When a business can’t pay its bills when they’re due, it’s called insolvent. Allowing your organisation to trade when it is insolvent carries substantial consequences. As soon as you fear your company will be unable to pay its debts when they are due, you should visit a registered liquidator, a properly qualified specialised insolvency accountant or lawyer, or a financial advice agency about your firm’s financial status.
In this post, we’ll explain in further detail what insolvency is and how to avoid facing major consequences.
What is insolvency?
When an entity is unable to pay its debts when they become due, it is said to be insolvent. In Australia, it is most commonly used in the context of a company, whereas insolvency for a natural person is referred to as bankruptcy. Insolvency has the consequence of causing a corporation to be wound up, either voluntarily or at the request of a creditor.
Under Section 95A of the Corporations Act 2001 (Cth), which governs Australian businesses, the terms “solvency” and “insolvency” are defined as follows:
(1) A person is solvent if and only if he or she can pay all of his or her debts when they become due and payable; and
(2) An insolvent individual is one who is not solvent.
In strict terms, a firm is insolvent if it is unable to pay all of its debts when they become due. However, over time, the courts have decided that a firm that is unable to pay a loan when it is due is not always insolvent. It could simply be due to a temporary shortage of finances to fulfill their bills. A corporation may have a lot of assets but little cash on hand. This does not always imply that the business is bankrupt.
What are the signs of insolvency?
If you are seeing these indicators happening in your company, make sure that you contact a Central Coast lawyer immediately to help you out. The following are some indicators of a company’s insolvency:
- The business continues to lose money;
- The company’s cash flow is bad;
- Outside of normal trading terms, the corporation owes money to creditors.
- The corporation owes back taxes to the Commonwealth and the state;
- The business is unable to borrow money or secure financing;
- Cheques have been returned unpaid by the company.
Corporate insolvency
- The term “corporate insolvency” refers to a company’s inability to pay its debts when they become due and payable.
- The courts apply what is known as the ‘cash-flow test’ to interpret it.
- If the insolvent debtor is a corporation, they will be handled under the Corporations Act 2001 (Cth), and any litigation will take place in the Federal Court or a state Supreme Court, with the Australian Securities and Investments Commission providing support, recourse, and regulation (ASIC).
Individuals that are insolvent (bankruptcy)
- Personal insolvency (sometimes known as bankruptcy) is a term used to describe a situation in which a person is unable to pay their past debts when they become due and payable.
- Individual insolvent debtors will be dealt with under the Bankruptcy Act 1966 (Cth), and any litigation will take place in the Federal Court or the Federal Circuit Court, with the Australian Financial Security Authority providing regulatory oversight (ASFA).
- Despite the fact that many sections in the Corporations Act are similar to those in the Bankruptcy Act, each has its own insolvency process. One point to keep in mind is that each regime has different access to third-party debt.
What can I do if my business is insolvent?
If you are unable to bargain with creditors after a firm is judged to be insolvent, you may need to consider winding up the company. Insolvent businesses can usually choose one of three paths:
- Administration by Volunteers;
- Liquidation;
- Company Arrangement Deed
- ASIC publishes information sheets that explain insolvency proceedings in plain English and are a useful tool for gaining a better grasp of them.
When are firms insolvent under Section 95A of the Corporations Act?
Corporate insolvency is defined by its polar opposite in law. Insolvency is defined in Section 95A of the Corporations Act, which also includes a definition of solvency. The section includes the following information:
- A person (or a firm) is solvent if and only if he or she is able to pay all of his or her debts as they become due and payable.
- Insolvent is a person who is not solvent.
- The term ‘person’ is used here to refer to both individuals and businesses. Once a company is registered with the Australian Securities and Investment Commission (section 1.5.1 of the Corporations Act), it becomes a separate legal entity, giving it a degree of legal personhood. This distinguishes the company from the persons who own and/or operate the firm by allowing it to own property, exercise rights and fulfill obligations.
Insolvent trading’s ramifications
Insolvent trading has a variety of penalties and repercussions, including civil penalties, compensation proceedings, and criminal prosecutions.
Directors have various statutory defences under the Corporations Act. However, if directors have not made steps to stay informed about the company’s financial situation, they may find it difficult to rely on these.
Penalties for civil offences
Infringing on the Corporations Act’s insolvent trading rules can result in civil penalties for directors, including monetary fines of up to $200,000.
Compensation claims/ proceedings
Compensation procedures for money lost by creditors can be brought by ASIC, a liquidator or a creditor against a director personally. In addition to civil penalties, a compensation order might be issued.
Compensation payouts have the potential to be limitless, putting directors in jeopardy of personal insolvency. A director’s personal bankruptcy disqualifies him or her from serving as a director or managing a firm.
Criminal charges have been filed
A director may face criminal penalties if dishonesty is shown to be a role in an insolvent business (which can lead to a fine of up to 2,000 penalty units or imprisonment for up to five years or both). A director’s certification will be revoked if he or she is found guilty of the criminal offence of insolvent trading.
ASIC has successfully prosecuted directors for permitting insolvent firms to accumulate debts and has sought orders holding directors personally accountable for corporate obligations.
The good news is that taking actions to ensure your company’s financial stability can reduce your chances of facing insolvent trading action. It may also help your organisation perform better.
What to do if you think you’re having financial problems?
Get competent accounting and/or legal assistance as soon as possible if you feel your firm is having financial difficulties. This improves the company’s chances of surviving. Don’t bury your head in the sand and hope that things will get better – they rarely do. Insolvency warning signals include:
- continuous losses
- a cash flow problem
- due to a lack of a business plan
- financial documents that aren’t full or internal accounting procedures that aren’t well-organized
- cash-flow estimates and other budgets are lacking.
- accumulating debt (liabilities greater than assets)
- selling stock or collecting debts are both difficult tasks.
- loans to related parties that are not repayable
- creditors who have not been paid in time
- issued against your firm via solicitors’ letters, demands, summonses, judgments, or warrants
- cash-on-delivery arrangements are being used by your suppliers.
- deals with a few key creditors
- lump-sum payments to creditors that cannot be reconciled to specific invoices
- overdraft limit exceeded, or loan or interest payments defaulted
- difficulties in acquiring funding
- change of bank, lender, or enhanced financial monitoring/involvement
- unable to raise financing from investors
- tax arrears and superannuation obligations
- disputes on the board of directors, director resignations, or management changes
- board disagreements, director resignations, or management personnel departures
- suppliers are receiving an increased number of complaints or inquiries.
- a belief that the company will be saved by the ‘next’ large job/sale/contract
A registered liquidator can assess your company’s solvency and provide you with a list of solutions. You must be aware of your alternatives in order to make informed decisions about the future of your firm. Refinancing, restructuring or modifying your company’s activities, or employing an external administrator are all possibilities.
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