To be or not to be… insolvent

| May 28, 2013

Do you ever go through stages where your business can’t pay its existing debts. Suelen McCallum discusses insolvent trading and what it could mean to you.

Much gets made of insolvent trading and all the threats and worries that go with it, but how much of an issue is it really, and why is insolvent trading a problem? 

Well, apart from the obvious continued losses to suppliers and the social and economic costs of those losses, there are statutory penalties that can make directors of those companies personally responsible for those debts. 

So, again, why is that a problem?  Shouldn’t those directors bear the consequences for their sins?  Well, especially for mid sized businesses, maybe not.

Firstly, how do those companies actually determine whether or not they are insolvent?  Do mid size businesses have all the skills and resources necessary to fully understand their financial position at any point in time?  In our experience, they still need a hand in getting to that level.

Secondly, management often makes that last ditch effort with the best interests of the business at heart. Such attempts often fail because those efforts and decisions are often made too late and without enough capital or other support behind them (refer back to the first point re lack of information!).

Thirdly, the business owners are often doing all that hard work without the benefit of independent and skilled advisors who can assist them through a very difficult phase.  They generally have no fallback and no guidance.  Skilled help is difficult to find because of those same insolvent trading laws, so business suffers again in a never ending cycle.

Finally, and I think very importantly, the concept of personal liability for insolvent trading is seen as hampering the risk taking that is part of entrepreneurship and business development, stifling growth in business, and acting as a deterrent to attracting suitably qualified people for management roles.

In 2010 the Labor government issued a discussion paper on some proposed changes to Australian corporations law, specifically in allowing directors a “get out of jail free” card which they could use in dire situations, by extending the business judgment rule to cover situations of possible insolvent trading.  Simply put, if directors obtained independent and expert advice in regard to the company’s financial position and undertaking a turnaround of the company’s position, and done so within a specified framework of checks and balances, then they had a defence against any claim for personal liability as a result of insolvent trading.  These changes were generally seen by the business community as being a positive step towards retaining the value of businesses by encouraging directors to seek assistance at an earlier stage; however the government decided it had no appetite to pursue the reforms and they were unfortunately dropped.

We need some champions to take up these battles once more – not only to encourage more of a turnaround mentality in Australian mid sized business but also to encourage that spirit of entrepreneurship and risk taking that seems sadly missing in the last few years.  For now, you’re damned if you shut shop because of the insolvent trading fears, and damned if you push on regardless.

Suelen McCallum is the CEO of dVT Consulting a member of the de Vries Tayeh group. dVT Consulting specialises in corporate strategy and turnaround management, particularly in the SME sectors, as well as due diligence, litigation support and business succession.