Insolvent Transactions and risks to Advisors Mervyn Kitay Worrells - - PDF document

Who should you trust?

Insolvent Transactions and risks to Advisors

Mervyn Kitay Worrells Solvency & Forensic Accountants

Insolvent Transactions and Risks to Advisors

Presented by: Mervyn Kitay, Partner Worrells

WHEN IS A COMPANY INSOLVENT? CASH FLOW TEST OR BALANCE SHEET TEST

INSOLVENT TRADING

HOW DOES THE COPORATIONS ACT DEAL WITH THIS?

• Positive obligation not to trade whilst insolvent
• Directors exposed personally

INSOLVENT TRADING

DUTY NOT TO TRADE WHILE INSOLVENT

• Directors’ have a positive duty to prevent a company trading if it is

insolvent.

• A company is insolvent if it is unable to pay all its debts when they are

due.

• Before a new debt is incurred, Directors must consider whether they

have reasonable grounds to suspect that the company is insolvent or will become insolvent because of incurring the debt.

• Whether a company can pay its debts when due and payable is a

question of fact to be determined objectively and without hindsight.

• An understanding of the financial position of the company only when you

sign off on the yearly financial statements is insufficient.

INSOLVENT TRADING

CONSEQUENCES OF INSOLVENT TRADING

• Civil penalties
• civil penalties against directors, including pecuniary penalties of up

to $200,000.

• Compensation proceedings
• Can be initiated by ASIC, a liquidator or a creditor against a director
• personally. A compensation order can be made in addition to civil

penalties.

• Compensation payments are potentially unlimited and could lead to

the personal bankruptcy of directors.

• The personal bankruptcy of a director disqualifies that director from

continuing as a director or managing a company.

INSOLVENT TRADING

CONSEQUENCES OF INSOLVENT TRADING CONT.

• Criminal charges
• If dishonesty is found to be a factor in insolvent trading, a director

may also be subject to criminal charges (which can lead to a fine of up to $220,000 or imprisonment for up to 5 years, or both

INSOLVENT TRADING

SIGNS OF INSOLVENCY

• ongoing losses
• poor cash flow
• absence of a business plan
• incomplete financial records or disorganised internal accounting

procedures

• lack of cash-flow forecasts and other budgets
• increasing debt (liabilities greater than assets)
• problems selling stock or collecting debts
• unrecoverable loans to associated parties

INSOLVENT TRADING

SIGNS OF INSOLVENCY CONT.

• creditors unpaid outside usual terms
• solicitors’ letters, demands, summonses, judgements or warrants issued

against your company

• suppliers placing your company on cash-on-delivery (COD) terms
• issuing post-dated cheques or dishonouring cheques
• special arrangements with selected creditors
• payments to creditors of rounded sums that are not reconcilable to

specific invoices

• overdraft limit reached or defaults on loan or interest payments

INSOLVENT TRADING

SIGNS OF INSOLVENCY CONT.

• problems obtaining finance
• change of bank, lender or increased monitoring/involvement by financier
• inability to raise funds from shareholders
• overdue taxes and superannuation liabilities
• board disputes and director resignations, or loss of management

personnel

• increased level of complaints or queries raised with suppliers
• an expectation that the ‘next’ big job/sale/contract will save the company

INSOLVENT TRADING

TEMPORARY WORKING CAPITAL DEFICIENCY OR ENDEMIC SHORTAGE OF WORKING CAPITAL

• Temporary working capital deficiency – “push on”
• Endemic shortage of working capital – “close shop”

INSOLVENT TRADING

TEMPORARY WORKING CAPITAL DEFICIENCY OR ENDEMIC SHORTAGE OF WORKING CAPITAL

How do you tell:

• Three-way forecast (P&L: balance sheet and cash flow)
• Pin-points when cash deficiency arises
• Uses the assumptions (reasonably tested) regarding trading

performance; debtors days; creditor days; stock turn etc.

INSOLVENT TRADING

TEMPORARY WORKING CAPITAL DEFICIENCY OR ENDEMIC SHORTAGE OF WORKING CAPITAL

• Three month rule allows some flexibility
• Degree of certainty
• Unlikely
• Possible
• Highly probable
• Defence to an insolvent trading claim

INSOLVENT TRADING

DIRECTORS DEFENCES TO INSOLVENT TRADING

• They had reasonable grounds to expect that the company was solvent
• They did not participate in the management of the company due to

illness or some other good reason

• They took all reasonable steps to prevent the company from incurring

the debt

INSOLVENT TRADING

DUTY TO KEEP BOOKS AND RECORDS

• For the purposes of an insolvent trading action against a director, a

company will generally be presumed to have been insolvent throughout a period where it can be shown to have failed to keep adequate financial records

• Arises where no records or where documents kept are “deficient as to

content” in not recording the company’s financial position and performance.

INSOLVENT TRADING

TO SUMMARISE: DEALING WITH A DISTRESSED CLIENT

• Solvency = Ability to pay debts when due
• Courts look at Cash Flow
• Three-way Forecast is most reliable tool  legally and commercially
• Advisers should capitalise on this

INSOLVENT TRADING

THE BIG BITE!! DIRECTOR PENALTY NOTICES (DPN’S)

• Applies to withholding taxes and now includes Super
• Has the effect of Piecing the Corporate veil by making directors

personally liable for company debts

• Relief from personal liability if:
• Company pays the overdue debt
• Directors appoints Liquidator or Administrator within 21 days of issue
• f DPN
• However new “lock down” provisions apply where the outstanding liability

remains:

• Unpaid and unreported 3 months after due date
• Personal liability cannot be avoided by placing company in

Administration or Liquidation.

• Only payment of the debt will relieve personal liability

INSOLVENT TRADING

PROTECTING YOUR HARD EARNED FEES - PREFERENCES

• Applies where
• Payment made by a debtor to a creditor
• At a time when the company was insolvent
• Having the effect of preferring the creditor over others
• By the creditor receiving more than they would have if the company

was placed into Liquidation

• All occurring within 6 months of commencement of the Liquidation
• r 4 years involving a related party
• r 10 years where fraudulent intent

PREFERENCES CONT.

• Accountants / Advisers easily exposed to preferences
• Strategy to “side step” receiving a preference
• Receipt of funds before a debtor creditor relationship is established
• Alternative to register a GSA and become secured

PREFERENCES CONT.

The ATO

• Director Indemnity (S588FGA) is a hidden trap
• Good discussion to have around asset protection!

QUESTIONS?

For any future questions please contact: mervyn.kitay@worrells.net.au

• T. 08 9460 1044

Disclaimer: All material contained in this paper is written by way of general

• comment. No material should be accepted

as authorative advice and any reader wishing to act upon material contained in this paper should first contact Worrells for properly considered professional advice, which take into account specific situations.