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Insolvency News March 2009
Solvency and the Responsibilities of Company Directors
Section 588G of the Corporations Act provides that company directors may be personally subject to both civil and criminal penalties where they have continued to trade a company which is insolvent. Solvency is defined for the purposes of the Corporations Act as ‘the ability to pay debts as and when they fall due and payable'. This means that the company cannot obtain access to funding from its own resources or from third parties to pay its debts as they fall due.
S.588G aims to protect the interests of unsecured creditors, as well as ensuring accountability of the company and its directors. The duty placed on directors here is strict. De facto and passive directors may also be held to be personally liable
Directors must cease trading if they reasonably believe the company to be insolvent, or when they believe that it is likely to become insolvent from continuing to trade. In determining the appropriateness of a director's actions in such a situation, it must be asked: what would a director of reasonable competency have done in the same circumstances?
Directors must be able to show a readiness to appoint external administrators in the face of liquidity difficulties, even where this approach does not best serve the interests of shareholders in the circumstances.
However, a director will not be held liable where he or she is fully informed of the company's position, has acted in good faith and in a way that they reasonably believed was in the best interests of corporation in selecting a course of action. The following factors are critical:
- Seeking independent advice. Such a step may arm a director with information that is crucial to determining the solvency of a company, including the funds and assets that are available for any necessary restructuring.
- Ensuring that a business plan is in place;
- Maintaining complete and well-organised company records;
- Effective forecasting and budgeting;
- Effective monitoring of cash flow, debts, losses and unrecoverable loans;
- Monitoring of legal proceedings brought, and judgements entered, against the company; and
- Watching for deteriorating relationships with suppliers: an indicator of a deteriorating financial position.
If a director reasonably believes that the business cannot trade out of its difficulties and insolvency is probable, voluntary administration or the appointment of a liquidator must occur. This provides short-term protection from the claims of creditors, and prevents the erosion of company assets which will ensure better returns for creditors in the long run.
Please do not hesitate to contact Annette Fontana if you have any concerns about the solvency of your company and your duties as a director. We can advise and assist you with the options available to you