LAWS20029 - Corporate Law
Term 1, 2014
Prepared and Submitted by
Tutor: Peter Robinsion
Due Date: 10th April, 2014
Date Submitted: 10th April, 2014
Table of Contents
Insolvency is defined in section 95A of the Corporations Act 2001 as it works in reverse. First, solvency is defined as when a person is able to pay all their debts as and when they become due and payable. A person including a company who is not solvent is then deemed to be insolvent. On the other hand we can say that Insolvency is generally defined as a financial state in which a company can no longer pay its bills and other obligations on time. This occurs whenever liabilities, or debts, exceed assets and cash flow. Courts frequently consider whether or not a company or individual is insolvent and if so, when that insolvency started and when various people should have suspected it. This usually occurs when a liquidator or bankruptcy trustee commences a recovery action. It is also a critical issue for directors of companies when liquidators or creditors commence an action for the recovery of damages arising from insolvent trading or related claims. Whether a company or business is insolvent is also an important piece of information before a liquidation or bankruptcy. It allows a business owner to decide of action that may avoid a winding up or take other corrective action before insolvency becomes fatal to the business. Hence these indicators are not just for insolvency practitioners trying to prove insolvency; they are also for business owners trying to avoid it. Proving the date that a company or a person became insolvent is usually one of the most difficult, time consuming and also most expensive tasks to complete. Because this issue frequently arises in the corporate world, some Judges have developed indicators of insolvency that they look for when considering the question as direct evidence. The courts looked closely into the question of insolvency and indicators that directors and other parties should notice. In ASIC v Plymin (2003) 46 ACSR 126, the Judge (para 386) referred to a check list of indicators of insolvency as follows: These are indicators that directors and other parties would use when considering business is insolvent or not.
There are some well recognised direct evidence indications of a company's likely insolvency. Those include:
Cash Flow Indication
Factors that indicate the availability of cash, or lack of it, become increasingly important if the company goes into voluntary administration or liquidation because the level of scrutiny steps up. These are the sort of things a liquidator will look at in determining when a company became insolvent. Insolvency must be distinguished from a short term cash-flow problem.
Insolvent indicator 1. An inability to raise equity cash or loan capital cash. A company with insufficient cash to pay its due debts will have to raise extra cash to stay solvent. It can do so by way of refinancing, the raising of equity or the rescheduling of debts. An inability to do this within a reasonable time indicates that the problem is not simply short term cash-flow problems.
Insolvent indicator 2. Issuing post-dated cheques or having cheques dishonoured. Issuing a post dated check is an admission that a company has insufficient funds to pay all due debts. A post dated check that is also dishonoured is a clear sign that the problem is more than a cash-flow.
Insolvent indicator 3. Payments in rounded sums and for the minimum amount due. Debtors sometimes resort to making a small payment to a creditor, often in a round amount. This is a sign that the debtor hopes to resolve the situation in the near future and that the creditor will be satisfied with a series of small payments. The inference is that this small payment is being made because the debtor cannot pay all its debts as they fall due and