Solvency – the eternal challenge for directors! 


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Solvency – the eternal challenge for directors! 

Directors do not wake up one day and say “wouldn’t it be a good idea to wind up the company!”  It is either something that happens slowly and gradually (the “boiling frog” syndrome!) or something unexpected, like a devastating bushfire, that grabs them by surprise. 

As well as managing the day-to-day business activities and finances, directors have a number of legal obligations.  They must also always act lawfully and honestly and make decisions for the benefit of the company and its shareholders.  A key component of these obligations is to ensure that the company does not trade while it is insolvent.

What does this involve?

  • Directors should be very familiar with Sections 180 to 184 of the Corporations Act, which are all about good faith, care and diligence and acting in the interests of the company. Failure to do so recklessly or dishonestly can actually result in criminal penalties.
  • A director has an obligation to prevent insolvent trading (Section 588G) and can be made personally liable for incurring additional debt after the date the company becomes insolvent or is deemed to have become insolvent.  Again, if that insolvent trading is done dishonestly, the director can face criminal charges.  ASIC has recently been successful in prosecuting directors on criminal charges for insolvent trading, so they are serious about taking action.
  • A director can also be made personally liable by the ATO for failure to report and/or pay Superannuation, PAYG, GST, and other indirect taxes If a director has received a Director Penalty Notice from the ATO, they should immediately seek professional advice.

The challenge of identifying if a company is trading solvent

Whether the company has more assets than liabilities may be, and often is, irrelevant.  The definition of solvency is all about cash flow – can the company pay its debts as and when they fall due?  This is not always a simple question, particularly when you are looking at the complex business structures of major organisations.  Nevertheless, the indicators of insolvency are the same, regardless of the company size.

It is crucial that directors are able to recognise the potential indicators of insolvency, such as:

  • Poor cash flow;
  • Overdue Commonwealth & State taxes;
  • Not paying superannuation liabilities;
  • Incomplete financial records or disorganised internal accounting procedures;
  • Not being able to invest in repairs or maintenance;
  • Increasing debts;
  • Push-back from banks and other lenders, perhaps requests to reduce borrowings etc.;
  • Suppliers changing supply terms to cash on delivery or demanding special payments before resuming supply;
  • Failure to pay within trading terms;
  • Special arrangements with selected creditors.

Sometimes the indicators might be non-financial – increased warranty claims or disputes with customers or lowering staff morale (which often comes very early as a sign that all is not well with the business).  This latter indicator can result in production or sales problems, further increasing the risk of insolvency.

What to do if the director feels the company is in trouble? 

In the instance that a director feels the company is in trouble and may be trading insolvent, it can be a difficult and emotionally draining exercise to decide what to do and when to do it.

Under the recently introduced legislation to combat illegal phoenixing, directors are now personally liable for a range of liabilities and may even face criminal charges if dishonesty is involved.

It is crucial to get the right advice at the right time.  Failure to do this will have a potentially devastating impact on directors as well as employees, suppliers, customers and other stakeholders.

What to do?

If one or more of the above applies to your business or a business you know, and there are doubts about the company’s solvency, you should:

  1. Speak to your accountant – to help directors with financial issues, prepare budgets or a cash flow and understand what the future of their company looks like.
  2. Only incur debts that you are able to pay as and when they become due and payable.
  3. Seek professional advice from a specialist insolvency practitioner who can advise directors of their available options.dVT Group can help determine the solvency of a company and can also discuss different options.

If you would like to know more and find out what options you might have, please contact Suelen McCallum at dVT Group on 02 9633 3333, or by email mail@dvtgroup.com.au

dVT Group is a business advisory firm that specialises in business turnaround, insolvency (both corporate and personal), business valuations and business strategy support.