In most cases directors have done nothing wrong in the lead-up to a Creditors Voluntary Liquidation (CVL) and are rarely intentionally insolvent. As such they are unaware of any common risk areas.
Once the CVL starts, Liquidators review and make sure any unintentional actions undertaken by directors in the best interests of the company are appropriately dealt with. But your’re probably thinking it’s a bit too late now.
So how can you minimise these risk areas in a CVL with early problem identification.
Let us explain the potential risk areas for directors.
Illegal Phoenix Activity
Illegal phoenix activity relates to a transaction where a company director transfers the assets (i.e. plant & equipment, stock, customer list, etc.) of an insolvent company into a new company in which they are also company director or otherwise associated with.
Directors looking to start up again and transfer assets out need to be aware of the restrictions placed on them by the law.
Illegal phoenix activities are a breach of directors’ duties, in that case, you should also be aware that civil and criminal penalties exist and director banning for illegal phoenix activities if identified by a Liquidator.
We would suggest that you understand the legal repercussions of being involved in this type of transaction and suggest you stay free from the penalties of getting it wrong.
Insolvent trading occurs when directors allow a company to incur debts even though they are aware that the business operations are unable to pay them as and when they fall due, making the company insolvent.
The law states that a director of a company has an obligation to prevent a company from trading whilst insolvent (insolvent trading is illegal).
Directors found guilty for insolvent trading, may become personally liable for the repayment of debts incurred after the company became insolvent. This might result in the loss of personal assets (i.e. family home) and even personal bankruptcy.
ASIC Director Banning
The Australian Securities and Investments Commission (ASIC) may disqualify a person from acting as a director or being involved in the management of a company for up to 10 years.
An ASIC banning order would relate to any or all the following:
- Failure to exercise due care and diligence.
- Failure to exercise good faith.
- Improperly used your position as a director.
- Improperly used information you had obtained as a director.
Directors should be mindful as to who they seek advice from when their company is experiencing financial difficulties to protect themselves from potential director disqualification.
Unfair Preference Payments
If significant payments (identified as unfair preference transactions) have been made to associated entities, friendly suppliers or other company suppliers in the statutory period leading up to the CVL then a Liquidator can overturn these transactions previously entered by the company.
Unfair preference payments are important for directors to consider when the company is insolvent. Clearly paying friendly suppliers and associated entities is risky and as this provides them a better position than other creditors should a company be placed in a CVL.
In most cases, company assets are subject to leases, hire purchases or any other finance agreements that typically have a guarantor, being the company directors. So, any leases in the name of an individual or an individual has guaranteed a lease on behalf of the company, then personal liability for the lease may exist.
Once a company has been placed into CVL, there is often scope for negotiating in these circumstances.
Directors should understand whether a personal guarantee has been provided when the company is borrowing. This might apply to company loans, bank overdrafts, asset finance agreements (i.e. leases), factoring agreements, credit cards, and trade supply accounts.
In the event of a CVL of a company, a personal guarantee may mean the responsibility for paying the guaranteed debt may pass onto the director who provided same.
We often see at times that directors have provided a personal guarantee but don’t understand the consequences of them.
It is common upon the commencement of a CVL that director loan accounts are not recorded correctly. So, it’s important that company accounts are up to date to ensure that any claim can be fully verified especially if directors owe money to the company.
Also, if directors are drawing down on their loan accounts for the period leading up to the CVL there must be a very strong commercial reason to do so. Should a Liquidator have reason to believe that the nature of these payments/transactions are voidable transactions, a Liquidator with the assistance of the Court can overturn these payments/transactions.
Poor Advice from Unregulated Advisors
Quite simply, if you are not dealing with the individual who will be your Liquidator, who are you talking with? Directors getting advice from unlicensed advisors should be careful if they say there is no need to address any of the above prior to a CVL. Note that these advisors will not be the appointed Liquidator, so seek professional advice from a register Liquidator if you are concerned any of the above may relate to you.
Remember that a Liquidator will be in control of the company placed into CVL.
By identifying these potential risk areas, a strategy can be implemented to minimise or even eliminate any of these risks. Our registered Liquidators (i.e. Insolvency Practitioners) can help you understand any of these risk areas that may affect you.
So, if you have any concerns relating to the common risk areas for directors, please contact our Insolvency Practitioners at What Is Liquidation.