Back from the brink

• Josh Mehlman
• 19 November 2008
• Page 1 of 2 : single page

The issue of insolvency was brought home to Nett and its readers in a dramatic way, when the company organising Donald Trump’s tour of Australia – heavily promoted in last month’s magazine – went belly up.

Promoter Malcolm Quinn’s company The Concept Store had already paid Trump the majority of his $2.5 million speaking fee. However, by early October Quinn’s firm had only sold a reported 1500 out of 8000 tickets. Unable to find sufficient cash to pay the bills, Quinn put his company into voluntary administration.

The administrator, Brisbane-based SV Partners, quickly put the firm into liquidation. The firm’s creditors – among them people who bought tickets, venues where Donald Trump was to speak and Trump himself – may be repaid a small fraction of what they are owed. [The Concept Store booked advertising space in the last issue of Nett, which means this magazine’s publisher is among the creditors. –Ed]

Almost every business has cashflow problems from time to time, but how do you tell if you’re in danger of going bust? What’s the difference between administration, insolvency, liquidation and receivership? And is your business career over if it happens to you?

A quick guide to insolvency

An insolvent company is “one that is unable to pay all its debts when they fall due for payment”, according to the Australian Securities and Investments Commission (ASIC) publication Insolvency: a guide for directors.

ASIC advises that unless you find a way to restructure or refinance those debts, an insolvent company must either go into voluntary administration or appoint a liquidator.

Voluntary administration means placing the company in the hands of an independent administrator who looks after the financial affairs of the company and its creditors. It is an opportunity to give an organisation time and breathing space to work out the best way to return creditors the money they are owed. Following voluntary administration, a company can:

• Pay back its creditors and go back into business
• Go into liquidation, which means the company is closed down, and its assets are sold off and divided among the creditors
• Enter into a deed of company arrangement with its creditors, in which creditors immediately receive a percentage of the money they are owed, giving the company a chance to pay back the rest later.

A company can also involuntarily be placed into administration or liquidation by a court or the Australian Taxation Office. A secured creditor – one that holds security over some of the company’s assets, such as a bank – can place a company into receivership. The aim of receivership is to administer the sale of those secured assets so the creditor can get its money back.

According to the Australian Securities and Investments Commission, 765 businesses entered external administration for the first time during August 2008 (the last month’s data available at time of writing).

In Australian terminology, ‘bankruptcy’ is a personal form of insolvency in which an individual can’t pay back his or her debts. In the United States, bankruptcy can refer to a person or a company.

Personal liability

Here’s the good news: there’s a big difference between having a few overdue bills and being insolvent.

“A temporary lack of liquidity is not insolvency,” says Paul Cook, president of the Insolvency Practitioners Association. “Nor is an excess of liabilities over assets.  It is only when the company cannot meet all its ongoing liabilities that it becomes insolvent.”

And here’s the bad news: you may become personally liable if your company trades and incurs further debts while it is insolvent.

“The Corporations Act has the power to make directors personally liable for insolvent trading of companies,” says James Stewart, partner at insolvency and turnaround specialist firm Ferrier Hodgson.

“If a director knows there’s a reasonable prospect their company is insolvent, or may become, they have to tread very carefully. If the company incurs debts it can’t pay when directors know or should have known it can’t pay, they can be personally liable.

“There’s a very heavy onus on directors. If these problems are happening, the law says you’re not allowed to continue to incur new debts – buying supplies or signing new leases – unless you have an expectation that you can pay those debts as and when they fall due.”

Signs of trouble

Given that is the case, business owners may be keen to know how they can tell if they’ve crossed over the line and are in danger of being insolvent.

“That’s the $64 million question,” says Cook. “There are warning signs in your accounts – high-level things like debt and liquidity ratios. You need to monitor these ratios and have good cashflow planning that extends out a number of weeks.

“There are also warning signs from other people. If an existing supplier says they want to put you on cash-on-delivery or prepay terms, that could indicate difficulties within their business, but is more likely to indicate they have a concern about your ability to pay them.”

The Australian Taxation Office is another good bellwether for a company that is having difficulties.

“Normally when we get involved with a company, they’re in arrears of GST, PAYG and superannuation,” Stewart explains. He warns that the ATO is not to be trifled with.

“The tax office can issue director penalty notices. It can say to a director, ‘Your company owes $100,000 in GST’, for example. If the company doesn’t pay, reach an agreement to pay or go into administration within the next 21 days, the director will become personally liable for that tax debt.”

ASIC provides an extensive list of potential warning signs (see 'warning signs' below).

In the current economic climate, larger companies are running into trouble more than small businesses, Cook says. However, that means smaller businesses need to keep a close eye on their major customers.

“A director might be aware that a major customer is either insolvent or about to go broke; that could have a knock-on effect,” says Stewart.