By Adam Tims, Partner, Martin O’Connor & Partners
Inside Racing – May 2008
Part 2: YOUR COMPANY AND THE LAW
Following from our article (April 2008 IR), it is timely for company directors to be fully aware of their legal requirements and obligations. The first quarter of 2008 has brought with it an economic reality check in most parts of the world. Australia like most countries faces a more volatile economy together with higher interest rates and costs of living. Most banks are actively increasing their resources to concentrate on assessing risk and associated debt. Company directors need to be particularly mindful when taking on debt in such a challenging economic environment.
What are directors’ duties if the company is unable to pay its debts?
The Corporations Act 2001 (C’wth) imposes liability on a director of a company who allows the company to incur a debt at a time when:
- The company is insolvent at the time that the debt was incurred; or
- Where there existed reasonable grounds (and the director is aware of these grounds) for suspecting that the company was, or may become, insolvent as a result of incurring the debt.
This is commonly referred to as “insolvent trading”.
If the directors of a company determine that the company cannot pay its debts when they become due for payment (ie. the company is insolvent), then there are a series of steps that the company is required to take.
These include:
- Appointing an administrator;
- Applying to the Court for the appointment of a provisional liquidator; or
- Applying to the Court to wind up the company and appoint a liquidator.
A company may be insolvent even if it appears to have more assets than liabilities. This is because the assets may not be liquid or easily saleable yet the liabilities are current. It is the expected cashflow of the business that determines its solvency in the short to medium term.
If you think that your company is not able to pay its debts when they become due, or is heading that way, it is imperative that you immediately seek the advice of your legal advisor or accountant.
Common signs of financial trouble are:
- Low operating profits or cash flow from the main business;
- Problems paying trade suppliers and other creditors on time;
- Trade suppliers refusing to extend further credit to the company;
- Problems with meeting loan repayments on time or difficulty in keeping within the overdraft limits;
- Legal action taken, or threatened, by trade suppliers or other creditors over money owed to them.
There are a number of situations in which a director may become personally liable for company debts. These include trading when the company is insolvent.
Summary
If you hold a position as company director you should be aware that the role is a lot more than just a name to paper. There are a number of legal obligations associated with Directors and the role should be taken seriously. Be sure to seek advice and understand your obligations to avoid any unwanted surprises.
This article is of a general nature only and is not intended to be relied upon as, nor to be a substitute for, specific
professional advice. No responsibility for loss occasioned to any person acting on or refraining from action as a result
of this article can be accepted.