Section 95A(1) of the Corporations Act 2001 (Cth) defines a ‘person’ (which includes a company) as being “solvent if and only if, the person is able to pay all the person's debts, as and when they may become due and payable.” Insolvent is defined in s95A(2) as being unable to pay all of its debts as and when they become payable. This definition clearly places the test on a cash flow test rather than a balance sheet test.
The courts showed this line of thinking with Austin J in Australian Beverage Distributors Pty Ltd v The Redrock Co Pty Ltd [2008] NSWSC 3. The courts affirmed that an assessment of a company’s solvency should be made on an overall basis and should consider questions such as, whether the company’s financial difficulty stems from a temporary lack of liquidity or an endemic shortage of working capital.
This thinking was also shown by Austin J in Lewis v Doran (2004) 184 FLR 254 in that the commercial realities of the company must be considered, and the financial position must be examined as a whole.
The affirmation of that case refers explicitly to the judgment in Southern Cross Interiors Pty Ltd v Deputy Commissioner of Taxation (2001) NSWSC 62. Palmer J outlined 6 propositions with regards to determining whether a company is or was solvent at a particular time. These are summarised as follows:
In summary, the court must consider whether a company can procure funds by realising or borrowing against assets within a relatively short period of time. This principle can also extend to the acquisition of unsecured funds by way of a loan such as a Directors Loan.
While the courts process of determining solvency includes a broad analysis, there are explicit times when an entity is determined to presumed insolvent. These are listed in s459C of the Corporations Act 2001 (Cth) and include:
For many small to medium businesses, they will at some point be served with a Statutory Demand under 459E of the Corporations Act 2001 (Cth). It is crucial that the directors of the company take this demand seriously. If it is not, the company can be wound up and the directors face possible personal liability under breach of the Corporations Act 2001 (Cth).
Conclusion
It is crucial that Directors and Secretaries take their role seriously and understand whether the company is solvent or insolvent. If you have concerns whether your company or your client’s company is solvent and would like to know the options please contact James Frank at jfrank@franklaw.com.au
The Key Takeaway
Understanding whether your company is solvent is like ensuring your car’s brakes work. If they don’t work, you will eventually find out, but it will be too late.
This is not legal advice.