The risks of going belly up - liquidation, insolvency and director's liability.

Updated: Aug 28, 2019

If taken early, the right type of advice and intervention can save a struggling business by putting it on a better trajectory with a more secure foundation. However, in the worst-case scenario, when a business cannot pay its bills ‘as and when they are due’, your accountant will provide much-needed support and expert advice to help explore the options available to deal with the financial distress.

Australia has very clear rules pertaining to the duties and obligations of company directors when it comes to business finance, matters of solvency, risk and liability. If you’re a company director, even in a family business, it pays to refresh your knowledge.

If your business is set up using a company structure and you’re nervous that it may be at risk of going into liquidation, it’s important to clearly understand where your responsibilities begin and end so that you can act early and be aware of the responsibilities of a Director under the Corporations Act.

Company directors are always expected to be aware of and proactive about company finances. With the personal wealth of directors potentially on the line, it’s important to seek expert advice from your accountant to ensure the correct actions are taken in a timely manner so that risks are minimised.

What does it mean to be insolvent and why does it matter?

The Australian Securities and Investment Commission (ASIC) states that company directors have a positive duty to prevent companies from trading if it is insolvent. Insolvent trading occurs when a company continues to trade and incur debts after a business is deemed to be insolvent – i.e. when it can’t meet its financial obligations ‘as and when they fall due’.

Identifying insolvency at a point in time is not always straightforward. However, at the earliest possible sign of a potential problem, directors can and should take clear, simple steps to demonstrate a responsible approach, and to minimise financial risk to their stakeholders and creditors (e.g. customers, suppliers, contractors and employees) as well as their own potential liability for business debts. Directors duties are clearly explained on the ASIC website.

How will you know if your company is insolvent?

In today’s business environment, with long debtor due dates, large contract amounts, fluctuations in both local and overseas markets and payment arrangements, it is not uncommon for companies to experience cash flow issues or even undergo dramatic changes while not being identified as being insolvent. This makes it difficult for directors to know exactly when a company has passed the point of insolvency and missed the opportunity to trade out of financial difficulty. A business that continues trading past the point of insolvency, can limp along incurring more debt potentially creating a serious personal liability issue for directors.

Understanding director liability

One of the most common questions from directors, when a company is in financial distress, is what is my personal exposure? While the answer to this question is quite difficult to answer, there are some specific items which can be used as a starting point:

• Employee Superannuation – Under current rules directors can be made personally liable for unpaid super. With the implementation of single touch payroll and current changes being proposed to the Fair Work Act, which will allow employees to recoup unpaid super through the Fair Work Commission, the risk of directors being pursued personally is greater than ever. The ATO has also become more aggressive in its approach to pursue directors personally for unpaid superannuation, including superannuation owed to working shareholders and directors.

PAYG withholding – Under current rules directors are personally liable for unremitted PAYG, however, this can be remitted if the directors act within 21 days of the time stated on a Director Penalty Notice Statement AND the organisation has made all lodgements on time. It is essential the 21 days be adhered to as being granted extended time by the ATO to respond will not extend the exemption.

• Division 7a Loans – Under current rules division 7a loans are effectively loans owed to the business and therefore open for a liquidator to pursue.

• Unpaid Share Purchases – In the event of liquidation, any unpaid shares can be called at the discretion of the administrator.

• GST – Under current laws, there is no personal liability of a director for outstanding GST, however, due to GST being one of the largest unpaid statutory debts currently owed, there is currently a bill in progress which proposes to make directors personally liable for outstanding GST. If passed Directors will also become personally liable for any unpaid GST.

Insolvency - managing personal exposure as a company director

When a business’s finances get out of control it is vital to act early, seek professional advice and take quantifiable steps to manage in order to reduce the risk of further exposure to creditors, and of personal liability for directors. The longer a business trades after it is deemed insolvent, the higher the risk for a director to be exposed to greater personal liability for the company’s debts.

Currently, if a director continues to trade and incur debts after the business has been deemed insolvent, they risk being personally liable for unpaid debts. So, when a business finds itself in difficulty, directors need to be proactive in their efforts to identify, clarify and resolve. Ignorance is not bliss. Take the following steps:

• Visit your accountant; • Review your current financial reports; • Develop a business plan designed to: • Change the current trading conditions; • Provide a pathway to profits; • Closely monitor your organisations' financial operations going forward; • Ensure the business is trading its way to success; and • Set red flag indicators and points signifying for Directors that liquidation is inevitable, that trading must cease and outline what further actions are required e.g. voluntary administration/liquidation.

NB: Directors should never inject personal funds into the business until a strategy is set out that ensures the company will return to solvency.

Rowe Partners have a wealth of experience in assisting businesses through all types of challenges.

The key take away message is that help, and expert advice in the form of a confidential, non-judgemental chat about your business finances, is available at the end of the phone.

Call Rowe Partners on 1800 04 7693.

General Advice Warning:

The information contained in this blog post has been provided as general advice only. The contents have been written without taking account of individual personal, financial or business circumstances. You should, before you make any decision regarding any information, strategies or products mentioned, consult your Rowe Partners accountant.