Company directors facing cashflow issues
Company directors must be mindful of potentially breaching their duty to prevent insolvent trading during difficult financial periods. Directors may be personally liable for continuing to incur debt when it is reasonably foreseeable that the company is, or likely to become, insolvent. Directors of companies facing financial difficulties should obtain immediate professional advice.
Certain defences may be available to directors who breach their duty to avoid insolvent trading. In addition, safe harbour provisions may help directors avoid personal liability if they take certain action that will likely lead to a better outcome for a struggling company, than administration or liquidation. Reliance on these provisions depends on a range of factors and directors are urged to consult their lawyer as soon as financial issues become apparent.
What happens when a company is insolvent?
A company facing insolvency may be liquidated either voluntarily or involuntarily. A liquidator is appointed to identify, salvage and liquidate any available assets to pay creditors and wind up the company. The company ceases to operate, and the directors no longer have control or authority over its affairs.
As an alternative to liquidation, a company in financial difficulty may resolve to appoint an administrator which may result in better outcomes for the company, its members and creditors.
The administrator investigates the company’s affairs and may allow it to continue trading in an effort to sustain it, or at least maximise the return to creditors. The administrator may negotiate a Deed of Company Arrangement with creditors setting out a proposal for reconstruction or amalgamation with the objective of minimising loss and generally trading out of the company’s financial difficulties.
Receivership occurs when a secured creditor appoints an external person to collect and sell the company’s assets after the company has defaulted on its contract either through non-payment or breach of other terms. The receiver acts in the interests of the secured creditor to ensure the debt is repaid.
The effect of administration and liquidation
The appointment of an administrator will adjourn any court proceedings to wind up the company unless the court considers liquidation to be in the best interests of the creditors. The administrator takes control of the company and stands in the shoes of its directors.
All claims against the company are suspended and creditors may not enforce their rights against the company. This ‘moratorium’ is designed to buy time while the administrator assesses the company’s position and determines the most appropriate action to ensure the best outcome for the creditors.
If a Deed of Company Arrangement is negotiated, the administrator retains control of the company until the obligations under the deed are finalised. The directors may subsequently be reappointed.
In the case of liquidation, the appointment and authority of the company directors cease, and the liquidator takes over the company’s affairs for the sole purpose of winding it up.
How does a person become bankrupt?
Individuals may choose to be declared bankrupt if they have a debt that they are unable to pay. This is known as voluntary bankruptcy and requires the filing of a debtor’s petition and statement of affairs with the Official Receiver.
Alternatively, a person may be ordered bankrupt by court upon the lodgement of a creditor’s petition in circumstances where the creditor is owed more than $5,000. The grant of a sequestration order by the court declares the individual bankrupt.
In either case a trustee in bankruptcy is appointed to administer the financial affairs and deal with the assets of the bankrupt person.
Implications of bankruptcy
Bankruptcy is a legal process that protects an insolvent individual from being further pursued by creditors. The creditors must instead deal with an appointed trustee who manages the financial affairs and property of the bankrupt.
Apart from certain personal assets, all property vests in the trustee who may sell those assets to pay debts. The following is excluded:
- clothing, personal and household items;
- a motor vehicle and tools of trade or property used to earn a living (to a prescribed value);
- awards of damages for personal injury and compensation payments;
- superannuation and life policies.
The bankrupt may continue to earn an income however earnings over a prescribed amount may need to be surrendered to repay debts.
The bankrupt may be prevented from acting as a company director or managing a company and / or restricted from continuing in certain professions that are governed by specific codes of conduct.
After three years, the bankrupt is automatically discharged unless the trustee objects based on the bankrupt’s conduct.
Alternatives to bankruptcy
If possible, it may be advisable for an insolvent person to avoid bankruptcy by entering into an alternative arrangement. Talking to an insolvency expert can assist to explore these options and make a decision that will provide the best possible outcome.
An informal agreement is usually the first option explored and involves negotiating a repayment plan with one or more creditors. This is most effective if negotiated sooner rather than later and where there are only one or a few creditors.
We advise individuals and companies on the most appropriate outcomes when facing financial uncertainty and will guide you through the many pitfalls and traps along the way to foster a best-case scenario in your circumstances. Obtaining specialist advice early about your legal rights and options may help mitigate loss and increase the chances of financial recovery.