Insolvency is the inability of a debtor to pay their debt. Cash flow insolvency involves a lack of liquidity to pay debts as they fall due. Balance sheet insolvency involves having negative net assets—where liabilities exceed assets. Insolvency is not a synonym for bankruptcy, which is a determination of insolvency made by a court of law with resulting legal orders intended to resolve the insolvency.
A business may be cash-flow insolvent but balance-sheet solvent if it holds illiquid assets, particularly against short term debt that it cannot immediately realize if called upon to do so. Conversely, a business can have negative net assets showing on its balance sheet but still be cash-flow solvent if ongoing revenue is able to meet debt obligations, and thus avoid default: for instance, if it holds long term debt. Many large companies operate permanently in this state. However, Bankruptcy is when the individual is cash flow insolvent and at the same time balance sheet insolvent.
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 • 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. Duty to not trade while insolvent
As well as general directors’ duties, you also have a positive duty to prevent your company trading if it is insolvent. A company is insolvent if it is unable to pay all its debts when they are due. This means that before you incur a new debt you must consider whether you have reasonable grounds to suspect that the company is insolvent or will become insolvent as a result of incurring the debt. An understanding of the financial position of your company only when you sign off on the yearly financial statements is insufficient. You need to be constantly aware of your company’s financial position. Duty to keep books and records
Your company must keep adequate financial records to correctly record and explain transactions and the company’s financial position and performance. A failure of a director to take all reasonable steps to ensure a company fulfils this requirement contravenes the Corporations Act.
Insolvent, may affect the assets available for distribution by existing stakeholders reduction. Even in the case of insolvent business will not result in the loss of the value of the company, it may impact on the transfer of losses from the company's existing shareholders and creditors, the company continued to transactions arising new creditors.
The company is in no danger; there may be an incentive to management to engage in the behavior, and the interests of the shareholders, the risk of loss to creditors unacceptable disproportionate level. However, with these actions, shareholders because their shares can be no real value, it may be without its drawbacks, they will benefit from any success. Therefore, the company can afford the high-risk rescue attempt, or may try to just keep the terms of trade or some happenstance unlikely hope of a turnaround. Even with self-protection measures are feasible, differences in bargaining power may lead to some creditors are effectively protected or fair bargain with the results.
4.1 Non-payment of Tax Liabilities
A Company will often forgo the payment of its tax liabilities to ensure that it has sufficient cash flow to meet its wages and critical...