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To avoid putting themselves at legal and financial risk, it is increasingly important for company directors to ensure that they do not allow a company to trade whilst it is insolvent. Clyde White explains.
It is equally important for companies that trade with a customer that is in financial difficulty to be aware of the risk that payments received through diligent debt collection practices may be clawed back by a liquidator, should that customer be wound up.Risks of insolvent trading
If a director is aware that the company is insolvent, ie incapable of paying liabilities, and allows the company to continue trading and incur debts, the Corporations Act provides for a Liquidator or a creditor to pursue the director for debts incurred.
The compensation generally sought by a liquidator in these circumstances is for the total value of the debts incurred by the company, from the time it was deemed to be insolvent, that remain unpaid at the date of liquidation.
The Corporations Act sets out the defences available to a director against claims of this nature.
They include:
• that there were reasonable grounds for the director to expect that the company was solvent and would remain so even if debts were incurred
• the director had grounds to rely on advice, given by a competent person that the company was solvent, and would remain solvent
• the director was incapable of taking part in the management of the company due to illness the director took reasonable steps to prevent the debt being incurred.
Preferential payments
There is always a risk when receiving a payment from a company in financial difficulties that at the time of payment the customer was insolvent and may subsequently be placed into liquidation.
What some creditors may consider diligent debt collection procedures, may be seen as preferential treatment over other unsecured creditors.
The Corporations Act seeks to ensure equal treatment amongst creditors by providing a liquidator with a range of powers.
These include the power to set aside transactions by an insolvent company that prefer one creditor over another.
An unfair preference is seen as a transaction between a company and a creditor that results in the creditor receiving a greater return than it would have if it had to prove for its unsecured claim in the winding up of the company.
A transaction can only be clawed back by the liquidator if:
• it is an insolvent transaction of the company; and
• it was entered into during the six months prior to the commencement of the winding up of the company.
A company is considered to be solvent if, and only if, it is able to pay its debts as and when they fall due. It follows that a company that is not solvent is insolvent.
A creditor may be able to defend an unfair preference claim by a liquidator, if it can be proven that:
• the transaction was in
good faith, for valuable consideration
• at the time of the transaction, the creditor had no grounds for suspecting that the company was insolvent or would become insolvent a reasonable person in the creditor’s circumstances would have no grounds for suspecting that the company was or would become insolvent.
Clyde White has worked in the Corporate Advisory area for over twenty years. At accountants, business and financial adviser HLB Mann Judd Melbourne, he specialises in business recovery and insolvency. White is a Registered Company Liquidator, Registered Trustee in Bankruptcy and an Official Liquidator with the Supreme Court of Victoria and the Federal Court. He is also a member of the Institute of Chartered Accountants in Australia, the Australian Society of Certified Practising Accountants, and the Insolvency Practitioners Association of Australia.
