Indicators of Insolvency

Overview

As a director of a company, it is essential that you are aware of the key indicators that your company may be insolvent or heading down the path to insolvency and the consequences that may arise from insolvent trading.

Director’s Duty

Pursuant to section 588G of the Corporations Act[1] a director has a duty to prevent the company from insolvent trading. Failing to do so can lead to criminal prosecution, fines, disqualification from managing a company, civil penalties, and compensation proceedings.

Indicators of Insolvency

Insolvency is defined under section 95A of the Corporations Act[2]:

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.
2. A person who is not solvent is insolvent.

It is often difficult to determine whether a company is able to pay all it’s debts, as and when they become due and payable. To assist in determining whether a company is insolvent or on the path to becoming insolvent, the Court in ASIC v Plymin[3], established the “indicators of insolvency”, which include:

1. Continuing losses;
2. Liquidity ratios below one;
3. Overdue Commonwealth and State taxes;
4. Poor relationship with present bank including inability to borrow further funds;
5. No access to alternative finance;
6. Inability to raise further equity capital;
7. Suppliers placing the company on COD (Cash on Demand payments) or otherwise demanding special payments before resuming supply;
8. Creditors unpaid outside trading terms;
9. Issuing of post-dated cheques;
10. Dishonoured cheques;
11. Special arrangements with selected creditors;
12. Solicitors’ letters, summonses, judgements or warrants issued against the company;
13. Payments to creditors of rounded sums which are not reconcilable to specific invoices; and
14. Inability to produce timely and accurate financial information to display the company’s trading performance and financial position and make relevant forecasts.

Using these indicators to monitor the company’s performance, will assist in determining whether or not urgent action should be taken to avoid insolvency. If you suspect insolvency, advice should be urgently sought on the options available moving forward.

If you or someone you know wishes to speak to one of our experts regarding insolvency, please phone on 07 5444 4750 or email [email protected].

[1] Corporations Act 2001 (Cth), s588G.

[2] Corporations Act 2001 (Cth), s95A.

[3] ASIC v Plymin (No 1) (2003) 46 ACSR 126 at 214; [2003] VSC 123.