During difficult economic conditions it is important that all directors revisit their duties as directors and are aware of how the board should deal with the situation where a company is in financial difficulty and may be insolvent.
What is insolvency?
A company is deemed to be insolvent when it cannot pay its debts as and when they fall due.
The test sounds simple however its application involves a range of accounting and legal issues. When determining a company’s solvency a Court will consider the overall financial circumstances as a matter of commercial reality. Particular emphasis will be placed on a cash flow test, however, there are also a range of balance sheet factors including the ability to realise the value of assets and raise further funds, be it equity or debt.
Directors Duties in general
Directors in Australia face onerous duties if their company faces financial difficulties.
It is a director’s duty to prevent a company from trading whilst insolvent. Importantly, directors must prevent their company from incurring debts where the company is insolvent, or becomes insolvent by incurring the debt/s if there are reasonable grounds for suspecting the company is insolvent, or would become insolvent.
The test requires that whatever is “suspected” must be based on reasonable grounds and imports an objective test for suspicion.
Failing to guard against insolvent trading may result in the director being personally liable for payment of compensation, a pecuniary penalty and/or disqualification from managing a corporation.
What should a director do?
Directors should apply the following five recommendations:
Practical considerations indicating insolvency
There are some practical factors that may indicate insolvent trading, including:
Penalties for insolvent trading include disqualification from managing a corporation or a pecuniary penalty of up to $200,000.
A director may also be liable to criminal proceedings by ASIC through the Commonwealth Director of Public Prosecutions if they contravene a civil penalty provision.
A director may be convicted of an offence where it is proven that they knowingly, intentionally or recklessly:
It is essential that directors are aware of their duties and of the consequences including civil and criminal penalties that can be imposed if trading whilst insolvent.
If you feel you might need to explore your company’s legal position and your duties it’s always prudent to do so sooner rather than later, particularly as it takes time to turn a company around or to arrange a restructure.
If you need any guidance or advice regarding insolvency or if you are a creditor of an insolvent company please contact us on (02) 9238 0060 or email firstname.lastname@example.org to edit.