Insolvent Trading – What Is It?

Insolvent Trading – What Is It?

Insolvency is defined under the Corporations Act as being a person (a natural person or a company) who is unable to pay their debts when they become due and payable. Insolvent trading occurs when a company is insolvent but the director(s) of the company allow the company to incur new debts.

The Corporations Act sets out that a directors of a company are responsible for ensuring that the company does not trade while insolvent, and any further debts incurred while insolvent is the director’s personal responsibility.

Is my company insolvent?

It is important to tread carefully when you realise that your company may be in financial difficulty and to seek legal advice and advice from your accountant as soon as possible to discuss your choices in how to go forward as the date that is used if legal action comes about is from the date that you were aware or should have known that you would be unable to pay the debts payable.

The legal tests to determine if your company is insolvent are:
1. The company has insufficient cash to make payments on debts when they become payable;
2. When the company’s current liabilities exceeds its current assets; and/or
3. When the company’s net assets are negative.

What are my options if my company becomes insolvent?

The most important thing to remember is not to incur any further debt or you, as director, would be made personally responsible.

First, obtain independent financial and legal advice regarding your options and see if you would be able to restructure or refinance in order to allow your company to continue trading.

If that is not possible, there are three main options in which the company and you as director should consider:

  1. Voluntary Administration – this is designed to resolve the company’s future direction quickly. A voluntary administrator takes full control of the company to try and save it.
  2. Liquidation – This is where the liquidator takes full control of the company and winds up the company’s affairs in an orderly and fair manner to make sure it benefits the creditors.
  3. Receivership – A receiver is appointed by a secured creditor who holds some security over some or even all of the company’s assets. They then sell the assets to repay the debt to the company’s creditors.

Penalties for insolvent trading

If a director is found to be insolvent trading, not only are they personally liable for the debt incurred but there would be further penalties that may be applied depending on the circumstances, such as:

  1. Civil Penalties – for contravening the Corporations Act, a penalty of up to $200,000.
  2. Compensation Proceedings – Can be commenced by ASIC. A compensation order but may be given along with a civil penalty. As they are potentially unlimited, it may be enough to make the director bankrupt, which means they are not able to direct or manage a company.
  3. Criminal Charges –
    a. If dishonesty is a factor, a penalty of up to $220,000 and/or 5 years imprisonment can be ordered by the court;
    b. Being found guilty of an offence – would receive a director’s disqualification.

If you are in need of legal advice regarding insolvency of a company, please contact a corporate lawyer as soon as possible to discuss your situation.

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