The Australian Securities and Investments Commission (ASIC) is piloting a scheme designed to identify and engage with companies that are on the verge insolvent trading.
There are major civil and criminal penalties that apply to the directors of companies found to have been trading while insolvent – but it is generally only ever acted upon after a company has collapsed. ASIC is now formulating a plan to attack the problem much earlier in the piece. Executive director of public and commercial services at ASIC, Mark Drysdale, said IT companies are among those being targeted by the regulator.
“Insolvent trading is a high risk in the IT sector as it is an area where managing a business is quite often not the director’s core skill,” Drysdale said. “Often it is only their first or second time at running a company.”
The issue is particularly problematic for the directors of businesses in the IT channel – where small margins and inconsistent sales patterns have had many operators teetering on the edge of ‘calling it quits’ for several months or years. It is very difficult for such companies to know when they are in danger of trading while insolvent. Even under Federal law, there is no concrete definition of what insolvent trading is. A recent paper by law firm Allens Arthur Robinson, for example, stated that the only way to define if a company is insolvent is if it is “not solvent”.
A reasonable definition of insolvent trading is continuing to trade under the knowledge that you do not have the cash flow to pay your debts.
ASIC has identified several practices that would indicate being insolvent – including poor cash flow or no cash flow forecasts, disorganised internal accounting procedures, incomplete financial records, continuing loss making activity, accumulating debt and excess liabilities over assets, default on loan on interest payments, outstanding creditors of more than 90 days, and difficulties in obtaining finance.
ASIC’s usual role with regards to insolvent trading is to wait until after a company has collapsed to check whether the directors of the company need by prosecuted for insolvent trading. But after some of Australia’s largest corporate collapses in recent years, the watchdog is looking to be more proactive in the market.
ASIC recently formed a National Insolvency Co-ordination Unit – which alongside insolvency experts from PricewaterhouseCoopers and Ernst & Young, is targeting directors suspected of insolvent trading.
The pilot program, in Sydney and Melbourne, has targeted a select group of companies considered to be candidates for insolvent trading. These targets are selected via complaints from the public and intelligence gathered from financial services organisations such as credit agencies and insolvency practitioners. “Most often the complaints are made by a business’ creditors or company officers,” Drysdale said.
In the first couple of months of a six-month pilot, ASIC has approached 130 companies associated with 35 directors – several of which were involved in the IT industry. Of these, there have been five insolvency appointments (companies placed in administration or liquidation), a further five companies in the process to do the same, and 57 companies preparing further information for ASIC investigation.
Companies that ASIC is proactively targeting are generally issued notices under the ASIC Act, compelling the company to provide the watchdog with requested information about its operations.
ASIC then discussed the company’s finances and formed a view as to whether any further action was required, Drysdale said.
“We ask the director to prepare a proper set of management accounts,” he said. “We explain to the director the risks that are involved, and the way the civil provisions work. Most directors at that point choose to have the company put into administration or liquidation. If they do not, and we believe it needs to be wound up, we take an enforcement response and let the court determine the outcome.”
An insolvency specialist and partner at Allens Arthur Robinson, Michael Quinlan, said directors of companies need to be ever more cautious of insolvent trading in the current economic environment since the collapse of HIH Insurance.
Ever since the massive corporate collapse, insurers offering Directors and Officers Insurance have started inserting exclusion clauses in their contracts for any liability associated with insolvency. Effectively, under the majority of insurance policies available to company directors, insurers will not foot the bill for any charge related to insolvent trading.
Drysdale said insolvent trading had a dramatic impact on the industry – both in terms of its effects on an insolvent business’ unpaid creditors (such as distributors and vendors) and its effect on competitors who were competing at a higher cost base while ever they were able to meet their debt obligations.
And while ASIC was very careful about where it applies its resources, Drysdale said insolvent trading had been earmarked as an area of major interest for the commission.
“I would expect that, given the success of this trial, the program will be rolled out on a much larger scale and into several more geographies,” he said.