Directors of companies facing cashflow problems should get early advice
Corporate insolvency occurs when a company cannot pay its debts when they are due. It is an offence for company directors to allow a company to continue to incur debts when it is insolvent or likely to become insolvent.
Certain defences may be available to directors who breach their duty to avoid insolvent trading. Safe harbour provisions may protect directors from personal liability if they take certain prescribed action that will likely lead to a better outcome for a struggling company, than administration or liquidation, however a range of factors must be considered if relying on these provisions.
Directors of companies facing cashflow problems should obtain immediate professional advice to mitigate the potential risk of personal liability and to work towards the most viable financial outcome in the circumstances.
What happens when a company is insolvent?
A company facing insolvency may be liquidated either voluntarily or involuntarily. A liquidator is appointed for the sole purpose of identifying and liquidating any available assets to pay creditors and winding up the company. The company ceases to operate, and the directors no longer have control or authority over its affairs.
Depending on the circumstances, as an alternative to liquidation, an administrator may be appointed to a struggling company 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 with the objective of minimising loss and generally trading out of the company’s 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
Generally, 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. 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 generally retains control of the company until the obligations under the deed are finalised. The directors may subsequently be reappointed.
While a company is in liquidation, a person cannot without leave of the court, commence or continue legal proceedings against the company.
A person is considered bankrupt when he or she is unable to pay his or her debts. Bankruptcy laws aim to provide a fair approach for the insolvent individual to repay creditors and explore options that deliver the most effective outcome in the circumstances.
A trustee is appointed to manage the bankrupt’s financial resources and assets. The bankrupt is protected from being sued by creditors however faces the adverse consequences of poor credit ratings, potential restrictions on future borrowings and is obliged to disclose the bankruptcy in various dealings. He or she may also be disqualified from holding certain positions.
There are significant consequences of being declared bankrupt and it is important to identify possible alternative options before taking this step. A lawyer will help explore such options and assist in negotiating and preparing a debt agreement which may provide a better outcome and avoid the pitfalls of bankruptcy.
If you are experiencing financial difficulties, whether as an individual or as a director of a company facing cashflow problems, it is important to obtain urgent professional advice.