What is insolvency?
Section 95A of the Corporations Act 2001 (Cth) provides that a company is ‘solvent’ if it can pay its debts once they become due and payable. If a company cannot satisfy its debt obligations in this manner, it is ‘insolvent.’
Courts have been clear that the ability to pay debts will not be assessed solely by reference to the company’s accessible cash. That assessment considers funds that could be made available within a relatively short timeframe, whether by the sale or mortgaging of assets or by other means.[1]
Although there is a commonly accepted commercial reality that creditors may afford debtors some leniency in respect to payment due dates, the Courts have held that this does not detract from the fact that a debt is contractually due and payable.[2]
It is inevitable that some companies will fail before repaying their debts. Hence, insolvency law plays an important role in structuring the impacts of insolvency on creditors, directors, employees, and the wider community by providing:
- A fair and orderly process for dealing with an insolvent company’s financial affairs; and
- A convenient means of collecting or recovering company property to be applied towards debts and liabilities.
Factors in ASIC v Plymin & Ors (2003)
When it comes to assessing insolvency, the case of ASIC v Plymin & Ors (2003) is commonly cited for its concise (non-exhaustive) summary of factors which, when considered in their totality, serve as indicators of corporate insolvency:
- Persistent financial losses.
- A liquidity ratio <1.
- Outstanding tax liabilities.
- Strained relationship with financiers.
- An inability to procure further financing with no access to alternative lenders.
- An inability to raise further capital by equity.
- Strained relationship with suppliers, often indicated by resumed supply being made contingent on repayments.
- Monies owed to creditors outside agreed-upon trading terms.
- The issuance of post-dated cheques.
- Frequent dishonoured cheques.
- Necessitation of special payment arrangements with creditors.
- Accrual of solicitor’s letters, summonses, judgments, warrants, etc, against the Company.
- Payments are being made to creditors in irregular sums that are not reflective of the relevant outstanding invoices.
- An inability or difficulty in producing accurate financial reports or information in a timely manner.
Potential Consequences of Insolvency
Insolvency rarely arrives in a single catastrophic moment. Rather, it can develop gradually and is elucidated by established patterns of financial stress.
It is important for directors to be aware of the early signs of insolvency, and to monitor the financial status of a company to ensure its ability to pay debts as and when they fall due. Waiting too long to invoke the mechanisms of insolvency law can expose directors to significant liability under section 588G of the Corporations Act 2001 (Cth), for failing to prevent the company from trading while insolvent.
Invoking insolvency processes at the right time can protect a company’s assets and provide creditors with a better chance of recovering debts owed to them. Please get in touch with the team at EMS Legal if you have any questions or concerns regarding a company’s solvency.
[1] ASIC v Plymin [2003] VSC 123, 374.
[2] Southern Cross Interiors Pty Ltd (in liq) v DCT (2001) 53 NSWLR 213 [54].