What is Insolvency?

Insolvency refers to a situation where a business or individual is unable to pay their debts when they are due. In Australia, insolvency is governed by the Corporations Act 2001, and it is overseen by the Australian Securities and Investments Commission (ASIC).

Signs of Insolvency

Common signs that a business may be insolvent include:

• Failure to pay creditors on time.
• Difficulty meeting payroll obligations.
• Frequent requests for payment extensions.
• Receiving legal demands from creditors.

Example:

ABC Pty Ltd is a retail company that has struggled to pay its suppliers for several months. Despite efforts to restructure its finances, ABC has fallen behind on its obligations, including employee salaries and tax payments. These are clear signs of potential insolvency, and the directors may need to consider voluntary administration or liquidation.

Types of Insolvency Procedures

Voluntary Administration

When a company is insolvent, the directors may appoint an independent administrator to take control of the company’s affairs. The goal of voluntary administration is to assess the company’s financial situation and decide whether it can be saved, sold, or needs to go into liquidation.

Liquidation

Liquidation is the process of winding up a company’s affairs, selling its assets, and distributing the proceeds to creditors. Liquidation occurs when a company is unable to pay its debts and is considered the final stage of insolvency.

What Happens to Directors?

Insolvency can have serious consequences for company directors. Directors have a legal duty to prevent a company from trading while insolvent. If a director allows the company to continue trading while it is insolvent, they can be held personally liable for the company’s debts. This is known as insolvent trading.

Example:

John is the director of XYZ Pty Ltd. The company has been struggling financially for some time, but John continues to accept new orders and extend credit to customers. As the company’s financial position worsens, it becomes clear that XYZ is insolvent. If John is found to have allowed the company to trade while insolvent, he could be held personally responsible for its debts.

Seeking Professional Advice

If you believe your company may be insolvent, it is crucial to seek professional advice as soon as possible. Insolvency practitioners, such as administrators and liquidators, can help you understand your options and navigate the process of insolvency.

For more insights on business risks and insolvency, visit our page on what ASIC does.