What is insolvency?

18 December 2020

Broadly, insolvency is when a company is not able to pay its debts when they become due and payable.

The Victorian Supreme Court case of ASIC v Plymin, Elliott & Harrison [2003] VSC 123 is widely acknowledged by those in the insolvency space (including the Courts) as providing an agreed list of indicators of insolvency. This list of indicators, along with our brief comments on each (where necessary) is as follows:

  1. Continuing trading losses;
  2. Liquidity ratios below 1 – A liquidity ratio involves a comparison between a company’s current relatively liquid assets and its current liabilities. The purpose of which is to determine whether a company can pay off its debts with its realisable assets – a liquidity ratio below 1 means that it can not.
  3. Overdue Commonwealth and State taxes – typically includes Company (income) tax, capital gains tax, goods and services tax, payroll and land tax;
  4. Poor relationship with present bank or lenders, including inability to borrow further funds – usually as a result of defaults, overdrawing and, or credit extensions;
  5. No access to alternative finance – where a company is unable to obtain a loan from a financial institution other sources of finance may include, cash injections from the director or securing third party investors such as through debt capital;
  6. Inability to raise further equity capital – the Company may not be able to dilute its issued shares any further or alternatively, there may be no prospective investors / buyers willing to buy the Company’s shares;
  7. Suppliers placing company on cash on demand terms, or otherwise demanding special payments before resuming supply;
  8. Creditors unpaid outside trading terms;
  9. Issuing of post-dated cheques;
  10. Dishonoured cheques;
  11. Special arrangements with selected creditors;
  12. Solicitors’ letters, summonses, judgments or warrants issued against the Company – this may include letters of demand issued to the Company and debt recovery proceedings commenced against the Company;
  13. Payments to creditors of rounded sums which are not referrable to specific invoices;
  14. Inability to produce timely and accurate financial information to display the company’s trading performance and financial position, and make reliable forecasts – for example failing to maintain satisfactory financial statements for the Company.

All of the above are relevant for directors in the context of the following:

  1. directors must not trade a company whilst insolvent (s 588G, Corporations Act 2001 (Cth); and
  2. the powers of a liquidator to pursue a director personally for any transactions made whilst the company was insolvent (s 588FC, Corporations Act 2001 (Cth)).

Relevantly, section 588GA of the Corporations Act 2001 (Cth) provides for safe-harbour provisions to protect directors if the company is, or should reasonably be suspected to be, insolvent. These safe-harbour provisions will be the subject of a subsequent post.

Please contact Walker & George to discuss how we may assist if you suspect your Company is insolvent.