Insolvency – How to protect yourself from insolvent trading

The Government’s National Innovation and Science Agenda has brought about some of the most significant insolvency law reforms in 30 years. The objective of these reforms is to encourage innovation, even after business failure.

There is a stigma engrained in the Australia around business failure. Business owners do not go into business to fail, or do they? Some may fail a number of times before they succeed. Some set out to simply rort the system and Phoenix their companies a number of times. Rest assured, big brother is watching, and those that facilitate Phoenix Activity have their days numbered.

The rate of technological advancements is increasing with time. Liquidators and others have observed countless distressed businesses collapse because they did not restructure themselves to suit their changing marketplace.

The insolvency framework in this country has been long overdue for a cultural shift, to remove the stigma of business failure, to encourage Directors / Business Owners to take a risk and to encourage innovation.

Directors are ever so often stigmatised and penalised for insolvent trading. Insolvent Trading sees a Director become personally liable for the debts of an insolvent company. Under new ‘Safe Harbour’ laws, Directors who seek assistance from a Restructuring Adviser at the earliest business risk factor, and certainly before the Company becomes insolvent, are granted protection from personal liability for insolvent trading. There are a number of simple tests that can be done to assess business risk factors and insolvency.

This is how it works.

BuildProof Pty Ltd is a building company. In the current construction boom, the company expands rapidly with new contracts, taking on new employees, new offices and leasing new equipment.

Unfortunately, heavy rains over an extended period has delayed construction works on a number of contracts. Works are delayed up to 3 months. Progress payments are as a result also going to be delayed. Rent payments remain payable within terms, tax liabilities remain payable, employee payments remain payable, and lease payments on equipment remain payable. The company finds itself with a temporary cashflow shortage. It does not own any other assets that it can use as security for short-term borrowing to fund the cashflow shortage. Unsecured borrowing by the company to pay company debts may be digging a deeper hole for itself.

The Director is aware of their personal liability if the company is insolvent and it continues to trade, so is contemplating borrowing against the equity on the matrimonial home to fund the cashflow shortage, thanks to a recent increase in the property’s value. Borrowing against personal assets to pay company debts may be digging a deeper hole.

The Director receives advice from their solicitor and to avoid personal liability for the company’s debts through insolvent trading, she places the company into voluntary administration. A number of developers terminate their building contracts under automatic termination clauses because of the voluntary administration (ipso facto clauses), which destroys all chances of saving the business and forcing the company into liquidation.

Under the Safe Harbour provisions, if the Director appoints a Restructuring Adviser (at the earliest time of determining the company’s business risks and financial risks) to address the temporary cash-flow problem, the Director will be afforded protection from insolvent trading and the contracts containing ipso facto clauses will be unenforceable against the company while the Restructuring Adviser is in place.


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