can be made in addition to civil penalties.

Compensation payments are potentially unlimited and could potentially lead to the personal bankruptcy of directors. The personal bankruptcy of a director disqualifies that director from continuing as a director or managing a company.

Criminal charges

If dishonesty is found to be a factor in insolvent trading, a director may also be subject to criminal charges which can lead to a fine of up to $220,000 or imprisonment for up to 5 years, or both. Being found guilty of the criminal offence of insolvent trading will also lead to a director’s disqualification.

The good news is that taking steps to ensure your company remains financially sound will minimize the risk of an insolvent trading action. It may also improve your company’s performance.

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