In the business world, there is a range of risks associated with commercial agreements. Directors are tasked with ensuring that these risks are mitigated, however, this is not always possible.
In Australia, the majority of insolvencies affect SMEs. According to the Australian Securities and Investments Commission (ASIC), 79 per cent of all insolvencies in the 2014-15 financial year were by businesses that employed less than 20 people.
In Australia, the majority of insolvencies affect SME.
A good way to reduce the impact of insolvency is by enlisting the expertise of a professional lawyer whenever you sign a commercial contract.
What does insolvency mean for directors?
A director's role is to ensure that a company is compliant with general economic principles and more specific legislation that applies to the company's operations. Moreover, a director is primarily focused on servicing the company's shareholders – for instance, fulfilling financial obligations and responsibilities in relation to them.
In Australia, directors must act in accordance with the duties outlined in the Corporations Act 2001 (Corporations Act). These include:
- The careful and diligent execution of powers in relation to the financial status of the company;
- When powers are utilised, the needs of the company come first;
- To not use his or her powers in a way that will lead to personal gain.
However, in the event of insolvency, a director's role expands to incorporate the company's obligations to creditors.
If a company becomes insolvent, the director is also tasked with preventing it from trading and thus incurring new debts. This duty involves the assessment of the company's financial state to determine if the organisation will be able to satisfy its obligations to service its debt.
To fulfil this duty, a director must be in a position to understand the financial status of the company at all times.
A second key duty is the safeguarding of the company's financial records. This is especially important as a director will be asked to explain a company's transactions during any insolvency proceedings.
What are the consequences of insolvent trading?
If a director is found guilty of insolvent trading, they may be liable to a range of penalties and legal consequences. These can include:
- Civil consequences;
- Compensation lawsuits;
- Criminal charges.
The Corporations Act affords a series of statutory defences for a company's directors. However, to properly access these, directors will need to have complied with their expanded duties during the period of insolvency.
To properly understand these duties, directors are encouraged to seek the counsel of experienced commercial lawyers. If you believe your company may be in financial trouble, contact McCarthy Durie Lawyers today.