Directors beware: Don’t be an ostrich

One of the unpalatable consequences of operating in a competitive, free market economy is insolvency. In a strong economy, insolvency is generally the result of controllable factors such as insufficient working capital, poor management or bad decision-making. However, in a weaker economic environment, such as that which we are currently experiencing, insolvency might be the result of factors that cannot be controlled by a company, such as the economy itself or a large bad debt. 


Insolvency can therefore be an unintended consequence of doing business and might occur regardless of a director’s financial skill or ability to manage his or her company. Sometimes, insolvency is the result of just plain bad luck. However, there are steps that can be taken by directors concerned about the solvency of their company that will have a positive effect on the eventual outcome.


The key to addressing insolvency is to recognise the signs early and act promptly. At a minimum, early intervention will improve the outcome for stakeholders. Perhaps more importantly, the exposure of directors to personal liability for the debts of the company can also be reduced as trading as an incorporated company does not automatically protect directors from actions by creditors.


What is insolvency?
Printing businesses are particularly vulnerable to insolvency during the current recessionary economic environment, coming as it does after an extended period of sustained downward pressure on selling prices, combined with upward pressure on input costs such as paper, chemistry and labour. Times were tough enough in the printing industry before the so-called global economic crisis, let alone after.


For many printers, sales have sunk like a stone since October last year, and it remains unclear when in fact the bottom of the market will occur. As horrifying as the thought is, things might get worse before they get better.


The definition of an insolvent company is one that is unable to pay its debts as and when they fall due. However, there are various indicators that point to insolvency which can be monitored by directors to assist in identifying issues early. These indicators include:

  • Poor cash flow;
  • Creditors constantly pressing for payment and remaining unpaid outside their usual trading terms (for example, stretching payment from 60 to 90+ days);
  • Paper suppliers demanding cash-on-delivery (COD) payment terms (a requirement of the debtor insurance policies held by many merchants when balances reach 80+ days);
  • Special arrangements with selected creditors (for example, paying round amounts off a large outstanding debt in weekly or monthly instalments);
  • Overdraft constantly at its limit and/or the need to open a second cheque account with another bank;
  • Pressure from financiers (that is, banks and finance companies) to maintain interest and/or equipment payments;
  • Overdue taxes (PAYG deductions from employees and company PAYG instalments) and superannuation liabilities; or
  • An unreasonable expectation that the next big job will save the company.


The above list is not an exhaustive. However, it does illustrate that directors need to be constantly aware of their company’s relationship with its creditors and its financial position. It is probably too late if there is not enough cash in the bank to pay this week’s wages. 


Insolvency and directors’ personal liability
In addition to the numerous general duties imposed on directors of companies by the Corporations Act, there is a positive duty to prevent your company trading while it is insolvent. The consequences of breaching this obligation can include civil penalties, compensation proceedings to recover amounts lost by creditors, and even criminal charges. Compensation proceedings can be initiated by ASIC, a liquidator or a creditor, and are against a director personally for debts incurred whilst the company was insolvent.


Companies experiencing cash flow difficulties sometimes enter into arrangements with the Australian Taxation Office to defer the payment of amounts due. Ordinarily, directors are not personally liable for the tax debts of a company. However, directors should be aware that a personal liability to the ATO does arise if a company enters into a payment arrangement which it then fails to complete.

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