When you are in the throws of running a small business, you will sometimes trade close to the wind. However, provided you have funding in place and you’re working to your business plan, you shouldn’t have to worry about insolvent trading issues.
Sometimes though, things don’t go as you planned. Revenue may be delayed or unexpected costs brought forward – and all of a sudden you find yourself in a tight cash flow position. In addition, as a company director, you may need to take calculated commercial risks to achieve your longer-term objectives. So, if you feel that you’re taking actions that could lead the company into an insolvent situation, what are your options?
The good news is that the Corporations Law now provides a ‘Safe Harbour’ option to assist directors to continue to trade without the fear of insolvency action against them. Introduced in September 2017, the Safe Harbour reforms are designed to help you keep control of your company instead of appointing an insolvency practitioner. The key is that there must be a real and high probability that the company directors will be successful in their plans.
Signs of potential business insolvency
Firstly, how do you know when you’re running into insolvency territory? ASIC’s ASIC Information sheet 42: Insolvency: A guide for directors, provides very useful guidance. Regulation Guide 217 sets out fifteen (15) factors that are potential indicators of insolvency. Although this is not meant to be a specific test for the purposes of determining if a company is insolvent, it is very useful to know when you’re heading into stormy waters. The guide outlines some well-recognised indicators of insolvency:
- Ongoing losses
- Poor cash flow
- Liquidity ratios below 1
- Absence of a business plan
- Incomplete financial records or disorganised internal accounting procedures
- Creditors remain unpaid outside usual trading terms
- Company is receiving solicitor’s letters, letters of demand, or summons, judgements or warrants are issued
- Overdue taxes and superannuation liabilities.
What is the Safe Harbour exception?
The Safe Harbour exception to insolvent trading is available under section 588GA(1) of the Corporations Act 2001. Directors can avoid liability for insolvent trading if, once they suspect the company may become insolvent, they develop plans for one or more courses of action that are reasonably likely to lead to a better outcome for the company.
The Safe Harbour provision is not available if the company is failing to pay employee entitlements or complying with its tax obligations.
How to stay within the insolvency Safe Harbour provisions
Recommendations to ensure directors are within the Safe harbour protections include:
- Regularly and properly informing the directors of the company’s financial affairs. This may be as intense as regular weekly cash flow meeting and director approval for making any payments.
- Taking steps to ensure the company is keeping appropriate financial records
- Obtaining advice from an appropriately qualified party, ie a lawyer.
- Developing or implementing a plan for restructuring the company to improve its financial position.
It is important to keep comprehensive meeting minutes capturing the decisions of the directors to help ensure the company is trading under Safe Harbour protection. In particular, minutes need to include the reasons that your business actions are likely to lead to a better outcome in a reasonable timeframe.
The insolvency Safe Harbour will cease, however, if the directors do not take the action planned within a reasonable period, or where the course of action ceases to be reasonably likely to lead to a better outcome, or an administrator or liquidator is appointed.
Prevention of insolvent trading is better than cure
We certainly hope none of our director clients find themselves in a possible insolvency position. Accru advisors are of course here to assist in your planning and cashflow management to prevent that possibility. Understanding funding needs, cashflow forecasting and good business planning are all part of the business management services we offer. Please contact us to find out more.
However, if you do get capsized, it is some comfort to know that there is now an Insolvency Safe Harbour option to create a temporary respite so you can try to get the wind back in your sails.