If you run a business, you need to understand corporate insolvency. Research from the Reserve Bank of Australia shows that small businesses in particular are more likely to be rejected for loans, and Australian Securities and Investments Commission (ASIC) and EY data indicates that only 52 per cent of Australians dedicate a lot of time to considering financial information before making money decisions.
Do you struggle with key terms when it comes to corporate insolvency?
This is largely due to the sheer complexity of a lot of financial concepts. For example, the ASIC report showed that 88 per cent of people cannot explain what diversification is. Additionally, many directors don't think about insolvency until their business runs into trouble.
Do you struggle with key terms when it comes to corporate insolvency? Here are seven important definitions to understand for anyone involved in running a business.
When a company is unable to pay its debts at the time they are due, it is insolvent. This is the starting point for directors to seriously consider their company's financial position and where Cactus Consulting can help you.
When a company enters liquidation its business is shut down and affairs wound up, as its debts cannot be paid in full. Equipment and other assets are sold, the company's affairs are investigated, a report is submitted to ASIC on the directors' conduct and potential recovery claims may be pursued against directors and other parties.
If sufficient funds are recovered to cover liquidation costs, surplus funds are distributed to secured creditors and employees, then other creditors including trade suppliers and the ATO.
This can be initiated in two ways: either by the court on application of a creditor or other party, or the shareholders of the company (voluntary liquidation). It's the end of the line for your company, but pre-insolvency advice can help you avoid or deal with it.
The liquidator is the person appointed to oversee liquidation of the company. They are an independent party with special qualifications and they are regulated by ASIC. There are approximately 710 liquidators in Australia.
4) Voluntary administration
If your company is insolvent, voluntary administration is an alternative to liquidation. It is intended to provide an opportunity to save the company and/or its business. The directors may appoint an Administrator with a view to putting forward a proposal for a Deed of Company Arrangement (DOCA) to settle debts owed to creditors and return control of the company to the directors.
Administration is a temporary phase for the company during which the Administrator is in control of the company's affairs and the Administrator conducts investigations and reports to creditors regarding the options of placing the company in liquidation or accepting the directors' proposal for a DOCA. A meeting of creditors is held within 25 business days (i.e. 5 weeks) of the Administrator's appointment and at that meeting creditors vote on whether to place the company in liquidation or accept the DOCA proposal.
Administration provides breathing space for a company that can't pay its debts but is expected to trade profitably in the future.
5) Deed of company arrangement (DOCA)
A DOCA may be proposed while a company is in administration. The administrator will report to creditors on the likely outcomes if they accept the DOCA proposal or if the company enters liquidation, and they will vote on these options at a meeting of creditors.
Creditors generally receive less than full payment under a DOCA, but it's better than liquidation. Funds available to DOCA creditors may come from future trading profits or alternative sources including from a bank, the directors or sale of some or all of the company's business. If a DOCA is accepted, control of the company is returned to directors, the company makes the required payments under the DOCA and creditors receive those funds towards their outstanding debts.
6) Insolvent trading
As a director, it is your responsibility to ensure you cease trading or incurring debts.
Insolvent trading occurs when you continue trading your business, after it becomes insolvent (described above). As a director, it is your responsibility to ensure you cease trading or incurring debts, and seek specialist insolvency advice when you suspect your company may be insolvent.
Directors can be held personally liable for debts incurred after a company becomes insolvent. In these circumstances a liquidator can make a claim against you for the amount of the debts, which may ultimately result in personal bankruptcy.
7) Pre-insolvency advice
Insolvency professionals, accountants and lawyers can help structure and operate your business to help prevent insolvency or set up a strategy to address existing problems. Pre-insolvency advice can be either a preventative measure or a reactionary one, but an essential service nonetheless.
Knowing these key terms is one of the first steps to fully grasping insolvency concepts and how to deal with them. The team at Cactus Consulting is on hand to assist with any further corporate insolvency-related questions you have.