The dangers of trading while insolvent

While insolvency might be the ultimate solution for a failing company, expert advice can help a business recover from insolvency, keep trading and save jobs.

Insolvencies are rising in some sectors and accountants need to warn clients of the dangers of trading while insolvent – and of the resources available to help when a company is in financial trouble.

With economic growth in Australia faltering and the A$150 billion construction sector under pressure, insolvencies are on the rise.

Data from the Australian Securities and Investments Commission (ASIC) for the three months to September 2019 show that insolvencies in the construction sector jumped by 78 per cent in Victoria, 41 per cent in Queensland and by 7 per cent in NSW.

It is inevitable that directors of some companies will face court action if their companies are found to be trading while insolvent.

A study of all insolvent trading cases nationally between 2004 and 2017 by Melbourne University academics Ian Ramsay and Stacey Steele found that directors were found to be personally liable in 71.2 per cent of cases brought before the courts.

If the action was brought by liquidators rather than creditors, the percentage was even higher, at 84per cent.

Preventing insolvency

While insolvency might be the ultimate solution for a failing company, Shabnam Amirbeaggi, the managing partner of Crouch Amirbeaggi, one of Australia’s 200 specialist accountancy firms offering insolvency services, says that expert advice can help a business recover from insolvency, keep trading and save jobs.

“People often reach out when the available assets and options have been depleted,” says Amirbeaggi, who deals largely with SME clients, many of them sub-contractors in construction.

“It’s vital in our line of work to get in early. Directors frequently inject fresh funds into a failing business before it’s restructured and call us in when these funds are exhausted, so there’s no working capital and no prospect of alternative funding.”

Amirbeaggi says there are formal and informal options available to save a business in distress, but all of them require funding.

“The new provisions of the Safe Harbour legislation are a good development, but this new framework has some limitations.”

Alternatives to liquidation

Since 2017, Australia has had Safe Harbour legislation which was designed as a circuit breaker for insolvency, giving directors another option beyond liquidation or a deed of company arrangement. 

That legislation has been in place for two years and is being reviewed, so its impacts are yet to be fully understood, but already there is an anecdotal view that while it might be an option for large companies, it is a bridge too far for many small enterprises.

“The Safe Harbour was set up for a number of reasons, and one was that the Government wanted to encourage investment in start-ups and didn’t want to discourage investors,” says Ian Ramsay, the Harold Ford Professor of Commercial Law at the University of Melbourne.

“While larger companies have the resources to get specialist advice, smaller companies struggle to pay for that and they also can’t take advantage of the provisions if employee obligations, such as superannuation, are not paid.”

Amirbeaggi agrees. In her experience, the first thing that struggling SMEs fail to pay is employee superannuation.

Even in situations where large companies are still solvent, their payment terms often create cash flow problems for their suppliers, which can leave them teetering on the brink, even though they may have significant receivables on paper. For other companies, operating on the brink of negative cash flow and waiting for the next cheque is “business as usual”.

Consult the insolvency professionals

Amirbeaggi’s message to struggling companies is that accredited insolvency professionals don’t just put companies into administration and liquidation, but they can offer advice on the legitimate available options. 

In cases where directors seek the advice of unaccredited pre-insolvency advisors and their companies are ultimately insolvent, the directors will, after paying for the services of a pre-insolvency advisor, still need to engage the services of an accredited professional.

“They still have to deal with an insolvency practitioner if the company goes into liquidation,” says Amirbeaggi.

While much of her work comes from referrals from accountants, she says that another channel is from directors “googling” for help when they are desperate. In those situations, it is easy for directors to reach out to “random people or take advice from the sales team of 20 to 30 pre-insolvency companies that sounds too good to be true”.

“Sadly, it’s so common in the SME market for directors to accept vague restructure plans and empty promises from unqualified advisers” says Amirbeaggi.

Her advice to directors in this position is to spend their internet search time on Government websites such as ASIC and Australian Financial Security Authority (AFSA), where they will see published details such as the recent case of the ongoing court action involving two businessmen who pleaded guilty to money laundering charges over their roles in a pre-insolvency scheme.

Then there is the advice of accountants and accredited insolvency professionals.

ASIC and AFSA publish on their websites the list of 700 registered insolvency practitioners in Australia. 

“Almost all of us will offer you some of our time over the phone to discuss your options for free,” says Amirbeaggi.

“At least this gives them the comfort that they are speaking with someone who is accredited in a very specialist area who can clarify exactly what options are viable.”

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The dangers of trading while insolvent

December 2019
December 2019

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