Insolvency is a serious matter that any business should avoid at any cost as it has far-reaching consequences. Once a company is facing a financial crisis, it is best to seek help with a professional immediately to help guide through the devastating situation and obtain advice on how to solve related matters instantly before they reach a crisis point. The term insolvency refers to a company or an individual person that is unable to pay their obligation when due. This is when the debtor is recognised as ‘insolvent’, legally defined by the Corporations Act 2001. To assist with the first questions on the subject insolvency we are going to answer a couple of legal FAQs to help deal with the pending processes.
How to define a company insolvent
If a company is in debt, it is essential to determine if it is able to pay its full debts and whether it is possible to pay when they are due. To pay back debt, it is helpful to look at the company’s assets, which can be sold to pay back the receivables. There is also the possibility to look into cash reserves, working capital and expected cash flow. Furthermore, it is imperative to check whether the company is able to borrow money to get out of debt.
What to do when found insolvent
Once a company is found insolvent, there are three options on how to deal with the situation. The first option would be Liquidation, which is also often referred to as “winding up”. In this scenario, a liquidator will estimate the value of assets of the company and sell them under the rules of the Corporations Act to pay back debt to unsecured creditors. The company will then be deregistered and its licence expires. Voluntary Administration is another option before being declared insolvent. The director appoints a Voluntary Administrator who will be in charge of the company and looks deep into the history and finances to make suggestions on how to pursue the company’s future. Receivership is the last of the three options for the directors to choose a controller who is then in charge of certain assets and has the responsibility to a single secured creditor, which is usually a bank.
What is the difference between bankruptcy and insolvency
These two words are often confused. To clear things up a bit, the term insolvency is equally used for an individual person or company, which is temporarily not able to pay debts when they are due. As laid out above, an insolvent company may enter either Liquidation or external administration as a form of insolvent administration. A creditor, however, can place an individual person into bankruptcy if the debtor owes at least $5000. This declaration is done by a court order. To obtain relief from creditors, the individual can also file for bankruptcy himself and holds a financial disability for at least three years. The individual will not be able to obtain further credit or loans and if employed, some the salary will go straight to the creditor to pay back debt. One of the hardest impacts bankruptcy has on an individual is a permanent record on his credit rating and commonly the debtor is not allowed to leave the country without the approval of his trustees.
Consequences for the director of an insolvent company
Once a company becomes insolvent, there are serious consequences for the director. If the company is unable to recover, the director might not only lose the position but also have a hard time seeking employment again. There is also the chance of losing assets such as properties and cars. Heavy fines could come with the company being declared insolvent and depending on the circumstances, which lead to the company’s breakdown and the director might even face jail time depending on the amount of debt owed.
Suffice to say, a director should avoid insolvency at any cost, hence hiring a professional to identify early indicators is advisable to protect a company from the devastating scenario to cease to exist.