Unfortunately in the current times, insolvency (the term as applicable to companies as opposed to bankruptcy being the applicable term for individuals) is an option being considered for many business as a result of the downturn and crisis environment being experienced.
But may ask, well how do I know if our business is in fact insolvent? Rather unhelpfully, the legislation provides a somewhat circular definition in saying that a company is solvent if and when it is able to pay its debts as and when they fall due. This begs the question but it is the law that a business is able to utilise the sale in some circumstances of business assets. But it is primarily a cash flow test (as opposed to the balance sheet test that the law looks to in determining the question of solvency or insolvency and not profits per se.
As a result of being insolvent, a company could end up being wound up either voluntarily by putting up its own ‘hand’ and saying we are insolvent, or through a creditor applying for a wind up.
There are related insolvency processes such as receivership, voluntary administration and liquidation. Not all processes necessarily lead to the ‘death; of a company however and a current illustration of that is the Virgin Airlines situation, It is a common misconception that once a company goes into any form of external administration process that the company is doomed but with voluntary administration, one of the stated aims of the process in the legislation is to work out a way to save the company or its business. If this cannot be achieved then the aim to administer the company’s affairs in a way that maximises as far as possible, the return to creditors.
So what sorts of things get looked at by an appropriately qualified person to assess if a company is insolvent. It must be remembered at this juncture that insolvency must always be contrasted with temporary drops in liquidity that result even in extreme situations where on a given day none of the debts can be paid! The things that may indicate solvency or a lack thereof are where the business is taking longer and longer to pay creditors, multiple and ongoing losses as reflected in the profit and loss statements, unpaid or multiple payment arrangements with the Australian Taxation Office (many wind ups occur as a result of the ATO initiating a wind up on the basis of large amounts of taxation) and where there are no borrowings or no further borrowings available to the business for various reasons such as poor financials and or defaults on previous borrowings.
If you are a director of a company that is business still continuing to trade while insolvent (and thereby presumably incurring debts) there is a lot of legal and financial risk involved. Despite the fact that a company and its directors are separate legal entities, there is a possibility that if a director suspected the company was trading whilst insolvent, and allowed this to continue and it incurred further debts, that the director may be held personally liable themselves to pay the debt. In addition a director penalty notice could be issued by the ATO and they place significant pressure on a company director in relation to unpaid debts such as PAYG withholding payments or superannuation to either pay the debt forthwith or place the company in liquidation. Urgent professional advice should be sought in such a situation.
A further process or option that a company has in times of financial difficulty is to enter what is called a Deed of Company Arrangement (“DOCA” for short). What they are is an arrangement which is binding, between the company and its creditors which provides for example with how the debts are to be paid and as to how the company’s affairs are to occur, and are entered into following a meeting of creditors where a vote is passed as to the proposed DOCA but if the proposal it passed it is important to realise that the Deed once voted on and signed binds all of the unsecured creditors, even those who voted against the proposal. Director personal guarantees given can still be enforced whilst a DOCA is in force. Often what results out of the DOCS being adhered to and its coming to an end is that the company resumes normal operation thereafter.
Now to the recent changes to the law passed by the Commonwealth as responses to the coronavirus situation. It must firstly be remembered that the measures are temporary and so when one looks at their prime facie dramatic effect, their temporary nature needs to be borne in mind. Firstly, directors are temporarily relieved from the risk of personal exposure to company debts as mentioned above as long as the debt is incurred within the standard range of its normal business. The measure is in place for six months.
The second measure is in relation to creditors statutory demands (a notice a person or entity dealing with a company sends to the company and which demands payment of a debt within 21 days or risk company winding up) and the minimum amount such a notice can be issued for has increased from $2,000 up to the much higher amount of $20,000. Note that personal bankruptcy has been effected too on that now for six months, the minimum amount a bankruptcy notice can be issued for is now $20,000, up from $5,000. Finally, the creditors statutory demand period for compliance is now increased to six months, a significant increase from just 21 days. Again there has been a corresponding increase for personal bankruptcies so it is now six months within which an individual must respond accordingly to a bankruptcy notice.
It will be interesting to see how these changes play out in practice, albeit they are a small sample size in being six months and it will also be interesting to see if by late September, any of or all or some of the changes are extended further in time.