Trading whilst insolvent
In sole proprietor or partnership businesses, the owner or partners are personally liable for the debts of the business.
These days, many businesses are proprietary limited corporations—these are owned by members, and operated by directors. In many family-run corporations the owners and directors are the same people.
This structure is normally suggested by accountants and lawyers in order to limit liability but, as a general comment, the directors of family-run companies would not have the first idea about their roles and responsibilities as directors and these are rarely explained to them.
When businesses are experiencing very poor cash flow, directors should be very wary of 'trading whilst insolvent'. This occurs when a business buys materials or services on credit in the knowledge that they cannot meet the credit terms.
The potential effect on company directors should not be taken lightly. The following points come from the ASIC website:
- Contravening the insolvent trading provisions of the Corporations Act can result in civil penalties against directors, including pecuniary penalties of up to $200,000
- Compensation proceedings for amounts lost by creditors can be initiated by ASIC, a liquidator or a creditor against a director personally. A compensation order can be made in addition to civil penalties.
- Compensation payments are potentially unlimited and could lead to the personal bankruptcy of directors. The personal bankruptcy of a director disqualifies that director from continuing as a director or managing a company.
- If dishonesty is found to be a factor in insolvent trading, a director may also be subject to criminal charges (which can lead to a fine of up to $220,000 or imprisonment for up to 5 years, or both). Being found guilty of the criminal offence of insolvent trading will also lead to a director's disqualification.
In practice, legally determining when a company is trading whilst insolvent may not be straightforward.
However, ethically, if a customer buys goods on credit knowing full well that payment will not be made within the credit term, that is a sufficient initial ground for personally recognizing that insolvent trading is taking place.
This should prompt a complete appraisal of business performance and financial position.
Screwing suppliers (continued next month)
See this article in Tree Fruit May 2015
