Insolvency and insolvent trading
When a company is insolvent, it is an offence for it to continue trading. If it does, the director of the business becomes personally liable for this new debt the company may occur. In this blog, we cover what insolvency is and the consequences for insolvent trading.
What is insolvency?
If a company is unable to pay back its debts when and as they are due, it is deemed to be insolvent. This means that its liabilities exceed its assets. In this circumstance, there are the three common insolvency procedures including voluntary administration, liquidation and receivership. And it is an offence – in fact, it is a breach of director duties – for a director to allow their business to continue trading and incurring further debt once it is insolvent.
Risks of becoming insolvent
There are a few examples that may indicate a company is headed towards insolvency or is at risk, including, but not limited to:
- Poor cash flow
- Badly maintained financial records
- Difficulties obtaining finance
- Cash on delivery terms
- Overdue taxes
- Dishonoured cheques
What are the penalties for insolvent trading?
If a company trades once it is insolvent, it is committing an offence under the Corporations Act. The penalties that could apply for insolvent trading could include:
- Disqualification of a director from managing a company
- Fines of up to $220,000
- An order to pay compensation to the company equivalent to the loss suffered by creditors
- Criminal proceedings
- In a serious case, it can also include a prison term.
Since a director can be personally liable for debts of an insolvent company that is continuing to trade, a liquidator may look to recover these losses directly from the director’s personal assets. This is why it is important for directors to demonstrate competence and financial acumen when leading a company, rather than behaving with ignorance or denial to their financial situation or it could be a costly exercise.
Defences for insolvent trading
Even if a company has been trading once insolvent, a director may be able to claim any of the following defences, relieving them of the liability. Though, this list of possible defences is not exhaustive. Some of the possible defences include:
- The company was solvent at the time it incurred the debt and would remain solvent upon incurring that debt.
- It was reasonable for the director to believe that the company was solvent at the relevant time they received information from a reliable source
- The director took reasonable steps to prevent the company from incurring the debt.
Further information on insolvency, insolvent trading and more
If a director has concerns or believes their company might be at risk of insolvency, it is advised they seek prompt accounting and legal advice. These early discussions could present a number of options for restructuring the company out of a potentially dire situation, or alternatively, encourage them to consider entering into voluntary administration or appointing a liquidator. These options could all prevent any further debts being incurred and will also protect the director’s personal assets.
Contact an insolvency lawyer
Our team of qualified insolvency lawyers are available to discuss your options and also legally represent you if you are facing any insolvency concerns with your company.