When business debts fall due and can’t be paid, an organisation may become insolvent. In this scenario, company directors have specific duties and options: failing to discharge these appropriately can result in fines and even criminal prosecution.
Andrew Beck, partner, RSM, said, “There are many potential causes for insolvency, such as ongoing losses, poor cash flow, increasing debt, unrecoverable loans or problems selling stock, judgments or warrants issued against the company, inability to raise funds from shareholders, board disputes, and more. Recognising and responding to the warning signs is vital and can help turn the company around.
“If insolvency is a possibility, then knowledge is power. Make sure you are aware of your company’s financial performance and keep an eye out for the warning signs. If you act quickly, ideally with the help of an experienced financial advisor, you can potentially save the company.”
Options to save the company include refinancing, restructuring, pursuing different activities, or appointing an external administrator.
If your company is insolvent, then you must prevent it from trading. This is particularly important if you are likely to incur new debts: doing so while knowing you are insolvent or reasonably suspecting you may become insolvent can make you, as a director, personally liable.
It is important to remember that you do not have to be officially appointed as a director to be considered as a director. According to the Australian Securities and Investments Commission (ASIC), if you act in that role or the directors of the company act in accordance with your instructions or wishes, then you may legally be considered a company director.
Andrew Beck said, “Anyone who could potentially be deemed a company director must be proactive to protect themselves and their organisation from legal exposure that could come with insolvency. For example, it’s vital to know exactly what’s happening with the company’s financials throughout the year, not just at the end of the financial year. Having a timely and accurate view of the company’s performance can reveal the early warning signs of insolvency.
“Directors can then work to prevent escalation of the risky behaviours or issues, potentially saving the company from insolvency altogether. If insolvency is unavoidable, keeping a close eye on the finances can help prevent unnecessary liabilities.
“RSM recommends working with a financial advisor that is experienced in insolvency and can guide you through the steps needed to either save the company or wind it up. Doing so can significantly reduce the risk of being held personally liable for failing to comply with directors’ duties, especially when you may not be aware of your responsibilities.”