Many businesses are facing hard times in the current market with cashflow stretched and delayed creditor payments. Your business might be one of them. Early action is critical in determining whether your business can be rescued or not.
Taking steps to ensure your company remains financially sound will minimise the risk of an insolvent trading action and facing personal liability. It may also improve your company's performance.
There are serious penalties and consequences of insolvent trading including civil penalties and criminal charges. Insolvency can be established by either of the Cashflow test or Balance Sheet tests. Note, importantly, that only one of these tests needs to be met to establish insolvency.
- The Cashflow Test is simply whether your company can pay its debts when they fall due for payment. If you are paying your trade creditors at 90 days plus and yet the trading terms are 30 days, your company could be insolvent.
- The Balance Sheet Test is whether the company's assets are exceeded by its liabilities. It is important to point out that this test must include contingent or prospective liabilities.
A solvent balance sheet may include items that are overstated, such as obsolete stock, plant, and work in progress, or debtors that are not really collectable. After deducting these items many balance sheets become insolvent.
Your company must keep adequate financial records to correctly record and explain transactions and the company's financial position and performance. A failure of a director to take all reasonable steps to ensure a company fulfills this requirement contravenes the Companies Act 1993.
Some of the key signs of insolvency are:-
- Bad management or no management
- Cash flow difficulties
- Excessive debt and under-capitalisation
- Inadequate accounting
- Reliance on a small number of customers, suppliers etc
- Net asset deficiency (liabilities greater than assets)
- Exceeding overdraft facilities or defaults on loan or interest payments
- Increased borrowings
- Statutory demands, solicitors' letters, summonses, judgements or warrants issued against the company and winding up notices
- Lack of cash-flow forecasts and other budgets
- Change of bank, lender or increased monitoring/involvement by financier
- Reliance on key customers
- Loss of long-standing suppliers
- No directors' meetings, management meetings, or clear objectives
- Contract disputes
- Creditors unpaid outside usual terms
- Issuing post-dated cheques or dishonouring cheques
- Suppliers placing the company on cash-on-delivery (COD) terms
- Payments to creditors of rounded sums that are not reconcilable to specific invoices
- Part payments and instalment plans with essential creditors
- Failure to pay GST and PAYE
- Late collection of payments from debtors
- Artificial valuation of assets
- Higher stock levels with static sales
- Shareholder disputes and director resignations, or loss of management personnel
- Increased level of complaints
- Sale and leaseback of assets
- Factoring of debtors
- Unrecoverable loans to associated parties
- Injection of directors' own resources to provide short-term relief
This list is by no means exhaustive, but it does give an idea of where to look for signs of impending trouble. You should constantly be on the look out for these signs - because your creditors certainly are!
As a director you need to be aware of your options so that you can make informed decisions about your company's future. If your company is insolvent you must not incur further debt in the name of the company or you could be made personally liable for that debt. Options include refinancing or capital injection (to return the balance sheet to a solvent position or to remove cash flow pressures), sale or acquisition, restructuring or changing company activities, and appointing an external administrator. Generally the matter is left too late and the only options left are to appoint a voluntary administrator, receiver or a liquidator.
Voluntary administration
Voluntary administration is designed to resolve the company's future direction. The voluntary administrator takes full control of the company to try to work out a way to save either the company or the company's business.
The aim is to administer the affairs of the company in a way that results in a better return to creditors than they would have received if the company had instead been placed straight into liquidation.
A mechanism for achieving these aims is a Deed of Company Arrangement. VA however suits certain companies and can be a costly exercise. A company compromise can achieve similar results.
Liquidation
A liquidator is an independent person who takes control of the company so that its affairs can be wound up in an orderly and fair way for the benefit of creditors. Sometimes business assets can be sold at market value and a new business resurrected. It pays to get good advice to avoid being held personally liable and have the sale managed by the liquidator.
Receivership
A company goes into receivership when a receiver is appointed by a secured creditor who holds security over some or all of the company's assets. The receiver's primary role is to collect and sell sufficient of the company's charged assets to repay the debt owed to the secured creditor. Sometimes there is nothing much left and liquidation can also follow.
Of course, if your company is in financial difficulty, the best scenario is to avoid a crisis in the first place, and the best way to do this is to seek independent expert advice in respect of your duties and the options available.
DISCLAIMER
This article is intended to provide general information and should not be construed as advice of any kind. Parties who require clarification on issues raised in this article should take their own advice.