If your business is struggling financially, you may have heard terms like ‘winding up’ or ‘liquidation’. But what do these terms mean and what happens to you as a business owner if your company is wound up? This article explains what insolvency means for you as a company director, and what options are available to you.
Is My Company Insolvent?
Under s 95A of the Corporations Act 2001 (Cth), a company is insolvent when it cannot pay all of its debts as and when they become due and payable. This is not about what the company owns on paper – it is about whether it can actually meet its obligations when they fall due.
There are some common signs your company may be insolvent:
- Your company relies on credit cards to cover everyday expenses;
- Your company falls behind on ATO obligations (such as BAS or PAYG);
- Creditors sent a statutory demand or letters of demand; or
- Suppliers demand cash upfront or cutting off credit
Legal tests for insolvency
Under s 95A of the Corporations Act, insolvency is defined as the inability to pay debts as and when they fall due. Put simply – it is a cash flow question, not a balance sheet one. A company can own significant assets on paper and still be legally insolvent if it cannot find the cash to pay what it owes today.
For example, a company with property worth $2 million that cannot pay a $50,000 supplier invoice on time may legally be insolvent – even though it looks financially healthy on a balance sheet.
What are my options as a director?
Many directors assume that once a company is in financial trouble, there is nothing left to do but shut the company down. That is not true – there are a few steps before a company is wound up by the Court.
- Voluntary Administration
Voluntary administration places the company under the control of an independent administrator. This gives you time to explore whether the business can be saved through a Deed of Company Arrangement (‘DOCA’)
This usually happens before winding up – it is a pre-insolvency tool. After an administrator is appointed, a moratorium kicks in immediately. This will pause most creditor action, legal proceedings, and enforcement.
The creditors will then vote on three outcomes:
- Execute a Deed of Company Arrangement (DOCA)
- Return the company to the directors – if the administrator believes it is solvent.
- Place the company into liquidation.
- Winding Up
If the business is no longer viable, an orderly winding up may be needed for creditors and for you personally. A creditors’ Voluntary Liquidation allows you to initiate the process before a creditor forces it through the courts. Acting voluntarily gives you more control and reduces the risk of personal liability continuing to accumulate.
If you do not act, a creditor may take the decision out of your hands. A creditor – most commonly the ATO – can apply to the court to have the company wound up compulsorily under s 459A of the Corporations Act. This process typically begins with a statutory demand: if the company fails to pay or dispute the debt within 21 days, the creditor can apply for a court order. Once made, you lose control of the company and a liquidator is appointed.
- Receivership
Receivership is not an insolvency process initiated by the director or a court in the same way. It is initiated by a secured creditor – typically a bank – who exercises a contractual right to appoint a receiver under a security agreement (such as a General Security Agreement or mortgage).
When the company defaults on a secured loan – for example, missing loan repayments to a bank – and the bank exercises its contractual right to appoint a receiver. This can happen quickly and without warning to the director. In practice, receivership usually leads to the company being wound up afterwards because the secured assets have been sold.
What Happens to Me Personally?
If you are the director of an insolvent company, you might be personally liable for debts incurred after the date of insolvency. As a director, there are three common situations that you need to be aware of:
- Insolvent Trading
Under s 588G of the Corporations Act, you can be held personally liable for debts incurred by the company while it was insolvent, if you knew – or ought to have known – that the company could not pay its debts. The liquidator can pursue you directly for compensation.
- Director Penalty Notice (‘DPN’)
If your company has unpaid PAYG withholding, superannuation guarantee charges, or GST, the ATO can issue a DPN that makes you personally liable for those debts. You cannot avoid these obligations simply by closing the business.
- Personal Guarantee
If you signed personal guarantees for business loans, leases or supplier accounts, you become personally liable for those debts. Creditors can pursue your personal assets to get paid.
What can Verge Legal do to help
We understand that this is a stressful situation a business owner can face – and we are here to help you understand your options clearly. At Verge Legal, we work with small business owners and directors who are facing exactly the kinds of issues described in this article.
If you have any questions, please feel free to contact us to further discuss your matter.
(Please note: this article provides general legal information only and is not legal advice. If you believe you have been affected by any of the issues described above, you should seek legal advice as soon as possible.)