How to not trade whilst insolvent?

A company is a separate legal entity from its directors. It has its own rights, can own its own assets and incur its own debts. However, there are certain situations where company directors are held personally liable for the debts incurred by the company.

One of these situations occurs when a company trades whilst insolvent. If a company is struggling to pay its debts as and when they fell due, the company may be insolvent.

One of a company director’s duties is to adhere to Section 588G of the Corporations Act 2001 (Cth) (the Act), which is to prevent the company from trading whilst insolvent. Directors could face the following if in breach of insolvent trading:

• Civil penalties – up to $200,000.
• Compensation proceedings for amounts lost by creditors.
• Criminal charges; up to $220,000 or imprisonment for up to 5 years, or both.

We have put together some tips on how directors can avoid trading whilst insolvent:

1. Maintain accurate books and records

A good indication of a business’ performance is its ability to maintain accurate records. This can be done by ensuring that your company’s accounting records and required lodgements (BAS, income tax returns, etc.) are always up to date. If you are unsure as to how you can maintain accurate records and your required lodgements, you will need to speak to an accountant.

It is also important to note that Section 588E of the Act provides that a company is presumed to be insolvent where it has failed to keep appropriate financials records.

It is therefore imperative for a company to correctly maintain its books and records.

2. Monitor and improve your short-term cash flow

A business’ cash flow provides indication as to its ability to pay its debts with the cash resources it currently has available. To improve your short-term cash flow, you should closely monitor your debtors, inventory and suppliers.

You can monitor your debtors by regularly following up outstanding payments to ensure that your customers are always paying on time. You can also encourage customers to pay early (or on time) by offering incentives such as discounts for early payment. Having a large amount of uncollectable debtors can have a negative impact on your cash.

Another option to improve your short-term cash flow is to monitor inventory. Take note of goods you buy that are obsolete or are not moving at the same pace as your other products and replace these with stock that has a faster turnover. Slow-moving stock ties up a lot of cash which again, can negatively impact your cash flow.

Another option to improve your short-term cash flow is to monitor inventory. Take note of goods you buy that are obsolete or are not moving at the same pace as your other products and replace these with stock that has a faster turnover. Slow-moving stock ties up a lot of cash which again, can negatively impact your cash flow.

3. Manage expenses

You can closely manage your business expenses by examining your expenses to identify ones that are essential to your business and those that are discretionary. Some essential expenses are not easily reduced, but you can manage them. Start by eliminating unnecessary and discretionary expenses.

4. Negotiate with creditors

Negotiate some breathing space with some creditors. You may be able to negotiate more time to pay your creditors, or they may give you lower interest rates or charge lower penalties.

Negotiate some breathing space with some creditors. You may be able to negotiate more time to pay your creditors, or they may give you lower interest rates or charge lower penalties.

5. Prioritise your debt repayments

Ensure secured debts against income-generating assets such as plant and equipment are prioritised first. A loss of such assets will clearly have a negative impact on the business.

Paying off debts with high interest should also be another critical priority as these debts will accumulate faster if not paid off quickly.

6. Obtain professional advice

Have a discussion with your accountant or advisor regarding your situation. Do not leave it too late in order to avoid possible creditor actions.

Seek advice from a registered Insolvency Practitioner on turnaround or wind-up options. Most registered Insolvency Practitioners will offer some obligation-free consultations at no charge.

If you find your business is struggling, it is strongly recommended you obtain professional advice to avoid potentially trading whilst insolvent, which will make you personally liable for debts incurred by the company.

If you have any questions about how your client can avoid trading whilst insolvent, please feel free to contact our Restructuring and Recovery team today.

Disclaimer: The content of this article is general in nature and is presented for informative purposes. It is not intended to constitute tax or financial advice, whether general or personal nor is it intended to imply any recommendation or opinion about a financial product. It does not take into consideration your personal situation and may not be relevant to circumstances. Before taking any action, consider your own particular circumstances and seek professional advice. This content is protected by copyright laws and various other intellectual property laws. It is not to be modified, reproduced or republished without prior written consent.