There has been much media attention on the prevalence of insolvencies specifically with Small to Medium Enterprises (“SMEs”), and the anticipation that there could be stormier seas ahead. Financial governance and the Director’s statutory duty to not allow the organisation to trade whilst insolvent is top of mind. Many organisations and Boards in WA and across Australia are already taking action to brace themselves for what could be continuing challenging trading conditions.
Insolvency considerations for directors
When I’m facilitating the Financial Literacy and Performance day of the Australian Institute of Company Directors, Company Directors Course the first thing that gets talk about is “not to trade whilst insolvent“. All directors and aspiring directors are aware that this is one of our primary legal duties, and the personal consequences for a Board of Directors that allows a Company to trade whilst insolvent can be significant.
In the current trading environment, where the incidence of insolvency is at its highest since post GFC, financial governance and the Directors’ role in solvency is likely to be top of mind for many Boards.
As a Director, we have a legal responsibility to ensure that the organisation can pay it’s debts as and when they fall due. And this is not a once a year consideration when the Board resolve to sign the financial statements, or even once a month when the financials are considered at the monthly board meeting. If you’re a director, you’re a director 24/7.
Can the organisation pay its debts as and when they fall due?
As eluded to in this article, “Fight or Fail” as featured in the July 24 edition of the AICD Company Director magazine; the Board’s role in making informed decisions when there are signs of financial distress is complex. It’s not black or white. Paramount is that directors are financially literate, can read and interpret the financial statements and hence are able to recognise the warning signs.
There are 2 key takeaways from this article that I have supplemented with my own thoughts:
- Ensure that the Board is getting relevant, reliable and timely financial information. This information must enable directors to answer the question “Can the organisation pay its debts as and when they fall due”.
- If as a Director you feel that the financial reports you are getting in the board papers aren’t good enough for you to make informed decisions then look to work through the Chair with the executive team to change that.
- As a Director you have the right to ask for information that you need to be able to discharge your legal duties.
- It’s not about simply accepting the version of the financials that the executive team choose to share with the Board.
- Seek external advice sooner rather than later. Many Boards will not have the expertise around the table to navigate their options and governance in times of financial distress. There can be a reluctance to seek advice from a restructuring professional because of:
- the costs, and
- the misunderstanding that you only call in a restructuring professional when the Board has decided to appoint a voluntary administrator.
- Ensure that the Board is getting relevant, reliable and timely financial information. This information must enable directors to answer the question “Can the organisation pay its debts as and when they fall due”.
Can you afford not to take advice?
I’d challenge the Board to consider can they afford not to take some advice, if the consequences of not doing so could be insolvency? Or, if the Board aren’t pro-active in taking steps to improve the situation, a creditor, or the ATO or the bank could take matters into their own hands in making an external appointment.
Plus, in my experience Founder Directors of SMEs are eternal optimists by nature and may find it difficult to swallow their pride, acknowledge the extent of the financial distress that they are in, and hence are reluctant to ask for help.
Be proactive and take control
The Board taking control of the situation and working with a restructuring professional is more likely to lead to a better outcome than if a 3rd party takes action and places the Company into administration. Once that happens the Board has lost control and no longer has decision making rights. It’s worth remembering that once an appointment is made, the role of the administrator, receiver or liquidator is to act in the best interests of the creditors, and not the directors.
My recommendations
As a starting point I recommend:
- Ensure as a Director you are aware of your legal financial responsibilities, and not only in relation to trading whilst insolvent.
- Ensure you are getting good reliable up to date financial information.
- Make sure you have enough financial literacy knowledge to be able to interpret that financial information.
If you think you might need help with any of this, I would love to hear from you. Please reach out for a chat.
