COVID-19 hit small businesses hard, with forced closures and dwindling profits a reality for many. To relieve the pressure, the ATO hit the pause button on tax debt. The government also introduced temporary protection from insolvent trading and several fiscal support measures.

While this helped many tick over, protection is no longer in place and fiscal support ended in March. In addition, the ATO is expected to recommence recovery action imminently. This means accrued tax debt may now come back to bite and businesses are at increased risk of insolvency.

But what is insolvency? How do you know if you’re trading while insolvent? And what actions should you be taking right now?

What is insolvency?

A business is insolvent if it has debts it cannot pay in full by the due dates.

While cash has probably been tight at times, if you’ve managed to pay all your debts within a reasonable period, you’ve likely only experienced a temporary cashflow problem rather than insolvency.

However, if, like many businesses right now, your business has a large tax debt you can’t pay, chances are you’re insolvent.

If you let your accounting records and ATO lodgements fall behind during the pandemic, you may also be in a shaky position. These administrative challenges, which were a worrying trend during COVID-19, can also be early warning signs of insolvency.

Naturally, you want to pay your employees and suppliers to your business, but if your tax, super, finance or landlord debts start to go unpaid, these are serious signs of problems, and it’s definitely time to seek help.

What is insolvent trading?

Insolvent trading is when a business is insolvent but continues to trade and run up more debt. It falls under section 588G of the Corporations Act.

By continuing to trade when your business can’t pay its bills, you’re increasing the potential loss to those that deal with your business – and you can be held personally liable for these debts if they remain unpaid.

The penalties for insolvent trading can be severe. They can include disqualification from managing a company, fines of up to $200,000 and an order to pay compensation equivalent to the loss suffered by creditors.

Is insolvent trading a criminal offence? Yes, it can be. If you’re trading while insolvent, you can be referred to ASIC for further investigation and possible criminal prosecution.

A claim for insolvent trading can only arise if your company goes into liquidation. To make a claim, the liquidator must determine the date they believe you first had difficulty paying your debts and calculate all debts incurred since that date and still unpaid.

By continuing to trade while insolvent, as well as becoming personally liable for a claim for insolvent trading, it can also impact the potential availability and success of other options to rescue your business.

Is-Your-Business-In-Financial-Distress

Other debts a director can be held personally liable for

Insolvent trading is just one area of potential liability you can face as a director if your company is trading while insolvent. Importantly, when your company is trading while insolvent, it’s giving rise to further debts, including:

  • Superannuation and BAS debts, which, as director, you can be held personally liable for under an ATO director penalty notice
  • Landlord, supplier and finance debts which you may have signed personal guarantees for
  • Director loan account claims where your director drawings may be recoverable by a liquidator
  • Other less common claims that you can be held personally liable for

While company liquidation doesn’t automatically mean personal bankruptcy for you as a director, if you keep trading and become personally liable for the above debts, you may be forced to refinance or sell your house to pay them. Or look at personal insolvency options such as bankruptcy.

What should you be doing right now?

To ensure you’re not at risk of insolvent trading, the first step is to assess whether your business is viable. In other words, to determine if your company has the potential to survive and succeed.

According to the ATO, a business is viable if:

  • It’s returning a profit sufficient to provide a return to the owner while also meeting its business commitments
  • It has sufficient cash resources to sustain itself through a non-profit period

To carry out this assessment, you’ll need to look at documents including your profit and loss statement, your balance sheet, aged creditor listings, aged debtor listings and the total monthly repayments of all of your debts.

If there’s any question about your company’s ability to meet its debts, it may be insolvent. You should seek professional advice from a restructuring advisor to determine whether a turnaround or restructuring plan should be implemented.

The good news is, even if your business is experiencing insolvency, it doesn’t have to be the end of the road. If you act early, there are a number of options to keep your business on the right track, including:

  • Informal turnaround, which may include refinancing, and creditor negotiations and/or an ATO payment arrangement
  • A small business restructure, newly introduced from 1 January 2021
  • Voluntary administration in order to propose a deed of company arrangement (DOCA)
  • Selling your business – possibly to a related entity – before or following the appointment of a liquidator or administrator

If you enter into the small business restructuring process, voluntary administration or liquidation, your director liability for any further company debts ceases upon the appointment.

If you trade on with a turnaround plan, you can access safe harbour protection to avoid liability for insolvent trading – something any business undertaking a turnaround plan should consider.

If you’re struggling to pay your company debts and think you may be insolvent, the worst thing you can do is wait too long or do nothing.

Failing to act can lead to the ATO or another creditor commencing recovery action to pursue their debts from you personally or winding up your company.

As hard as it is to get help and save your business, in our experience, worse outcomes arise from doing nothing.

Get in touch with our experienced team today on 1800 534 534 or via the contact form for a free, confidential consultation to discuss your debt and insolvency concerns.

Topics: Voluntary Administration, Business Debt, turnaround, insolvent trading, corporations act, insolvent trading penalties, what is insolvent trading

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