Is My Company Insolvent? How do I know?

You’re having difficulty keeping on top of your company’s creditors, paying its taxes and the bank is putting pressure on your company overdraft, but you feel it is all a temporary cash flow issue. Is my company insolvent?

The Act

Section 95A of the Corporations Act 2001 (the Act) expresses insolvency as an inability to pay debts as and when they become due and payable.

The Courts

The Courts have considered the interpretation of section 95 of the Act in a series of cases. These cases have set out a number of indicators of insolvency, which are a useful checklist for companies and individuals to consider if faced with financial difficulties. We have briefly set these indicators out below in a clear understandable manner.

The Indicators of Insolvency

So what are the indicators of insolvency and what should you look out for?

1. Overdue Taxes – Have you been avoiding paying your taxes on time (such as GST and/ or PAYG) in order to pay those trade creditors that are vital for your business? If so, this can be a clear indicator of insolvency, as most businesses are able to pay their tax liability by or close to the due date. If you are unable to do so this may indicate that you are unable to pay your debts as and when they fall due.

2. Losses – Of course, every company can make a loss during the life cycle of its trading. Those losses in themselves do not mean that the company is insolvent. However, when losses cannot be covered by the company’s working capital, this is an indicator of insolvency.

3. Liquidity - Is the company’s liquidity ratio below 1? Basically, do the liquid assets cover the debts? If they don’t, this is another indicator of insolvency. Of course, this test merely indicates the liquidity at a particular time so care must be taken when considering this indicator.

4. Banking Problems – Having a poor relationship with the Bank is not of itself an indicator of insolvency, nor is having a good relationship with the bank a sign of solvency. However, if the bank is refusing your company funds, decreasing your company’s overdraft, dishonouring your company’s cheques and generally making life difficult, this is an indicator of insolvency.

5. Finance and Capital Raising – Are you able to raise finance to pay your company’s debts as and when they fall due? For example:

a. Are you able to borrow funds to pay your company’s debts?

b. Can you agree further time to pay your company’s debt with its creditors?

c. Are you able to raise funds for your company in the form of equity capital, from an equity investor?

If you can’t raise funds from any one of these sources to pay outstanding debts, this is an indicator of insolvency.

6. Cash on Delivery Arrangements – Is your supplier placing you on COD or demanding special payments before resuming supply? If so, this is a clear indicator that your supplier does not have faith in your company meeting its credit commitments and therefore a clear indicator of insolvency.

7. Unpaid Creditors – Are a number of your company’s creditors unpaid outside their trading terms? Though this in itself may be an indicator of insolvency, the circumstances surrounding why those creditors are not being paid on time must be considered more carefully. For example, does your company have the funds to pay those debts but it has not paid them due to poor administrative systems? If so, this needs to be addressed to avoid this being considered an insolvency indicator.

8. Issuing of Post-dated Cheques – This can be a clear indicator of insolvency as you are basically letting creditors know that your company has insufficient funds to pay its debts as and when they fall due. If you have been issuing post-dated cheques for some time, the company may well be considered insolvent. If you do it now and again, you may have a cash-flow issue, but this would still be an indicator of insolvency.

9. Payment to Creditors of Rounded Sums – Payment of rounded sums to creditors is an indication that the full debt is not being paid. It may be that these payments are part of an agreed payment arrangement with your creditors, which in effect extends the terms of payment. If there is a clear written agreement between your company and its creditors to extend the payment terms, this may not be an indicator of insolvency. However, in many cases, these payments are made without agreement or arrangement, because a debtor cannot pay the full amount of the debt. In those cases, this will be an indicator of insolvency.

10. Solicitors’ Letter, Summonses, Judgments, Warrants – If your company has had judgments entered against it or its directors, it is pretty clear the company is insolvent. However, what about letters of demand? A number of letters of demand from different solicitors representing different creditors may indicate insolvency. If you receive a letter of demand from a solicitor, but you dispute the debt, this does not in itself indicate insolvency, as you believe the debt is not due and payable. However, any disputed debt must be genuinely disputed, in particular in the case of setting aside statutory demands issued against the company. False disputes can be considered as an abuse of process.

11. Inability to Produce Timely and Accurate Financial Information – Just because you haven’t been able to prepare timely and accurate financial accounts to display the company’s trading performance and financial position does not mean your company is insolvent. However, many of the cases that have ended up in Court suggest that insolvency and incomplete/inaccurate financial books and records tend to go hand in hand. Without proper financial information, lenders are unable to determine the true picture of the company’s financial position and will be unable to extend funds.

What Should I do?

You may look down this list and consider that you and your company are experiencing a number of these issues. If you are, we suggest you seek immediate professional advice from a lawyer or insolvency specialist who will be able to clearly advise you on what you need to do, if anything. Please remember these are merely common indicators of insolvency and are a checklist for you to consider the financial position of your business. Further analysis would be needed to determine whether your company is in fact insolvent. We are more than happy to have a no obligation fee-free discussion to put your mind at rest or to discuss the action that may be required. Please call Sam Pandya on 1300 676 787 or send us an email enquiry through our contacts page.