With uncertain times on the horizon, contractors must be aware of the rules surrounding insolvent trading set out in the Corporations Act.
Contractors rely on their customers to pay invoices for services rendered in order to pay their own outgoings such as wages and materials. However, when a major client stops paying or goes into liquidation, receivership or administration, it impacts the trading status of a contractor’s own company operations.
In these circumstances, the contractor may be in breach of the Corporations Act through no fault of the their own if the contractor continues trading. It is also interesting to revisit insolvency rules in the wake of the James Hardie Appeal as a director’s personal liability is of concern.
Insolvency is not actually defined in the Corporations Act but “solvency” is referred to in Section 92A(2) as being able to pay all debts as and when they become due and payable.
A business may be operational, continuing with work and issuing invoices, but at the same time be considered insolvent. All directors have a personal duty to prevent insolvent trading and may be liable for civil and criminal liabilities under the Act.
Creditors, liquidators or the Australian Securities and Investments Commission (ASIC) can issue proceedings against a director for compensation for an amount lost by the creditor. This can potentially lead to personal bankruptcy of the director and the loss of personal assets.
Civil penalties can be ordered by the Court and where dishonesty has been found criminal charges may follow. Directors, however, can be reassured to some extent by the recent decision of McCracken v Phoenix Constructions (QLD) Pty Ltd  QCA 129 that determined directors do not owe a direct duty to creditors which would give creditors the right to seek damages under the Act.
However, ASIC can seek damages under s.1324 in the name of the creditor, as seen in ASIC v Plymin and others (2003) 46 ACSR 126.
Contractors should be proactive in their approach to insolvency and directors’ liability. Many businesses leave it too late to seek advice and believe unpaid invoices will eventually be paid and put their cash flow problems down as a temporary situation.
Delaying payments, especially those to the ATO, is not advisable as there are new measures which may automatically make company directors liable for the unpaid taxes of the company.
Directors could resolve their issues by placing their company into administration with the aim of preserving their company and its business under a Deed of Company Arrangement (DOCA). By doing this, an administrator is appointed.
Creditors meetings are then called where the creditors are given the option to consider alternative courses of action available to the company and to review any proposed DOCA which might enable the company to trade out of its difficulties. The creditors vote on the DOCA, which typically seeks to return the control back to the directors and to balance the cash flow by allowing the company to meet debts as and when they fall due from the cash that is actually available to it. The creditors must vote in favor of the DOCA and accept the usually reduced and delayed repayment plan for the DOCA to be effective.
Successful implementation of the DOCA usually protects directors from personal liability in relation to insolvent trading. Options, however, vary depending on the structure of the business. For instance, sole traders in a similar situation may have the option to enter into a ‘Personal Insolvency Agreement’ to protect themselves from personal liability and bankruptcy.
Being proactive is a key factor; situations must be identified early and immediate action can be taken. Time is of the essence as the implications of insolvent trading go beyond the business and affect creditors and customers. Advice should be sought early regarding non-payment and how it will effect your business options.