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In simple terms, insolvency is when a company is unable to pay its debts as and when they become due and payable. This does not necessarily mean that a company is or will become insolvent if they are unable to pay all of their debts at a particular point in time, or if their liabilities exceed their assets on either a ‘cash flow’ or ‘balance sheet’ test – there are a combination of factors that are taken into account when assessing whether a company is or likely to become insolvent.

Section 95A of the 2001 年公司法 (Cth),[1] defines solvency and insolvency as follows:

  • A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable.
  • A person who is not solvent is insolvent.

In terms of this definition, “person” refers to the company as it has a separate legal existence from its owners.

What causes insolvency?

As mentioned above, insolvency can be caused by a combination of factors, and it is important to recognise the difference between a ‘temporary lack of liquidity’ and ‘endemic shortage of working capital’, the latter being the more commonly accepted distinguishing feature of insolvency by the judiciary.

Some common indicators of insolvency include the following[2]:

  • Poor cash flow
  • Lack of cash flow management/budgeting
  • Liquidity ratio below 1
  • Inadequate accounting procedures and financial record keeping
  • Continuing losses
  • Excessive borrowing and increasing debt where liabilities are far greater than assets.
  • Inability and issues with obtaining finance or borrowing funds
  • Overdue Commonwealth and State taxes
  • Creditors unpaid outside trading terms
  • Dishonoured cheques
  • Payments to creditors of rounded sums, which are not reconcilable to specific invoices

What is the difference between insolvency and bankruptcy?

At times, the terms “insolvency” and “bankruptcy” are used interchangeably; however, although similar in definition, they are not the same. Put simply, insolvency pertains to a company, whilst bankruptcy pertains to an individual, as follows:

破產

  • Insolvency is when a company cannot pay its debts when they are due and payable.
  • Insolvent companies are governed by the Corporations Act 2001 (Cth).
  • The formal procedure that can be adopted for an insolvent company is to either be ‘wound up’ in insolvency (voluntary by its directors and shareholders, or involuntary by a creditor via either the expiration of a creditor’s statutory demand which creates a statutory presumption of insolvency, or via ‘just and equitable means’), or to enter into voluntary administration (voluntarily by its directors, or involuntarily by a secured creditor).

破產

  • Bankruptcy refers to the legal process whereby the individual is made bankrupt and a trustee is appointed. This process can either be done voluntarily by a debtors petition, or involuntarily by a creditors petition.
  • Bankrupt individuals are governed by the 1966 年破產法 (Cth).
  • In order for a debtor’s petition to be successfully presented, the individual must demonstrate that they would be unlikely (either immediately or within a reasonable time) to pay its debts as set out in a statement of affairs[3].

What are the consequences of insolvency?

If a company enters into an insolvent transaction or ‘trades whilst insolvent’, there can be severe consequences for directors and creditors alike. Generally speaking, an insolvent transaction may be able to be ‘clawed back’ by a liquidator of the company – from the director in their personal capacity via an insolvent trading claim (thereby piercing the ‘corporate veil’ of the company), or from the creditor who received the payment under the voidable transaction provisions in Part 5.6B of the 2001 年公司法 (Cth).

In more serious cases, insolvent trading can be referred to ASIC for investigation and possible criminal prosecution against the director’s.

As advisors, it is important to recognise when a client is or likely to become insolvent in order to provide timely advice that may help to negate or ameliorate the consequences referred to above.

文章作者 Betul Kaygisiz of our Melbourne office. Please reach out to our 破產 team if you require any assistance or advice.

[1] 2001 年公司法 (Cth) s95A

[2] Asic v Plymin (2003) 46 ACSR 126; Pearce v Gulmohar Pty Ltd [2017] FCA 660 at paragraph 156

[3] 破產 Act 1966 (Cth) s55(3AA)(a)