Don’t wait until it’s too late – get advice immediately
When a company is in financial distress, waiting too long before taking action will diminish your ability to restructure and save the business. When that happens, the only remaining option may be liquidation.
At IRT Advisory, we believe SME businesses in financial trouble should not appoint a liquidator unless and until all other options have been considered and rejected as unsuitable or unavailable. Getting the right advice is critical to ensure you do not make a costly mistake. When times are tough, IRT Advisory can assist you navigate the right path.
Insolvency Warning Signs
Under law, a company that can pay its debts as and when they fall due, is solvent. If it cannot, it is insolvent.
A temporary shortage of cash or some minor tax arrears doesn’t necessarily mean you’re insolvent. If it did, much of the business community would be insolvent most of the time!
Over the years and through many court judgements, the legal system has laid down a set of warning signs, or insolvency indicators, that collectively may point to a company being insolvent. As a business owner you should be on the lookout for these signs. Any one or more of them may suggest that financial difficulty is imminent.
Do any of the following indicators apply to your business?
- You’re trading at a loss;
- Your business has a deficiency of working capital;
- There is a deficiency of assets over liabilities in the balance sheet;
- You have difficulty paying creditors on time and outstanding accounts payable are becoming stretched out;
- You’ve entered into payment arrangements with suppliers or the ATO, and are making rounded sum payments to those creditors;
- Your business has been placed on stopped supply or COD by suppliers;
- You’ve suffered a one-off adverse event resulting in a significant deterioration in the balance sheet;
- Slow paying debtors are strangling your cash flow;
- You have stopped paying insurance premiums on the business or its assets;
- A marital or directors’ dispute is causing directors to lose focus on running the business profitably and efficiently;
- There has been a suspected fraud or theft of company funds by a director or employee;
- Your bookkeeping is behind or inaccurate, the company’s true financial and trading position is unknown and you’re unable to produce timely and accurate financial statements;
- Letters of demand or summonses have been served on your company over unpaid debts;
- Your own drawings from the company for personal expenditure may be excessive, leaving the company short of cash;
- You own personal resources are exhausted and there is no further personal money available to support your company through hard times;
- Taxation, superannuation or other statutory liabilities are behind;
- The bank overdraft is constantly under pressure;
- Your landlord has threatened to determine your lease and commence eviction proceedings due to rent arrears;
- Your bank has asked you to refinance debt owed to it;
- Your bank has engaged an investigating accountant to assess the solvency of your company;
- Financiers have threatened repossession of vehicles or equipment due to arrears of lease payments;
- You have received a statutory demand from a creditor;
- A winding up application has been filed against your company;
- A director penalty notice has been received from the Australian Taxation Office;
- You have sold your business but there will not be enough money available pay out all creditors;
- A secured creditor has or is threatening to appoint a Receiver & Manager.
If any of the above apply to your business, contact us now for quality advice.
My business may be insolvent – what are the options?
Well – it depends.
Are you burnt out from the struggle to survive? Have COVID-19 lockdowns or other adverse trading conditions smashed your business to the point of no return?
If you still have the emotional energy to press on, then what personal resources or capacity do you have to inject into your business to help it survive? How willing are you to back yourself by throwing what you have left into a restructuring proposal that can be offered to creditors?
The answers to these questions are critical, as they will determine the right way forward for you and your company.
But if you’re emotionally spent, with no desire to continue in your industry, then a dignified exit through liquidation may be the best option. If you’re still enthusiastic and wish to continue operating in your industry, but lack the capacity to offer anything more to creditors through a restructuring proposal than they will receive from liquidation, then although unpalatable, liquidation may be your only realistic alternative.
Placing your company into liquidation does not mean you can’t start again.
What is an insolvent liquidation?
This is best explained by describing in simple terms, the job of the liquidator.
At its simplest, a liquidator has three main tasks:
- Getting in, realising and converting to money, all of the company’s assets and other avenues of recovery available to the liquidator;
- Investigating what went wrong, who may be responsible and whether any offences have been committed (and if they have, reporting them to ASIC); and
- Distributing what remains after the costs of the winding up to the company’s creditors in the order of priority set down in the Corporations Act, based on a cents in the dollar proportion of the creditor’s admitted claim.
Thereafter, the company is struck off the register.
How does an insolvent liquidation commence?
An insolvent liquidation can be initiated voluntarily by the company’s shareholders, or by order of the Court.
Where the liquidation occurs voluntarily, the process is called a ‘Creditors Voluntary Liquidation’ or CVL.
A court-ordered liquidation will usually occur when an unpaid creditor has served a statutory demand for payment of an outstanding debt which has not been complied with after 21 days. The debtor company is deemed to be insolvent if it fails to comply with the statutory demand.
How does an insolvent liquidation affect the company?
The liquidator steps into the shoes of the directors, assuming all the powers previously held by the directors, plus those additional powers provided for in the Corporations Act.
The directors’ powers are suspended, although the directors can perform certain functions with the consent of the liquidator. The liquidator will take control of all of the company’s assets, including a trading business if there is one. The liquidator is empowered to continue trading the business for a limited period, sufficient to maximise its realisable value as a going concern.
How does an insolvent liquidation affect the directors?
Suspension of powers
The powers previously available to the directors are suspended immediately a liquidator is appointed. That means a director no longer has any control whatsoever over the company’s bank accounts, fixed and circulating assets, intangible assets (such as its business goodwill and customer relationships, domain names, trademarks, internally developed software, general knowhow etc), ability to trade or continue with contracts on foot at the appointment date and any litigation it may be involved in.
Directors must help the liquidator
The directors must deliver all the company’s books and records and provide the liquidator with a document called a ‘Report on Company Activities and Property’ (or ROCAP). This is in effect a company balance sheet supported by information schedules that helps the liquidator understand the company’s financial position and circumstances.
Directors may be examined in court
A liquidator is required under the Corporations Act to enquire into whether a director may have breached the law prior to the liquidator’s appointment. If there is a suspicion that a breach may have occurred, the liquidator has significant powers of enquiry.
Directors may be subject to claims by a liquidator if offences are detected
We cannot stress enough the need for early action by the directors of struggling companies. But because many directors resist seeking advice before considerable damage has occurred, we regularly see situations where a company will have been insolvent for some time prior to liquidation and/or where directors have taken steps to ‘protect’ assets (put them out of reach of a liquidator) in the belief that liquidation was imminent. Directors who undertake such steps are likely to be in breach of their duties.
The Corporations Act provides that it is an offence to trade while insolvent, or in other words, to incur new debt when the directors would not have any reasonable basis to believe that that debt (and all the company’s other debts) could be paid when it/they fell due.
Breach of duty
Many directors of SME companies have only a basic understanding of the duties of a director. They may have become directors because their accountant or lawyer advised them to trade the business through a corporate or trust structure. We commonly see directors who in their own minds make no distinction between what belongs to their company and what belongs to them personally.
Can a liquidator pursue a director’s personal assets?
Not directly. If a liquidator was successful in claiming against a director, the court hands down a judgement in which the director is ordered to pay the liquidator a specified sum. If the director does not comply with the court’s order, the liquidator can then enforce the order by means of bankruptcy proceedings against the director. If the director is made bankrupt, the trustee in bankruptcy takes control of the director’s personal assets and the liquidator stands in line for a dividend from the bankrupt estate along with other personal creditors of the director.
It is important to note that a liquidator’s claim against a director may make the difference between the director avoiding bankruptcy and not.
Can directors seek advice from the liquidator regarding insolvent trading, breach of duty or other claims?
Not in the sense that the advice sought was geared around helping the director avoid the consequences of any pre-appointment misconduct.
The liquidator can explain how the law operates, what duties the liquidator is required to comply with and indeed if a claim is identified, the nature and extent of that claim. However, no advice can be provided on how a director could defend themselves or otherwise mitigate the impact of a claim brought by the liquidator.
Whilst a director’s relationship with the liquidator may be amiable, it is important for directors to understand that the liquidator is not able to provide advice to the director personally in regard to any of the issues on this page. To do so would create a conflict of interest with the liquidator’s fiduciary duty to the creditors of the company in liquidation and require the immediate resignation of the liquidator.
At IRT Advisory, we treat all stakeholders including the directors of companies we administer, with Integrity, Respect and Trust. So if we’re asked for advice that we cannot give, we will say so honestly and respectfully recommend that you seek that advice from another professional.