Insolvency is the term used when an entity is unable to pay its debts when they fall due for payment. It is generally used in the context of a company, whereas insolvency for a natural person is generally referred to as bankruptcy in Australia. The effect of insolvency is that a company could be wound up, either by its own will or through a creditor’s application.
The Corporations Act 2001 (Cth), which regulates companies in Australia, provides a definition of solvency and insolvency under Section 95A, as follows:
(1) A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable; and
(2) A person who is not solvent is insolvent.
Strictly speaking, the legislation determines that a company is insolvent if it is unable to pay all of its debts, as and when they fall due. However, the Courts have determined over time that a company that is unable to pay a debt when it falls due may not be insolvent. It could simply be suffering from temporary lack of funds on hand to pay their debts. A company could be asset rich but have little cash on hand. This does not always mean the company is insolvent.
What are the indicators of Insolvency?
Some indicators of a company’s insolvency include:
- The company has ongoing losses;
- The company has poor cash flow;
- The company has unpaid creditors outside usual trading terms;
- The company has overdue Commonwealth and state taxes;
- The company is unable to borrow funds or obtain finance;
- The company has dishonoured cheques.
What can I do if my company is Insolvent?
If a company is found to be insolvent, you might need to consider winding-up the company if you are unable to negotiate with creditors. There are generally three avenues available to insolvent companies:
- Voluntary Administration;
- Liquidation;
- Deed of Company Arrangement
ASIC provides information sheets which explain these insolvency procedures in plain English and are a good tool to assist you in understanding what these procedures are.
These information sheets can be found here.
What to do if your company is experiencing financial difficulty?
If your company is experiencing financial difficulty, it is important to get proper legal and financial advice as soon as possible to guide you through the available options for you. This should be done as soon as possible to increase the chance of persevering through these hard times.
If you suspect your company is insolvent, you should not incur any further debts without first obtaining legal and financial advice. As a company director, one of your Director’s Duties is that you have to inform yourself of your company’s financial position and not to trade while the company is Insolvent. A breach of that duty could have serious consequences for you personally as a director. This includes incurring penalties, such as civil penalties, compensation proceedings, and criminal charges.
If your company is experiencing financial difficulty and you would like to have a confidential discussion about your options, get in touch with us now to see how we can assist you!