Insolvency in today’s uncertain times

Covid-19 has placed enormous strain on the construction industry and hospitality industry.

The fallen are usually small and undercapitalised and when they collapse, they have no assets and hundreds of thousands of dollars in liabilities.

How do you avoid becoming collateral damage.

Directors have a positive obligation to not trade whilst insolvent. So its important to know what insolvency is. The corporations act defines insolvency in relation to solvency. So you are solvent if you able to pay all of the debts as and when they fall due.  You are in insolvent if you are unable to pay all of the debts as and when they fall due.

If a director suspects that its company is insolvent, they must not allow it to incur further debt unless they qualify for the Safe Harbour defence and take courses of action that are reasonably likely to lead to a better outcome for the company than the immediate appointment of an administrator or liquidator. The director must investigate whether and how quickly it can liquidate assets and call in creditor payments. Voluntary Administration will need to be considered at this early stage aswell.

Secondly, you’ll need to watch out for the warning signs.  Warning signs of a distressed business will be more obvious in some cases than others but they always eventually emerge as cashflow problems. Mostly the blame is placed on low profit margins and human error.

Reacting to a contractor's insolvency situation requires an early determination of what sort of regime they are in. If the answer is voluntarily administration and receivership, there is a chance of a positive outcome. You will need to ascertain from the administrator what the administrator's intentions are.  This of course will depend on very much on the contractor's progress and progress in the project.  

If the answer is insolvency, it is highly unlikely the company will trade out.  If works are progressed or nearing completion and you are required to find an alternate contractor to complete the task, that alternate contractor, especially in the construction industry, will not give warranties for the work that has already been carried out by the prior contractor.  A decision needs to be made as to whether to terminate or perhaps take work out of the hands of the contractor. 

Where liquidation applies, a creditor with a claim against an insolvent company has the choice of lodging a Proof of Debt with the liquidator or seeking relief through litigation.

Litigation is only preferable if:

• The company is able to meet the judgement amount or there is non-monetary relief sough with utility to the claimant that cannot be obtained from the liquidator of the company
• An insurer is standing behind the company in liquidation, which has not denied liability for the claim,
• The creditor can make an arguable proprietary claim against the company.

One other factor to consider is whether any claims paid by a company in trouble can be clawed back by a liquidator  in the 6 month relation back period or be clawed back as an ‘unfair preference’ or uncommercial transaction.

You should also consider whether you are better off claiming the debt from other available companies or individual guarantors.

Companies can fall quickly into insolvency and receivership. They slide from a healthy company to an underperforming company to a stressed company, to a distressed company and finally to an insolvent company.

The first questions on the contractor’s mind is “How will I get paid?” and “How will I get my things back?”  The first question on the principal’s mind is “How will I finish the project?”

The quicker an entity can grapple with the challenges they are facing the more likely they are to emerge from this slippery slope otherwise their ability to control the problem and climb out of the stressful situation becomes unlikely as creditors become more and more involved and take control of the entity. It is very difficult to get the project back up and running without departed key players. So keep on top of your contractors and manage your finances. Also seek advice from the right experts, be it industry professionals, banks, financial advisors or legal advisors.