Whether a company is insolvent can be relevant in a number of circumstances. A director of a company must understand whether the company to which it has been appointed is insolvent so as to avoid being personally liable for the debts the company incurs while it is insolvent.
Furthermore, knowing whether a company that you trade with is insolvent may be relevant if you have received payments for services rendered while that company is insolvent and a liquidator subsequently appointed to wind that company up seeks to recover that payment as an unfair preference payment.
Determining whether a company is insolvent can be a difficult process.
Pursuant to section 95A of the Corporations Act 2001 (Cth) (the “Act”), a company is solvent if it is able to pay all of its debts as and when they become due and payable and a company that is not solvent is insolvent. In determining whether a company is solvent, the Courts generally apply a cash flow test and a balance sheet test.
The cash flow test reflects the test referred to in section 95A of the Act. Under this test a company will be insolvent when it does not have sufficient cash to pay its debts. Under the balance sheet test, a company will be insolvent if its total liabilities are greater than its total assets.
Notwithstanding the fact that section 95A of the Act requires the cash flow test to be applied, in most cases the Courts will also consider and apply the balance sheet test as the decided cases show that the nature and extent of a company’s assets should also be taken into account when determining a company’s solvency.
The following principles with respect to whether a company is insolvent can be drawn from the decided cases:
- whether a company is solvent or not is a question of fact, to be ascertained from a consideration of the company’s entire financial position including its activities, assets, liabilities and available cash;
- when assessing a company’s financial position, the Court must have regard to commercial realities including:
- what resources are available to a company to meet its liabilities as they fall due; and
- whether the company can raise cash by sale or by borrowing upon security of its assets and when such sales or borrowings can be finalised;
- in deciding whether a company is suffering from a temporary shortage of liquidity or an endemic illiquidity that will result in insolvency, the courts will have regard to the commercial realty that creditors will not always insist on payment strictly in accordance with their terms of trade, however, this does not on its own, warrant the conclusion that the debts were not payable on the dates specified in the contract; and
- a contract debt is payable at the time stipulated for payment in the contract, unless a person asserting otherwise can prove it.
Evidence of Insolvency
In ASIC v Plymin  VSC 123 the Court listed the following fourteen indicators of insolvency that it considered are relevant when determining whether a company is insolvent:
- continuing losses;
- liquidity ratios below 1;
- unpaid and overdue taxes;
- bank refusals to lend more funds;
- an inability to borrow funds or raise equity capital;
- bank requests to reduce overdraft limits;
- suppliers changing terms of supply to cash on delivery;
- suppliers demanding special payments as a condition to the provision of further supplies;
- failure to pay debts within trading terms;
- receipt of written demands from solicitors;
- payments to creditors in round sums that cannot be reconciled to specific invoices;
- payment by dishonoured or post-dated cheques;
- special arrangements with selected creditors; and
- the inability to produce timely and accurate financial information.
Presumption of Insolvency
Determining whether a company is insolvent at a particular time can be difficult, however, section 588E of the Act sets out certain circumstances when insolvency can be presumed.
Amongst other things, a Company will be presumed insolvent where it has breached its obligations at section 286 of the Act with respect to the keeping of and retention of accounting records.
A company will also be presumed to be insolvent pursuant to section 459C(2) of the Act if it has failed to comply with a statutory demand within 21 days of service of that demand.
Marino Law has extensive experience acting for liquidators, lenders and financiers in the administration of all corporate insolvency appointments. Our highly experienced lawyers regularly advise clients in the following areas of corporate insolvency:
- voluntary administrations;
- enforcement of securities; and
- statutory demands.
We also regularly provide advice to liquidators, lenders and financiers regarding the registration of security interests on the PPSR, the validity of those registrations and their enforceability.
Should you require assistance in any of the above areas, please contact one of our highly experienced lawyers.