02 9683 5999Most small business owners are not familiar with their legal obligations of being a director. However taking a few simple steps to comply can prevent life being stressful if your venture fails. All directors should be aware that the Corporations Act imposes important duties on directors;
- Duty to prevent insolvent trading
- General director duties
- Requirement to keep adequate books and records
General duties imposed by the Corporations Act on directors and officers of companies include:
- The duty to exercise your powers and duties with the care and diligence that a reasonable person would have, which includes taking steps to ensure you are properly informed about the financial position of the company and ensuring the company doesn’t trade if it is insolvent. A company is generally considered insolvent if it cannot pay all its debts as and when they are due.
- The duty to exercise your powers and duties in good faith in the best interests of the company and for a proper purpose
- The duty not to improperly use your position to gain an advantage for yourself or someone else, or to cause detriment to the company, and
- The duty not to improperly use information obtained through your position to gain an advantage for yourself or someone else, or to cause detriment to the company.
The National Insolvent Trading Program Report (NITP), released last month by the Australian Securities and Investments Commission (ASIC) is mandatory reading for small business owners who want to ensure they are complying with their director duties, should their venture collapse and leave a trail of angry creditors.
The key objective of the NITP was to encourage directors to identify insolvency indicators relating to their company and seek professional advice at an early stage. Key indicators of insolvency include, but are not limited to:
- Ongoing trading losses
- Cash flow difficulties
- Outstanding trade creditors
- Inability to obtain further finance
In addition the report identifies several key areas where there continues to be room for improvement by directors. These are as follows:
Maintaining Appropriate Books & Records
Directors must ensure that proper books and records are kept by the company taking reasonable and proper steps to keep themselves informed about the financial affairs of the company so that they are able to form a view in relation to the company’s present financial viability and the impact of incurring any further debts.
- As a director, you may need to undertake additional activities to ensure that you are sufficiently informed about the company’s position. Such activities may include;
- Being involved in the preparation of profit and cash flow budgets, regular management of accounts and monitoring the actual results against budget expectations.
- Review the company’s ability to collect debts owed to it and to realise other current assets (including stock) on a regular basis.
- Monitoring when creditors are due to be paid and the company’s ability to comply with normal terms of trade.
- Reviewing the company’s current bank lending facilities and its ability to access additional funding if required.
Identifying Insolvency Concerns & Assessing Available Options
As soon as there are reasonable grounds to suspect the company is suffering financial difficulty, directors should;
- Take steps to assess and confirm the financial position of the company and options available to deal with any financial difficulties.
- Carefully consider the solvency of the company before any new debts are incurred.
- Available options to address solvency concerns include;
- Obtaining and reviewing accurate and up-to-date financial information
- Restructure the company’s operations and financial affairs
- Obtain additional finance
- Seeking new funds via fundraising efforts
- Arranging formal repayment plans with creditors, including the ATO
Seeking Professional Advice
Directors should obtain appropriate advice from a suitably qualified, competent and reliable professional regarding the financial position of the company and how any difficulties can be addressed. Matters to seek advice on may include;
- Company solvency and whether the company is currently trading while insolvent
- Options available to the company to deal with and address any financial difficulties
- Whether it is realistically possible for the company to continue trading
- Whether the company should be placed into external administration
Acting In A Timely Manner
Where there are reasonable grounds to believe or suspect that the company is insolvent, based on the advice the director’s receive, directors should consider the immediate appointment of an external administrator to the company.
Alternatively the directors may implement a restructuring plan, however the directors need to continue to monitor trading to ensure the company’s continuing ability to meet its debts does not deteriorate. This is integral to the director’s duty to prevent insolvent trading and to act in the best interests of company stakeholders.
The key issue ASIC raises is the need to seek professional advice at the right time. A collapsing venture will not always have enough funds left to get good advice, and directors have usually exhausted their savings and are concentrating on saving their venture.
Below are some tips for small business owners to follow to ensure their business continues to operate successfully:
- Consider asset-protection strategies before starting a venture. If starting a venture with partners, being a sole director will expose you to the risk of accessible assets and litigation.
- Don’t be blinded by your company’s success. Always consider all possibilities such as venture failure.
- Don’t form overly positive forecasts. Always consider a number of different trading conditions.
- Ensure you have strong accounting systems in place from the beginning and always be aware of the cash flow cycle and trading performance of your business.
