Under Section 588G of the Corporations Act 2001, a director can be held personally liable by a liquidator (and sometimes by the Australian Securities and Investments Commission) for debts incurred whilst the company was deemed ‘insolvent’ (see Avoiding Insolvency – 10 Warning Signs to Heed ). This is because directors have a duty to prevent the company from continuing to trade past the point it is reasonably considered insolvent.
However, if there are reasonable grounds for suspecting their company is insolvent and the director genuinely takes steps to improve the position of the company, the director may be able to rely on ‘Safe Harbour’ legislation to limit their personal exposure.
Safe Harbour legislation came into effect in September 2017. Directors seeking to access the safe harbour provisions must meet certain eligibility criteria, including taking action to better the position of the company by seeking advice from a qualified advisor (i.e. an insolvency expert) and following an action plan (Section 588GA, Corporations Act 2001), to effectively reduce personal liability.
It can often be difficult for directors to know when the company might be heading towards challenging times and when external assistance should be sought. Being a director of a company can be a rewarding experience, however the role involves a large amount of responsibility. To help directors turn their mind towards issues contributing to those challenges, the following eight signs should be considered as signs their company may be heading towards insolvency:
1. Ageing Debts
Are a significant portion of your company’s debts well past their due date? In a marketplace where suppliers offer credit terms, it can be easy to put debts aside for a later date. There can be a lot gained in terms of cashflow management by paying creditors at the expiry of their credit terms. It’s when this gets taken too far that the debt can spiral into something more sinister. Assuming data entered into your internal accounting software is up-to-date and accurate, you should be able to generate an aged payables report which shows how many days outstanding the company’s debts are. It is also a good idea to consider the benchmark for your industry in terms of average trade creditors days.
2. Swapping Debt for Debt
We have all heard the expression ‘robbing Peter to pay Paul’. This describes the act of discharging one debt by incurring another. Whilst this could work as a short-term solution (i.e. in the anticipation of receiving income in order to payout the newly incurred debt), this strategy also has the potential to cause the company more harm in the long-term and can be considered an indicator of insolvency.
3. Poor Record Keeping
Far too often, a lack of reliable records can bring a company undone. Directors should ensure that there are strict controls in place to maintain the company’s financial records. The Corporations Act 2001 requires directors to keep the company’s financial records for at least seven years. Not only does this ensure directors meet their statutory duties but without reliable data, how can a director know the true financial position of the company? A lack of sufficient financial records is a potential indicator of insolvency and allows liquidators to rely on the presumption of the company’s insolvency (as there is nothing to indicate otherwise).
4. Relying on ‘The Next Big Job’
Occasionally, directors can get caught up in winning new work for the business to the point it becomes all-consuming and they lose focus on the financial performance of the business (i.e. what can be described as tunnel vision). Instead of profits generated from the business being reinvested into the company, it is used to keep creditors at bay. Directors face the added pressure of securing work in order to keep the business afloat and sometimes the stress can lead to poor work-life balance.
5. Increasing Receivables
There are a number of businesses who struggle to stay on top of their receivables. This could be a result of various factors such as a poor internal system in place to follow up outstanding receivables or perhaps there is a client who continues to delay payment. This could be costing the business its vital cashflow and impacting not only its solvency but its ability to grow and stay competitive in its market. There are many strategies which can be adopted to alleviate this problem.
6. Inactive Assets
At first glance, this may not appear to be much of an issue in terms of the company’s solvency. However, it’s something that time and time again has been a contributing factor to the failure of a company by unnecessarily draining its funds. For instance, transport companies with dormant vehicles which are under lease or retail businesses storing excess or obsolete stock. This all comes at a cost to the company. Inactive assets can be a hidden threat, causing serious financial drain in the long-term.
7.Outstanding Tax Lodgements
Often directors only have contact with their external accountant once a year to lodge their income tax returns. Whilst this might work for some companies, too often we see interim tax lodgements (such as GST and PAYG) fall by the wayside with hefty debts accruing in the process. To rely on safe harbour, directors must ensure all taxation returns are lodged when due under tax laws. It is important to note that outstanding tax liabilities do not necessarily need to be paid to access safe harbour, but the company must have reported those liabilities to the Australian Taxation Office (ATO) on time. Notwithstanding this being essential to access safe harbour, the lodgement of tax returns within their statutory due dates will help prevent personal penalties being levied on directors by the ATO.
8.Outstanding Employee Entitlements
Another key requirement for directors to meet if they are considering relying on safe harbour provisions is ensuring that all employee entitlements are paid to date. Generally, this relates to wages and superannuation as accrued entitlements, such as, leave is payable at a future point in time. As superannuation is often paid quarterly, companies may delay such payments to improve short-term cashflow, or fail to adequately provision for this expense. Also, the ATO can hold directors personally liable for any unpaid superannuation.
This is by no means an exhaustive list of pre-insolvency concerns for directors however, it is more of a guide to prompt directors to consider the current performance of their company and what they and the company might gain from speaking to an advisor. Safe harbour is available for those directors who genuinely want to see their business thrive.
This article covers legal and technical issues relating to safe harbour legislation in a general manner and is intended for information purposes only. This information should not be taken as constituting professional advice and William Buck is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly in this article. It is recommended that further advice be sought prior to taking action on any specific issues dealt with in this article.