Dealing with insolvency

What is insolvency?

A corporation is insolvent if it cannot pay its debts when they are due.

Being insolvent does not necessarily mean the corporation has run out of money completely. A corporation may own valuable assets but still be insolvent if it cannot pay its bills on time.

Example

A corporation may own:

  • buildings
  • vehicles
  • equipment

but if it does not have enough cash to pay wages, suppliers, loan repayments or tax obligations when they are due, it may be insolvent.

Why should directors understand insolvency?

Directors are responsible for overseeing the corporation's financial position and ensuring the corporation can meet its financial obligations.

If a corporation is experiencing financial difficulties, directors should:

  • understand the corporation's financial position
  • monitor cash flow closely
  • review financial reports and ask questions if they have concerns
  • take action as soon as possible.

The earlier directors identify financial problems, the more options may be available to address them and avoid insolvency.

Directors' legal responsibilities

Under the CATSI Act, every individual director has a number of legal duties, including duties to act with care and diligence, act in good faith in the best interests of the corporation, and not improperly use their position or information. Directors also have a specific duty not to allow the corporation to trade while insolvent.

Failing to meet the duty to not allow the corporation to keep trading while insolvent can have serious consequences. Individual directors can be fined or go to prison for allowing a corporation to trade while insolvent. 

Read more on legal duties of directors under the CATSI Act.

Tax and superannuation obligations

Directors should also ensure the corporation meets its tax and superannuation obligations on time. If the corporation doesn’t pay them by the due date, current and former directors may be personally liable in some circumstances. 

Check the ATO website for more information on the director penalty notice regime. 

Warning signs of insolvency

Your corporation may be insolvent if:

  • bills are regularly paid late
  • loan repayments are overdue
  • creditors are demanding payment
  • suppliers will only provide goods or services after receiving payment
  • the corporation is running short of cash
  • income has decreased significantly
  • expenses have increased significantly
  • the corporation is relying on loans to pay day-to-day expenses
  • financial reports are inaccurate, missing or out of date
  • the corporation is selling important assets to pay debts
  • funding has stopped or may stop

One warning sign does not necessarily mean the corporation is insolvent. However, several warning signs together may indicate serious financial difficulties.

What directors should do?

If you have concerns that your corporation may be insolvent, nearing insolvency, or a creditor is chasing payment from your corporation you must act early, get good financial information, seek advice and take steps to improve the corporation's financial position.

There are serious consequences if you do not do these things. 

  1. Act quickly
    • Discuss the situation at a board meeting.
    • Make insolvency a priority.
  2. Do not take on new debts
    • Be very careful about ordering goods, signing contracts or borrowing money unless the corporation can pay for them.
    • Making commitments that the corporation may not be able to meet may make the situation worse.
  3. Get up-to-date financial information
    • Review available cash, bank balances, debts and unpaid bills, expected income, cash flow forecasts.
    • Find out exactly how much money is owed and when payments are due.
  4. Seek professional advice
    • Talk to the corporation's accountant, auditor, bookkeeper or a qualified insolvency adviser about whether the corporation is insolvent, available recovery options, and legal obligations and risks.
  5. Continue monitoring finances closely
    • Review financial reports more frequently.
    • Keep track of whether the corporation can pay its debts when they fall due.
    • Reduce spending
      • Delay non-essential spending.
      • Look for ways to reduce costs.
    • Improve cash flow
      • Collect money owed to the corporation.
      • Review funding opportunities and other sources of income.
    • Talk to creditors
      • Contact suppliers, lenders and other creditors early.
      • Discuss payment arrangements if necessary.
  6. Consider all options
    • Depending on the circumstances, options could include restructuring operations, seeking additional funding, selling assets, or obtaining specialist insolvency advice.

Who to ask for help

Insolvency advice is best sought through a licensed professional who can provide advice specific to the circumstances of your corporation’s situation. You can try:

ORIC cannot provide legal or financial advice as to whether or not a corporation is insolvent, or your duties as a director in situations of insolvency. 

Can insolvency be addressed?

There is no single solution to insolvency. Depending on the circumstances, a corporation may be able to improve its financial position by:

  • reducing costs
  • increasing income
  • collecting overdue debts
  • negotiating payment arrangements with creditors
  • restructuring its operations
  • selling assets that are no longer needed

Professional advice can help directors determine which options may be appropriate.

Formal insolvency options

If a corporation cannot recover financially, professional advice may recommend formal insolvency processes such as:

Each process has different purposes and consequences.

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