Directors in Troubled Times: Notes for Company Directors

When debtors are beating on the door, how do directors sleep at night?

“Like babies. They wake up in the middle of the night crying and screaming and frequently need a drink”.

Of course, there are far more company directors than babies. There are about 2 million company directors in Australia. In my experience, they range from the directors of publicly listed companies at the “big end of town”, to the directors of the small family company, credit unions and professional bodies to the local sporting club.

The crying and screaming comes as no surprise. The “GFC” hit businesses hard. The economic decline affected many components of the Australian economy, including business development and business confidence, markets, jobs and the availability of credit.

Whilst the media often focuses on publicly listed companies encountering ‘management’ versus ‘board’ issues and high level corporate governance, a lot of these concerns just aren’t relevant to all business people and directors.

So what is on the minds of our company directors?

Well, the risks of insolvent trading, for starters.

In the recent case of Hall v Poolman [2007] NSWSC 1330, Justice Palmer offered guidance as to when company directors would be found to be trading whilst insolvent. And whilst the guidance was lengthy, it ultimately came down to the “90 day rule”. One of the key questions you should ask yourself is this:

“How sure are we that this asset can be turned into cash to pay all our other debts, present and to be incurred, within 3 months?”

The Court said that if the honest and reasonable answer is “certain” or “probable”, the director can have a reasonable expectation of solvency. If directors are acting honestly and ought reasonably be excused, they can be usually expect to be excused under ss 1317S and 1318 of the Corporations Act 2001 (Cth), something which is reassuring for all directors.

However, even though this guidance is reassuring, directors’ obligations to inform themselves as fully as possible of all company affairs remain onerous.

The Corporations Act 2001 (Cth) provides for civil penalties up to $200,000, compensation proceedings and criminal charges with potential penalties of up to 5 years in jail for those directors found to be trading whilst insolvent without a reasonable excuse. As directors can be found personally liable for insolvent trading, the question of asset protection then becomes an important one.

Of course, we all know that the life blood of any business, whether a company, partnership, association or sole trader, is CASH. Directors and business managers must keep a close eye on the company’s current and forecast cash position and cash flow.

From our experience, if a business is solvent but has a poor cash flow, then this usually presents a great opportunity for the owner to improve the cash flow and reap the financial benefit of doing so. Often the improvement to the business’s cash flow can be made with some effective tweaking of its existing processes. For example, it could be as simple as tightening the business’s terms of trade and implementing a stricter credit control policy.

So what do you do if you believe your company is on the brink of insolvency? Steps could include refinancing, restructuring or changing your company’s activities, or appointing an external administrator so there’s an attempt to trade out of insolvency before the company is wound up.

And if you’re involved in running a local sporting club, don’t be fooled that you’re an exception to the rule.

Committee members of not-for-profit associations have similar obligations. In fact, it is an offence for an association to incur a debt if there are reasonable grounds to expect that the association will not be able to pay its debts as and when they become due. Insolvency should not, however, be concluded merely because of a temporary lack of liquidity, for example, when an incorporated association can’t pay its debts for a short period of time prior to receiving capital in the form of a grant. The focus should be on the entire commercial reality – the type of business, the nature of its assets and the likelihood that incoming capital can be regarded as “immediately realisable”.

In troubled economic times, an even wider consideration is this: is the company a going concern and will it be around in 12 months time? At the end of the day, actively considering your company status and future cash flow is simply good business management and can help directors avoid a personal liability situation.

If you have any concerns about your business’s solvency, cash flow or you require ongoing advice about business structure and asset protection, please don’t hesitate to contact our Commercial Litigation Team.