Many businesses are currently facing financial pressure, either directly or indirectly because of the credit crunch. This can lead to concerns about solvency.
Directors, or persons who could be deemed to be directors, can be held personal liable for debts of the Company where:
- the Company incurs a debt; and
- the Company is insolvent at that time or becomes insolvent by incurring that debt; or
- when that debt is incurred, there are reasonable grounds for suspecting that the company is insolvent or would become insolvent.
Insolvency is the position of being unable to pay debts as and when they become due and payable. This requires a cash flow test as opposed to a balance sheet test. The balance sheet together with a number of other factors will, however, be relevant to determining whether or not a company is insolvent on the cash flow test.
Other indications of trading insolvent include:
- continuing losses
- overdue taxes
- poor relationship with the bank
- no access to alternative finance or further equity
- cash on delivery terms
- payment of creditors in rounded amounts (as opposed to the invoiced amount)
- unmet demands
- dishonoured cheques.
Whilst the presence of only a few of these factors may not necessarily mean a company is insolvent, a number of them would tend to suggest insolvency.
The global financial crisis and subsequently the credit crunch means that it has become difficult for a company to find alternative sources of finance. It has also led to a company’s debtors being unable to pay the company, affecting the company’s cash flow and therefore its solvency.
A director breaches their duty to prevent insolvent trading by the company if there are reasonable grounds for suspecting that the company is insolvent, or would so become insolvent, and they incur a debt. This is an objective test. Whether the director actually suspected the insolvency will be less relevant than whether or not a director of ordinary competence would have had that suspicion.
The defences to an insolvent trading claim by a liquidator or ASIC are notoriously difficult to establish. It is therefore important for directors or for persons at risk of being deemed to be directors to ensure that there are no objective grounds for them to suspect that the company is insolvent.
Should the suspicion of insolvency arise at a time when the company is in fact insolvent, directors are at risk of being personally liable for the debts which the company incurs. In those circumstances, it is important to obtain professional accounting and legal advice as to the possibilities of a restructure or, if necessary, to consider the appointment of either a liquidator or voluntary administrator to prevent the incurring of further debts and the possible breach of directors’ duties.
Please don’t hesitate to contact me if you have any questions regarding insolvent trading or insolvency in general.
The information provided in this article is for general information and educative purposes in summary form on legal topics which is current at the time it is published. The content does not constitute legal advice or recommendations and should not be relied upon as such. Whilst every care has been taken in the preparation of this article, FC Lawyers cannot accept responsibility for any errors, including those caused by negligence, in the material. We make no representations, statements or warranties about the accuracy or completeness of the information and you should not rely on it. You are advised to make your own independent inquiries regarding the accuracy of any information provided on this website. FC Lawyers does not guarantee, and accepts no legal responsibility whatsoever arising from or in connection to the accuracy, reliability, currency, correctness or completeness of any material contained in this article. Links to third party websites or articles does not constitute any endorsement or approval of those sites or the owners of those sites. Nothing in this article should be construed as granting any licence or right for you to use that content. You should consult the third party’s terms and conditions of use in relation to any third-party content. FC Lawyers disclaims all responsibility and all liability (including liability for negligence) for all expenses, losses, damages and costs you might incur as a result of the information being inaccurate or incomplete in any way. Appropriate legal advice should always be obtained in actual situations.