If your business is unable to repay its debts, it could be insolvent. Closing a business can be a complicated and emotional time, but insolvent trading laws means directors should understand their options and make a decision as soon as possible. Seeking advice from insolvency professionals can make the process easier, help you stay fully compliant with the law throughout the process, and help you avoid unwanted surprises.
These are the key options for insolvent businesses facing closure.
Duty to avoid insolvent trading
Directors have a duty under Section 588G of the Corporations Act 2001 to prevent the company from trading while insolvent. In other words, if your company is already insolvent or has a real risk of being insolvent, you need to take the interests of your creditors into account. In practical terms, this means you should not incur further debt if there is reasonable grounds that the company will become insolvent as a result of the debt, or if the company is already insolvent. As such, you need to be aware of your company’s financial position at all times.
Is your business insolvent?
Some of the key indicators of insolvency or financial difficulty include sustained periods of loss, increasing debt, and other red flags such as statutory demands and director penalty notices. One of the most compelling signs is that your company is unable to repay debts when they fall due.
There is one main option if you have already decided to shut down an insolvent company: liquidation. This can occur with or without the company going into receivership and a receiver being appointed. Additionally, it is also possible that you decide to appoint a voluntary administrator before eventually closing down your company.
Note that if you operate under a partnership or sole trader structure (rather than a company structure), the process is bankruptcy rather than insolvency.
If your business is solvent, you can simply wind it up or deregister it. In contrast, during liquidation the business stops operating and a liquidator is appointed by the shareholders, secured creditors, or by court order. The role of the liquidator is to wind up the company’s affairs and distribute assets to creditors in a fair way.
The liquidator will collect all the company’s assets, sell them off, and share the proceeds among creditors. His or her duties will include identifying liquidation costs and paying the creditors, usually the secured creditors first. The liquidator will also investigate possible reasons for the company’s failure and prepare reports for creditors. The liquidator will be the party applying to deregister the company.
Unlike voluntary administration, this option involves directly shutting down the insolvent company without first exploring other possibilities for continuing operations. As such, this is the most direct route to closing your business and the option to take if you have already decided to shut down an insolvent business.
With voluntary administration, the company directors might still be uncertain as to whether or not they want to close the company, and they want to find out whether it should indeed continue trading. The company directors can pass a resolution to appoint a voluntary administrator who then takes over the company, or the administrator can be appointed by a liquidator or secured creditor, though this is less common.
The voluntary administrator will investigate the company’s accounts and affairs, report to creditors, and to make recommendations to creditors on the issue of entering into a deed of company arrangement. A deed of company arrangement is a binding agreement between the company and the creditors on how the company will proceed, and this option is usually taken to restore the company for good and/or to ensure the creditors end up with a better chance of recovering their money than under liquidation.
Another outcome of voluntary administration is the administrator recommends the company enters into liquidation. Alternatively, they could recommend that the company be returned to the directors’ control. As such, voluntary administration could be an option if you would like to first explore the possibility of turning around your business.
The receivership process can exist in conjunction with voluntary administration or liquidation, and it is not a direct pathway to closing an insolvent business. In fact, businesses can continue trading after the receivership process ends. When the company enters receivership, a receiver is appointed by a secured creditor – for example, a bank – to protect their interests and assets and improve their chances of getting paid. Generally, receivers are appointed under the terms of a security instrument that outlines their role.
Other issues to consider
The closing of your company is final when it is de-registered with ASIC. Certain conditions must met before registration, and these include ceasing trading, not having any ongoing legal proceedings, and full payment of outstanding fees and penalties under the Corporations Act 2001. There may also be other things to consider, such as retaining records, lodging final tax returns, and notifying employees.
There are specific requirements for company closure and deregistration, so always make sure you have met all the formalities. For insolvent companies that are to be closed down, the requirements can be more onerous, so seek advice from experienced insolvency advisors in a timely manner to make sure you meet all compliances obligations. Insolvency professionals could even help you explore other options that could allow your business to continue operating and eventually return to profitability.