In 2023, media reports highlighted a significant surge in formal insolvency appointments, marking a sharp contrast from the COVID-19 pandemic days of 2020 to 2022. Voluntary administrations witnessed a notable 42% increase, while receiver and manager appointments skyrocketed by 56% compared to the preceding year. There were 10,366 corporate insolvencies in FY22/23, the highest level since 2019, in which 11,224 insolvencies were recorded.
We expect that the number of insolvency appointments will continue to increase, particularly as the ATO and other major creditors continue to take more aggressive action.
The causes
According to ASIC’s statistics, the predominant reported causes of business failure were inadequate cash flow and trading losses, with some trailing impacts of pandemic-induced failure. Of course, as the number of insolvencies increases, so does the likelihood that a liquidator will take action against parties for insolvent trading and/or voidable transactions. If the major causes of insolvency are inadequate cash flow and trading losses, then the liquidators will be looking to directors to make good any losses if those companies have been trading while ‘insolvent’.
Proving insolvency
It’s not always a simple case to prove insolvency of a company at any point in time, as there are a range of factors to take into consideration. However, there is one weapon readily available to a liquidator in recovery actions against related parties. It is the ‘presumption of insolvency’, which is available to a liquidator under section 588E of the Corporations Act 2001, where the company has not maintained proper books and records as required by section 286 of the Act.
Let’s look at those sections in a bit more detail:
Section 286 says a company must keep written financial records that correctly record and explain its transactions, financial position and performance, which would enable true and fair financial statements to be prepared and audited. The financial records must be retained for seven years after the transactions covered by the records are completed.
Section 588E of the Act says that if a company has failed to keep financial records in relation to a period as required by section 286(1) or failed to retain financial records in relation to a period for seven years required by section 286(2), then the company is to be presumed to have been insolvent throughout the period.
Some examples of where books and records have not been kept in accordance with section 286 include:
- Failure to provide sufficient or (as often happens) any books and records to the liquidator.
- Poorly maintained records, e.g. entries not up to date, not reconciled etc.
- Assets and/or liabilities recorded at incorrect values.
- Unreported, unrecorded and unreconciled statutory liabilities such as superannuation and PAYG.
Warning to Directors
Statutory Demand – It’s also not just the liquidator looking at insolvent trading and voidable transactions. Directors need to keep in mind that failure to comply with a statutory demand can lead to a presumption of insolvency, which open the doors for creditors to take action to wind up the company. The company would then have to try and defend its position and show that the company was solvent. The inability to produce that evidence because books and records were inadequate will likely lead to the winding up of the company.
Books & Records requirements – books and records have to be both able to be convertible into hard copy and kept in the company’s jurisdiction. So, if the books and records are maintained on cloud-based software such as Xero or MYOB, directors have a duty to ensure that backups are regularly kept and accessible and that these backups can be readily restored and accessed if needed.
We see many instances where directors and accountants have assumed that if the data is in the software, it’s safe. That’s not the case as the software providers will not accept responsibility for data loss if there are technical faults etc. Directors need to ensure these risks are managed by ensuring regular backups and data integrity tests are carried out.
Failing to maintain proper books and records not only hampers directors from properly managing the company’s affairs but also exposes them to personal liability by a liquidator. Directors (and their accountants and advisers) need to ensure that books and records comply with the requirements of section 286 to mitigate this risk.
dVT Group has years of experience dealing with issues related to insolvency, books and records, and compliance with director duties.
If you would like to have a no-obligation discussion about this, contact one of our experienced team at dVT Group at (02) 9633 3333 or by email at mail@dvtgroup.com.au.
dVT Group is a business advisory firm that specialises in business turnaround, insolvency (both corporate and personal), business valuations and business strategy support.
