As well as the general duties of a company director, a director also has a responsibility to ensure that the company does not trade while it is insolvent.
Insolvent means unable to pay all of its debts and bills as they fall due.
The penalties for trading while insolvent include:
- civil penalties of up to $200,000; and/or
- compensation proceedings that could lead to bankruptcy; and/or
- criminal charges leading to fines of up to $200,000 and/or imprisonment of up to 5 years.
It’s worth noting that a director does not need to have been formally appointed to be exposed for insolvent trading and other breeches of directors’ duties: it may be someone who acts as a director, or who other directors of the company follow.
As a director you should understand the financial position of the company at all times. In particular, you should know about the cash flow position - can you project the cash needs 30, 60, 90 or 120 days into the future? What are the outstanding invoices? What are the recurring costs for the business? What is the profit and loss situation?
Some of the warning signs that you may be trading while insolvent include:
- poor cash flow
- increasing debt
- letters of payment demands, summonses, judgements or warrants
- problems selling stock or collecting debts
- overdue taxes or superannuation liabilities
If you do not have a current business plan, or have incomplete or disorganised financial records, the risk that you may be trading while insolvent is significantly increased.
If, as a director, you believe your company is in financial trouble, seek professional accounting and legal advice as soon as you can. Do not wait until it is too late: an insolvency professional, such as those who are members of ARITA , may be able to outline alternate solutions to liquidation or bankruptcy. Many ARITA members will offer an initial consultation at no cost.
In some cases, it may be possible for the company to ‘trade out’ of the situation and return to being a viable business without the need for a formal administration. This is also known as ‘turnaround’ or ‘reconstruction’.
If the company’s financial situation is dire and a formal administration is required, company directors can initiate a creditors’ voluntary liquidation or voluntary administration. A table summarising the key features of the different types of formal administrations is available here.
No matter what the type of appointment, directors have a duty to:
- advise the administrator of the location of any company property
- deliver any such property in their possession to the administrator
- provide the company’s books and records to the administrator
- advise the whereabouts of other company records
- provide a written report about the company’s business, property and financial circumstances within either 5 business days (voluntary administration), 7 days (creditors’ voluntary liquidation) or 14 days (receivership and court liquidation) of the appointment of the external administrator; and
- meet with or report to the administrator to help them with their enquiries.
The powers of directors and other officers of the company cease on the appointment of the external administrator, however they retain their office and their statutory responsibilities continue. This means that they no longer have the ability to take part in the day to day operations of the company, unless the external administrator gives them authority to do so.
ARITA and ASIC provide a range of information sheets for further information.