Business owners face a lot of challenges day in and day out. And this is true not just because of the stiff competition in the market, but also because of the many external factors that pose risks and problems for businesses. For example, the impact of COVID-19 lockdowns and other natural disasters have affected a lot of businesses. The inflation rate and cash rates are also rising. With all these factors, businesses might find it difficult to stay afloat and may be put at risk of insolvency.
What is corporate insolvency?
Technically speaking, insolvency in Australia means a company is unable to pay its debts when they fall due (see section 95A of the Corporations Act 2001 (Cth)). But just because an entity (the company or person) wasn’t paying its debts doesn’t mean it could not pay the debts and be insolvent. This could simply mean that they have just decided not to pay for other reasons entirely.
Insolvency usually occurs when a company or individual are under a certain level of financial stress and, as a result, they can no longer meet financial obligations and commitments. Trading whilst insolvent is illegal in Australia as per the Corporations Act and there are severe penalties for insolvent trading. Penalties that could see company directors fall into some hot water and be personally liable.
This is why it’s important to understand the options available to insolvent companies, the indicators of insolvency in Australia, and the different types of insolvency.
What happens when a company becomes insolvent?
For a company, there are three common insolvency procedures: liquidation, voluntary administration, and receivership.
Liquidating a company
When an insolvent company goes into liquidation, a registered liquidator takes control of the company to ensure that all of its affairs are well-managed for the benefit of all creditors (secured and unsecured). It involves the process of winding up a company unable to meet financial commitments and has also been trading insolvent.
Among the roles of a liquidator are to collect, protect and convert the company’s assets into cash, conduct investigations and prepare reports on the company’s affairs to creditors, inquire into the failure of the company and assess possible offences committed by individuals involved with the company and report to ASIC. The liquidator will distribute company assets accordingly and officially deregister the company.
Herein lie some potential positives and opportunities. Voluntary Administration doesn’t necessarily mean the company is closing its doors. It may present opportunities to keep the company afloat or perhaps liquidate. There are options here and it’s not all gloom and doom.
When a director of a debtor company determines that the business is insolvent or is likely to become insolvent, they should immediately seek the consent of a registered liquidator to be appointed as a voluntary administrator.
Once the administrator accepts the appointment, they then start to take over the company and implement strategies to save either the company or its business. An administrator is an independent and suitably qualified person who investigates and reports to creditors on the company’s business, property, affairs and financial circumstances to determine whether to proceed with one of the three options. They could either approve a ‘Deed of Company Arrangement’ (DOCA), proceed into voluntary liquidation and commence the process of winding things up for the company or hand the business back over to the directors.
A receiver is appointed by a secured creditor or, in special circumstances, by a court to take control of some or all of the company’s assets. When a company undergoes receivership, the company’s assets are collected and sold to repay the debt owed to a secured creditor. The money collected from selling the company’s assets or business is paid out to creditors in the order of priority required by law.
A company in receivership may also have an appointed administrator or a liquidator.
Cash flow problems are not uncommon for businesses. This is why it’s important to consistently review your books and financial statements to detect any issues before they get out of hand. If your business is facing financial difficulties, you may check out the early warning signs of insolvency so you can act soon.
What are the early signs of insolvency?
There are many warning signs of corporate insolvency. It’s important to understand them and do a health check on the business so you can catch any problem areas early on and follow appropriate steps to try to avoid insolvent trading.
Some early warning signs are:
- The company is unable to pay its debts as and when they are due
- Key internal stakeholders have resigned which may show concerns for the company’s financial health
- The company is showing declining profit margins
- There are special arrangements and payment plans in place with creditors
- Taxation obligations aren’t being paid when due such as PAYG, GST or Superannuation, due to poor cash flow and cash flow management
- The company is unable to offload assets at short notice to meet debts owed without affecting the ability of the company to trade comfortably
- The company cannot produce accurate financial information on a timely basis to comply with regulatory requirements
- There are legal proceedings against the company
Insolvency can be a serious problem for a company. It’s extremely important to consult with professionals as early as possible to handle your affairs.
If you think your business is at risk of insolvency, contact Clout Advisory today. Our specialists are here to assess your situation and help you through the process.
The information that is provided in this article is general in nature and does not constitute business and financial advice. Every effort has been made to ensure that the information is accurate, but information may become outdated as legislation and new government announcements are made. Individuals should not rely on this information to make a business decision as it does not take into account their personal circumstances. Before making any decisions, we recommend you consult a licensed advisor to take into account your particular situation and needs.