How long can I keep going like this?

In dealing with the financial distress of their company, a key dilemma for the director is “how long can I allow this to go on for?” Responses to this question range from: “When we run out of options” to “When someone shuts us down.”

There are commercial and legal dimensions to this question. Commercially, the broad answer, not surprisingly, is the faster the problems are resolved the better. Damage to the balance sheet increases as time goes on. Trading results also deteriorate as management become increasingly distracted by the distress.

In respect of the balance sheet, however, considerations go deeper. Where the debts accumulate also matters, as it affects the choices of solutions available to resolve the crisis.

The more common place to quarantine the stress is the ATO. Cash flow shortfalls are easily plugged temporarily by not paying GST, PAYG and superannuation. Easily done and you can always enter into a payment plan later on when things improve. The problem with this strategy is that it takes informal restructuring solutions off the table. Sophisticated investors are unwilling to fund ATO liabilities as doing so adds nothing to the business’ value. You have therefore removed a possible source of external capital. Furthermore, the ATO is unable to compromise tax debts except as part of a deed of company arrangement or small business restructuring. Neither of those processes can be done informally. (Non-payment of tax debts also carries with it the risk of a director penalty notice.)

Contrast the ATO approach with containing the damage within trade creditors. This strategy keeps the door open for informal restructuring solutions. Compromises / new arrangements can be negotiated with individual suppliers. Investors are also open to funding supplier debts where those relationships are central to the business going forward. This approach is usually viewed as being unattractive because disclosing financial difficulties to key trading partners is hard. However, our experience is that the responses received in these circumstances are most often supportive. The key is ensuring that the company’s commitments in agreed concessions are adhered to – developing plans that under-promise and over-deliver have never been more important.

We move next to the legal dimensions of our question. Here, the director is considering (consciously or otherwise) the prospect of the company becoming insolvent. Being insolvent means that you are not able to pay all of your debts as and when they become due and payable.[1] It is a technical term that grows in importance when a company fails. At that time, the question posed shifts from, “Is the company insolvent?” to, “When did the company become insolvent?” Timing is important because the date the company objectively became insolvent is the start date for the calculation of a possible insolvent trading claim against the director.

The time period after which a director should recognise the company is insolvent will turn first on the facts of the situation. For example, it may be as little as a week if at the end of that week a legal judgement is made crystallising a substantial award against the company that it has no way of paying. On the other hand, the company’s trade debts may have extended payment terms, such that the director has six months to resolve the present distress. Generally, however, directors should be guided by the period of three months to resolve the distress. Three months is the time frame put forward by the courts in insolvent trading decisions.[2]  At the end of that time frame, if a sustained recovery has not begun, the company is arguably insolvent and the director is personally exposed.

If your company is in financial difficulty and you are considering options, one of your actions should include a conversation with us. There is no charge and the discussion will help you frame the problem, the constraints in solving it, and the legal and commercial strategies to mitigate loss. Contact us to arrange a discussion. Our goal is to develop a path out of the sea of negative you may find yourself in.

[1] Section 95A of the Corporations Act 2001.

[2] Hall v Poolman [2007] NSWSC 1330, [269] (Palmer J).