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Signs of Insolvency

Discus about the Business Law for Insolvency Company.

Insolvency is the state of the company where the company does not have enough money to pay back its creditors and smoothly operate its business operations. There are few signs through which it can be made out whether a company is insolvent or not. Firstly the most prominent sign of a company becoming insolvent is that it has reached the limit of its bank overdraft and the bank is refusing to give it any further loan without personal guarantees. The company does not have enough assets to secure short term loans and the suppliers are not willing to supply goods on credit. When the company is not able to pay back its creditors and or a statutory demand has been made by them with constant legal threats along with the winding up petition it is also a sign of insolvency (Harnahan., Ramsey. and Stapledon 2017). A company is also deemed to be in solvent when it does not have enough money to pay remuneration and salaries to its employees. This means that the chances of the company meeting wages bills are very slim. According to the company insolvency test accompany it is deemed to be in solvent in case it is not able to pay its liabilities when they fall due or the one or liability of the company becomes more than the total Assets of the company. According to the cash flow test even if the company has believe that in the reasonable near future it would not be able to meet the demands of its creditors it is said that the company is nearing insolvency. According to the balance sheet test a company is insolvent if the overall Assets of the company are more than its liabilities (Asic.gov.au 2017).

In case of insolvency that directors of the company have to be proactive in relation to their actions with respect to the company. First leader directors have to get rid of the mentality that the problem cannot be solved and must take appropriate action quickly in order to address the problem. The directors must increase supervising and monitoring the position of the company financially where it is found that it is facing financial difficulties. Director should also be aware of a few danger signs such as world liquidity ratio continuous loss overdue trade creditors or taxes and the inability to provide correct financial information in timely manner. The board of directors must also seek financial and legal advice to develop an alternative plan for the company in order to avoid insolvency. The directors have to understand that turnaround and restructures are time consuming process and in order to properly prepare and implement them they have to be patient (Brown 2015).

Proactive Measures for Company Directors


It is the legal obligation on the directors to act in the best interest of the company in a proper purpose. There are certain obligations which have been imposed to the directors with respect to common law and the Corporation Act 2001 (Cth) (CA) in Australia respect to the management of the company. The non-compliance with these responsibilities and duties can result in various Civil and criminal sanctions and penalties along with this qualification of directors for managing a company. Potential liability of directors in case of insolvency includes been personally liable to all debt which has been entered by the company when it has become insolvent because section 588 G of the Corporation Act provides that a director must not engage in trade when the company has become insolvent or they have the knowledge that the company is about to become insolvent. In the case of Carrello as liquidator of Perrinepod Pty Ltd v Perrine Architecture Pty Ltd (“Carrello’s case”) [2016] WASC 145 a claim was made by the liquidators in relation to insolvent trading against directors of the company along with the parent company with respect to Section 588G and 588V of the CA. However in this case the liquidator was not able to prove that the company was indulging in solvent trading as the standard financial statements did not depict conclusions in relation to the same. However when the company had adverse adjudication determination against it with respect to $1.06 million it was found by the court that it was indulging in solving trading. Therefore the court allowed the claim of the liquidators in part in this case.

It is a well-established fact that every case has two sides. In the same way section 588H of the CA provides a few avenues in form of defences which the directors may rely upon against a claim of insolvent trading. Firstly it can be claimed by the directors that they had reasonable evidence which suggested that their company during the time of trading was solvent. Secondly there is evidence available to the directors which suggests that the company would remain to be solvent even if it enters into a particular transaction. Thirdly a reasonable person put in the same circumstances as that of the director would conclude that the company was solvent at that time. Fourthly, positive actions was taken by the directors to prevent the company from in curing any further debt. Fifthly, it is also a defensive the directors can prove that they have reasonable Grounds which prevented them to take part in the management of the company such as unsound mind or illness. Sixthly, director would be able to rely on professional advice if they can establish that they had evidence to believe that the person who has given them advice is competent the person was fulfilling its role and responsibility and they were provided with the correct information in relation to the company. In order to decide whether the director to reasonable steps to prevent the company for enquiry any further debt it has to be proved that the directors appointed as administrator in relation to the company and proper Resolution was passed for such appointment. The principles in relation to reliance on the advice of an expert had been discussed in the case of Hussain v CSR Building Projects Limited; in the matter of FPJ Group Pty Ltd (in liq) (“Hussain’s case”) [2016] FCA 392.

Legal Obligations of Directors in case of Insolvency


When a company is no longer able to pay its creditors and there is no other option to escape such debt the company has to be brought to an end by the process of winding up. The process of winding up is divided into two types which is voluntary winding up and involuntary winding up. In the process of voluntary winding up occurs when the members of the company voluntarily agree to the winding up of the company. In the process of involuntary winding up the company is wound up through force by the creditors (Brown 2015).

There are two types of voluntary liquidation namely members voluntary liquidation and creditors voluntary liquidation. However the members can only avail liquidation in case the company is in a solvent state. In case of an involuntary winding up of a company the creditors force such winding up on the company because the company owns them a specified some up capital and is not able to repay it. The process of forcing winding up of a company is done through the court by the creditors. In such situation the court also analyses or misconduct of the directors in relation to the company (Innes 2016).

Another option for the company other than being wind up by creditors would be to go into voluntary liquidation of the company by its creditors. As discussed above a member voluntary liquidation can only take place when the companies in a solvent state, however creditors’ voluntary liquidation can take place when the company has become insolvent. The most important advantage of a creditor voluntary liquidation as compared to compulsory liquidation is that better opportunities are provided by it with respect to protection against a claim of misconduct. Although the creditors voluntary liquidation is little bit more expensive as compared to in voluntary winding up from the perspective of the directors it can put the directors in a position where they can be help personally liable for the debts of the company and may also face consequences in relation to the career which would result in a far more drastic long term loss. There is a risk in case of compulsory winding up by creditors that the directors can be accused of fraudulent and wrongful trading and both of such offences are punishable with Civil and criminal sanctions with respect to Section 1317E of the CA. Directors can also be disqualified from managing of operation with respect to such accusation show the virtue of s 206A of the CA. There would be additional time in the hands of the director to discuss the winding up process with the appointed liquidator in case of creditors’ voluntary winding up. Therefore the directors will have a chance to act in accordance with their guidance and minimise any liability in relation to misconduct (Australia, 2015).

Liabilities of Directors in Case of Insolvent Trading


In Australia the rate of insolvency with respect to companies are increasing. About more than 10000 companies every year go into the process of Administration. The number of Companies which entered into any form of insolvency Administration with respect to the year ended April 2017 was 10212. It has resulted in a 16% increase with respect to the average of the last 5 years and over 6% increase in relation to the last year. 1356 appointments were made by secured creditors most of which were banks in the year to April 2017 which is more than 73%as compared to the last 5 years. The statistics are provided by the Australian investment and securities Commission (Asic.gov.au. 2017).

There are various topical issues which are faced by the Australian companies in relation to insolvency. According to the Australian securities and investment Commission the most important and primary issue which leads to of insolvency with respect to the Australian companies is that of inadequate cash flow. The company suffers very much from inadequate cash flows and as a result and not able to meet the demands of the creditors and have to go into the process of winding up. Poor strategic management is also one of the most important issues which lead to the insolvency of the company. If the company does not get managed properly by directors it is evident that it is not going to make much profit. The most common issue which is brought before the court in relation to the insolvency of Australian companies is that the directors of the company were involved in insolvent trading. Recently the collapse of the Queensland Nickel company initiated acclaim for freezing more than 200 million worth Assets of the owner (Elks and Elks 2017). Another issue in relation to insolvency of Australian companies is that of preference payment (Coggins, Teng and Rameezdeen 2016). The question is who is to be given preference for payment when the company is getting wind up. One of the most recent cases in relation to the issue is the case of Blakeley and Australian Music Pty Ltd v Yamaha Music Australia Pty Ltd (“Blakeley’s Case”) [2016] VSC 231.


The Australian Investment and Security Commission is a Watchdog for corporate organisations in Australia. It has a major role to play in relation to the insolvency of Australian companies. The regulator contribute to the well being and reputation of Australian economy by ensuring that the Australian financial markets are transparent and fair which is supported by informed and confident consumers and investors. The regulator seeks to facilitate improvement in the performance of financial system and organisations within it. It also seeks to enhance informed and confident participation by consumers and investors in the Australian economy. The regulator implements the legal provisions in a very effective manner through the application of least procedural requirements. It also implements and give effect to the legal provisions. It provides the definition of insolvency as a position of a company where it is not able to pay its debts. It provides the three most common insolvency procedures in form of liquidation, receivership and administration. It provides insolvency information sheet in order to assist the companies and creditors who are affected by insolvency of the company and have no knowledge about what is involved. The regulator also publishes monthly statistics in relation to the number of Companies going into external administration first time along with number of insolvency appointments which are registered in that period. It provides guidelines for directors, creditors, employees, investors, shareholders and liquidators in case they come into contact with insolvency (Asic.gov.au. 2017).

References

Asic.gov.au. (2017). Insolvency for directors | ASIC - Australian Securities and Investments Commission. [online] Available at: https://asic.gov.au/regulatory-resources/insolvency/insolvency-for-directors/ [Accessed 18 Sep. 2017].

Asic.gov.au. (2017). Winding up a solvent company | ASIC - Australian Securities and Investments Commission. [online] Available at: https://asic.gov.au/for-business/closing-your-company/deregistration/winding-up-a-solvent-company/ [Accessed 18 Sep. 2017].

Australia, C.P.A., 2015. Small business survey program: Financial management, insolvency and fraud.

Blakeley and Australian Music Pty Ltd v Yamaha Music Australia Pty Ltd (“Blakeley’s Case”) [2016] VSC 231.

Brown, A., 2015. ASIC: From little things, big things grow-lodging and publishing. Australian Insolvency Journal, 27(1), p.42.

Brown, A., 2016. ASIC: Better communication, insolvent trading and notices to creditors. Australian Restructuring Insolvency & Turnaround Association Journal, 28(1), p.42.

Carrello as liquidator of Perrinepod Pty Ltd v Perrine Architecture Pty Ltd (“Carrello’s case”) [2016] WASC 145

Coggins, J., Teng, B. and Rameezdeen, R., 2016. Construction insolvency in Australia: reining in the beast. Construction Economics and Building, 16(3), pp.38-56.

Corporation Act 2001 (Cth)

Elks, S. and Elks, S. (2017). Clive faces ‘massive mega trial’. [online] Theaustralian.com.au. Available at: https://www.theaustralian.com.au/news/nation/clive-palmer-faces-court-set-for-one-massive-mega-trial/news-story/52d0666f855e0d54151da588928cab31 [Accessed 18 Sep. 2017].

Harnahan, P., Ramsey, I. and Stapledon, G. (2017). COMMERCIAL APPLICATION OF COMPANY LAW. 18th ed. Oxford University Press.

Hussain v CSR Building Projects Limited; in the matter of FPJ Group Pty Ltd (in liq) (“Hussain’s case”) [2016] FCA 392.

Innes, K., 2016. Australian insolvency : Cases and materials [Book Review]. Ethos: Official Publication of the  Law Society of the Australian Capital Territory, (240), p.61.

Osborne, M., 2016. Bankruptcy administration in Australia. Australian Restructuring Insolvency & Turnaround Association Journal, 28(2), p.22.

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