What you need to know about Corporate Insolvency in Australia
As we navigate the challenges of COVID-19, companies and businesses are staring financial distress in the face and grappling around issues of solvency. Insolvency and financial distress can be complex and technical to manage. However, seeking legal advice during this uncertain time is a means to help and guide organisations on what to keep an eye on around insolvency issues.
When does a company become insolvent?
Legally, a company becomes insolvent when it is unable to meet its debts as and when they are due and payable. However, the point of insolvency can be difficult to assess and as such it requires a complete assessment of the company’s financial position carefully and honestly by considering the following:
- Commercial realities with a cash flow focus
The commercial realities of a company involve the consideration of non-cash resources like resalable assets, financial support and borrowing and in what timeframes such resources may be available.
At the time of incurring debt, the company needs to ensure it has the resources available to pay the debt when it becomes due.
- Short-term liquidity issues
During this pandemic, there is a great likelihood that companies’ liquidity will be drastically impacted but it must be managed properly so that it does not affect working capital. An ‘endemic shortage of working capital’ is a characteristic of insolvency. The key to remaining solvent during this time is to ensure that liquidity issues do not transfer into a shortage of working capital.
- Endemic shortage of working capital
Businesses who are already working under severe financial constraints due to COVID-19 may have moved into a position where it is impossible to recover. If no other methods of financial support are available, a company may have crossed into insolvency.
- Due and payable
A company must make its payments when due. If an agreement has been reached with creditors to extend payment terms, then it should be done in writing.
What are some of the indicators of insolvency?
- A continuing trend of losses
- Having below 1 liquidity ratios
- Commonwealth and State taxes are overdue
- Unable to borrow additional funds and poor relationship with current bank
- Unable to secure alternative financing
- Incapable of raising further equity capital
- Being placed on COD by suppliers, or if they have special payments demands before recommencing supply
- Unpaid creditors outside trading terms
- Releasing post-dated cheques
- Having dishonoured cheques
- Seeking special arrangements with selected creditors
- Solicitors’ letters, summonses, judgments or warrants issued against the business
- Rounding off payments to creditors, which cannot be reconciled to specific invoices
- Unable to issue timely and accurate financial information of the company’s trading performance and financial position and in making reliable forecasts
Why is it important for a company to determine insolvency?
It’s important for a company that is on the brink of insolvency to realise such so that directors can take immediate action:
- To be able to save the business or minimise the issue if acted upon quickly.
- A company trading while insolvent could be breaking the law. This is a criminal offense that may impact the directors’ personal financial positions. Due to COVID-19, the Government has passed laws to provide temporary relief in this regard (see below).
What is the temporary relief for directors’ personal liability for trading while insolvent?
Due to the current pandemic, the Government has implemented temporary relief measures for directors from personal liability for trading while insolvent. These include:
- An increase in the threshold from $2,000 to $20,000 at which creditors can issue a statutory demand
- An increase from $5,000 to $20,000 at which creditors can initiate a bankruptcy proceeding
- Increasing the periods for responses to statutory demands and bankruptcy notices from 21 days to six months
- A temporary relief for directors from insolvent trading liability (although egregious cases of fraudulent or dishonest insolvent trading may still attract criminal actions)
To get up to date information on measures in place, visit the Federal and State governments’ websites.
What are some of the long-term options for insolvency issues?
- Doubts about solvency and whether there is a viable business
The restructuring with safe harbor protection or the voluntary administration with a deed of company arrangement to compromise debts and allow the company to restructure.
- Insolvent but there could be a viable business
The voluntary administration with a deed of company arrangement as above or liquidation.
- Insolvent and no viable business to save
A company going through financial distress is a stressful and challenging experience for directors. My Legal Crunch Lawyers is here to help you navigate this difficult time and provide guidance and legal advice on financial distress and insolvency issues.
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