Insolvency Essay: Signs, Liabilities, And Avenues Of Action.

This is a study of the topic of insolvency of a company leading to its wind up by either the members or the creditors, or alternatively how a company might be saved from liquidation. In this presentation you are required to address the following issues:

What are the signs that a company is insolvent, and what actions and proactivity is required of the directors in these circumstances?

What are the potential liabilities of company directors in the event of a company becoming insolvent?

What are the different avenues available to the company, in particular to the directors, if the company is presumed to be insolvent?

What is the difference between voluntary and involuntary interventions by different parties concerned by the potential insolvency of the company?

What might be a good outcome for a company other than being wound up by the creditors, and how might this be achieved?

What are the statistics on insolvency regarding Australian companies?

Are there any topical issues regarding insolvency of Australian companies?

What is the role of ASIC and any other statutory authorities regarding an insolvent company?

What are the signs that a company is insolvent, and what actions and proactivity is required of the directors in these circumstances?

Insolvency refers to such a situation in which the person is unable to pay back the money which they owed to the others. In terms of a company’s insolvency, the company is unable to pay the debts owed by it, to different stakeholders. Insolvency broadly has two forms, i.e., the cash flow insolvency and the balance sheet insolvency (Omar, 2017). In the former, the company has assets to repay the debts; though, it does not have the right form to make payment. In the latter, the company does not have the requisite assets for repaying its debts. In Australia, the directors have been embarked with certain duties, which include not trading when the company is insolvent. The ASIC, i.e., Australian Securities and Investments Commission, along with the other statutory authorities play a key role in this regard (Keay, Murray and Harris, 2013). In the following parts, a discussion has been carried whereby the different aspects of insolvency of the company have been discussed. This discussion would not only highlight the very basics of insolvency, but would also present the current state of company insolvency in the nation.

An insolvent company fails in paying their debts when the payment is due. There are three common procedures for corporate insolvency, which includes voluntary administration, receivership and liquidation. A company does not become insolvent in a single day; there are signs which often present as the possibility of a company being insolvent. There are always signs present which show that the company is facing financial difficulties (ASIC, 2014a). Some of the signs which indicate towards financial difficulty include poor cash flow, continued losses, creditors not being paid even out of their usual terms, lack of cash flow, debts continuously rising, absence of business plan, suppliers putting the company on Cash on Delivery terms, dishonouring cheques or issuing post dated cheques, problems in collecting debts or selling stocks, inability in raising funds from the shareholders, unrecoverable loans to associated parties, overdue taxes and superannuation liabilities, problems in getting finance, expecting that the next big contact would save the company, disputes in board or with suppliers, and overdraft limit being reached (ASIC, 2016).

In case the directors of the company suspect that the company is facing financial difficulties, there is a need to attain legal and accounting advice at the earliest, so that the chances of the company’s survival are increased. Amongst the leading reasons for a company not being saved in time includes the lack of seeking professional advice in timely manner. By appointing an insolvency practitioner, the solvency review of the company can be conducted, who could outline the options which are available for the company. These held in making informed decisions regarding the future of the company. When it is clear that the company is insolvent, it is of utmost importance that no further debts are incurred (ASIC, 2014b).

The directors have a key role to play when the company is about to be insolvent. Section 588G of the Corporations Act, 2001 (Cth) imposes a duty on the directors to prevent insolvent trading by the company. As per this section, the directors have the duty to stop the company from incurring debts at such a time period when the company is insolvent or by incurring such debt, becomes insolvent. As per subsection (2) of this section, the person would breach this section when they were aware of the company’s situation or had grounds for suspecting such, and that a prudent person would have been aware of such situation of the company. Subsection (3) attracts criminal liability and the person would commit an offence, when the requirements set out in subsection (1) are breached, along with the failure of the director in preventing insolvent trading being dishonest. For breaching this section, the ASIC has the power of initiating a case against the directors for filing in fulfilling their duties (Australian Institute of Company Directors, 2014). Section 1317G allows the civil penalty of up to A$200,000 be imposed on the directors. In ASIC v Rich [2003] NSWSC 328; 44 ACSR 682, ASIC initiated proceedings against the former chairman and sought not only pecuniary penalty, but also a disqualification order (Walker, 2012).

What are the potential liabilities of company directors in the event of a company becoming insolvent?

The directors, not only have to comply with the general and specific laws which are applicable on the operations of the company, but also owe a duty towards the shareholders. When the company is facing a risk of insolvency, the duties of the directors expand towards the creditors and also towards the employees who have outstanding entitlements. The duty of not trading while the company is insolvent has already been discussed. The other duty includes the duty of keeping the books and records (ASIC, 2014c). So, the directors need to ensure that the financial records of the company are maintained properly and show the true financial position and performance of the company. When it is presumed that the company is insolvent, the directors have different options available to them, which include restructuring the company, changing the activities of the company, refinancing, or the last one, which is appointment of an external administrator (ASIC, 2014b).

As has been stated earlier also, a company can be voluntary liquidated or can be liquated externally through appointing a receiver or liquidator. The voluntary intervention in case of a possible insolvency of the company is also known as the creditor’s voluntary liquidation. The process under this is started by the members of the company and a resolution is passed by the directors for winding up the company and ultimately appointing a liquidator. In the liquidation initiated by the creditors, the directors and members can choose the liquidator. The creditors also have the option of initiating involuntary company liquidation. When the money of the creditor is unpaid, they can start an involuntary liquidation of the company by making an application to the court for passing a winding up order. The judgment has to be firstly obtained for the particular debt for the district or local court, and depends upon the amount which is owed or the statutory demand raised by the creditors. And upon the application beings successful, a provisional liquidator or an official liquidator is appointed by the court (CRS Insolvency Services, 2014). Apart from the creditors, the employees can also apply for the company to be wound up, under the insolvent liquidation type in form of court liquidation or the voluntary liquidation of the creditors (ASIC, 2017b).

However, a better option in place of a company being wound up by the creditors is to put in place the schemes like changing the activities of the company, refinancing, or restructuring. The company can move its focus from a single core activity to diversified activities, particularly the ones which can be easily switched to. And instead of the company being wound up by creditors, it is better to opt for administrative receivership, company voluntary arrangement, members’ voluntary liquidation and administration. This helps in gaining a control over the liquidation process and the creditors being stopped from acting against the company. When the company is put under administration, the goal is to rescue the company as a going concern and it effectively protects the company from the creditors, whilst the company is in administration (Invest Northern Ireland, 2017).

What are the different avenues available to the company, in particular to the directors, if the company is presumed to be insolvent?

ASIC issues quarterly results whereby the insolvency statistics for each quarter are presented. As per the statistics of June 2017 quarter, there was an increase by 28% in the companies which entered external administration in comparison to the statistics for the last quarter. In comparison to the previous quarter, where the value showed 1,717, for this quarter, the appointments totalled at 2,198. However, the quarterly total in comparison to the 2016 June quarter was lower by 3.6%, as the value for last year stood at 2,283. The court liquidations for the June 2017 quarter stood at 634, the creditors’ voluntary liquidations stood at 1,098, the receiverships showed 156 and the voluntary administrations contributed to 309. The statistics given by the ASIC also have been given state wise where the increase in states has been compared with one another. This figured showed that in most of the states, the court liquidation appointments were raised, and the figure was up by 25.5% nationally, along with the rise in the director initiated winding up, which saw a rise by 35.9%. Similarly, the receiverships were raised by 45.8% and the appointments of the voluntary administrators saw a rise by 4.4% (ASIC, 2017a).

There are a range of topical insolvency issues for the companies in the nation. These include the reporting requirements/ obligation which have been imposed over the auditors of the companies to the ASIC. The one relating to security issues includes the attacks on charges as voidable transactions and the registration of charges (Quinlan, Fleming and Popkin, 2004). The payment by the third party, or the one made pursuant to a letter of credit or bank guarantee, could at times lead to an unfair preference, which is a key topical insolvency issue for the companies, particularly the ones operating in financial sector. The duties and the liabilities for the directors of the company, along with the element of unconscionability are some other topical issues (Allens, 2004).

The topical issues can better be explained with the help of case law. The Federal Court, in the case of Australian Building Systems Pty Ltd v Commissioner of Taxation [2014] FCA 116, stated that the liquidators were not under the obligation of paying the tax of a particular portion of proceeds received from the property sale which the company owned before liquidation, where the tax assessments had not been issued. Though, Logan J stated that a reasonable liquidator would have the right to retain the same till the time the Commissioner issues an assessment or advice. This decision is not consistent with the draft tax determinations given by the Commissioner, particularly the TD 2012/D6 and TD2012/D7, which the ATO released after the private ruling of the Commissioner (Piper Alderman, 2014).

As was aptly highlighted earlier, the ASIC has a key role to play when it comes to the insolvent companies. The key one in this regard relates to the one highlighted earlier, i.e., regarding taking actions against the director for indulging in insolvent trading. ASIC not only acts as a regulator, but also as a guide and in this regard, the Regulatory Guide 217 was issued by the ASIC in July 2010 where the directors have been guided to prevent the insolvent trading. In this regard, the directors are required to keep informed about the financial position and affairs of the company; they have to regularly assess the solvency of the company and also investigate upon the financial difficulties; they are required to take the requisite professional help to deal with the financial difficulties being faced by the company and they have to act in a timely manner on the advice which has been given. Hence, the statutory bodies not only act as the regulator but also as the guide for the companies facing insolvency (ASIC, 2010).

To summarize the discussion carried in the previous parts, the directors have a very important role to play when it comes to the insolvency of the company. The directors not only have to look out for the signs for a possible insolvency condition in the future, but also have to restrict themselves from indulging in such activities, particularly such debts, which can make the company insolvent. There is a need for the directors to adopt a proactive role and follow the guidelines which have been issued by the ASIC. Also, in such cases where the insolvency becomes a threat, the directors should opt for different techniques to take the company out of such situation. And when that is not possible, the company should opt for voluntary liquidation, so that the creditors are stopped from making any action against the company. The statistics clearly reveal that there is a rise in the companies being liquidated on quarterly basis and so, the discussion carried here becomes even more important. The crux of the matter is that the insolvency can still be avoided if the directors properly play their role, and take timely steps to safeguard the company from being placed in an insolvent position.

References

Allens. (2004) Restructuring & Insolvency. [Online] Allens. Available from: https://www.allens.com.au/pubs/insol/pap2dec04.htm [Accessed on: 04/09/17]

ASIC. (2010) Duty to prevent insolvent trading: Guide for directors. [Online] ASIC. Available from: https://download.asic.gov.au/media/1241384/rg217-29july2010.pdf [Accessed on: 04/09/17]

ASIC. (2014a) Insolvency. [Online] ASIC. Available from: https://asic.gov.au/regulatory-resources/insolvency/ [Accessed on: 04/09/17]

ASIC. (2014b) Directors - What to do if company in financial difficulty. [Online] ASIC. Available from: https://asic.gov.au/regulatory-resources/insolvency/insolvency-for-directors/directors-what-to-do-if-company-in-financial-difficulty/ [Accessed on: 04/09/17]

ASIC. (2014c) Directors - What are my duties as a director?. [Online] ASIC. Available from: https://asic.gov.au/regulatory-resources/insolvency/insolvency-for-directors/directors-what-are-my-duties-as-a-director/ [Accessed on: 04/09/17]

ASIC. (2016) Directors - Is my company in financial difficulty?. [Online] ASIC. Available from: https://asic.gov.au/regulatory-resources/insolvency/insolvency-for-directors/directors-is-my-company-in-financial-difficulty/ [Accessed on: 04/09/17]

ASIC. (2017a) Corporate insolvencies: June quarter 2017. [Online] ASIC. Available from: https://download.asic.gov.au/media/4410590/201706-june-qtr-2017-summary-analysis.pdf [Accessed on: 04/09/17]

 ASIC. (2017b) Liquidation: A guide for employees. [Online] ASIC. Available from: https://asic.gov.au/regulatory-resources/insolvency/insolvency-for-employees/liquidation-a-guide-for-employees/ [Accessed on: 04/09/17]

Australian Institute of Company Directors. (2014) Insolvent trading. [Online] Australian Institute of Company Directors. Available from: https://aicd.companydirectors.com.au/~/media/cd2/resources/director-resources/director-tools/pdf/05446-6-3-duties-directors_insolvent-trading_a4-web.ashx [Accessed on: 04/09/17]

CRS Insolvency Services. (2014) Media. [Online] CRS Insolvency Services. Available from: https://crsinsolvencyservices.com.au/voluntary-and-involuntary-company-liquidation/ [Accessed on: 04/09/17]

Invest Northern Ireland. (2017) Company liquidation. [Online] Invest Northern Ireland. Available from: https://www.nibusinessinfo.co.uk/content/alternatives-liquidation [Accessed on: 04/09/17]

Keay, A.R., Murray, M., and Harris, J. (2013) Keay's Insolvency: Personal and Corporate Law and Practice. Sydney, NSW: Thomson Reuters (Professional) Australia.

Omar, P. (2017) International Insolvency Law: Themes and Perspectives. Oxon: Routledge.

Piper Alderman. (2014) Welcome to this edition of Insolvency Update, looking at topical and important issues in relation to insolvency and bankruptcy law. [Online] Piper Alderman. Available from: https://www.piperalderman.com.au/__files/f/6391/Insolvency%200814.pdf [Accessed on: 04/09/17]

Quinlan, M., Fleming, S., and Popkin, M. (2004) You Oughta Know Topical Insolvency Issues of which Bankers Should be Aware. [Online] Allens. Available from: https://www.allens.com.au/pubs/pdf/insol/pap2dec04.pdf [Accessed on: 04/09/17]

Walker, I. (2012) Director's duties in financially distressed companies in Australia. [Online] Thomson Reuters. Available from: https://content.next.westlaw.com/Document/I8417b1a31cb111e38578f7ccc38dcbee/View/FullText.html?contextData=(sc.Default)&transitionType=Default&firstPage=true&bhcp=1 [Accessed on: 04/09/17]