directors; do you understand your rights and obligations?

There are a lot of SME’s around that are now in unexpected and unplanned financial trouble. For some it will be terminal with a potentially huge impact on personal assets, as well as those of the businesses they run.

Many owners of SME’s do  not fully understand their rights and obligations, often despite having an accountant that does their compliance and advises on financial structuring.

In particular, many owners of SME’s do  not understand the obligations they have under the Corporations Act as directors of their company.

This was brought home to me in a conversation yesterday with a casual acquaintance who I thought would be pretty well informed.

Following is a simple checklist, if in any doubt, ask your accountant the question. now is not the time to be dodging asking those questions because of the cost.

Insolvent trading.

It is illegal to trade while insolvent, and doing so risks personal and criminal liability. It is a black and white test: ‘Are you able to pay debts as and when they become due’?  For manufacturing businesses the answer is often tangled up in the valuation of inventory, and the state of your debtors ledger and revenue forecasts.

Can you collect what is owed to you, what can you reasonablly expect to sell, and how much cash do you have on hand.

Solvency is based on the expected cash flow, the result of these calculations. If you are not solvent, you are, by definition insolvent.

Directors duties.

As a director, which most will be, there are duties imposed by the Corporations act, and ignorance is not a defence.

You are required to act in good faith, with due diligence, and not improperly use information gained as a result of your privileged position. When solvency is in question, you are further required to look after the best interests of creditors.

In order to carry out these duties, you need to be fully aware if the financial position of the business, and have a management plan that addresses the problems. If in any doubt at all, ensure your accountant is completely informed and able to offer their expert advice.

What to do?

If your conclusion is that you are, or may be insolvent, a voluntary administrator can be appointed. The effect of this is to voluntarily relinquish control of the financial management of the business to an outsider, whose responsibility is to ensure creditors, in a defined order are paid. It does however, limit the liability of  the director after the day of the appointment. This option leaves you with more options than a wind up order instigated by a creditor, or group of creditors.

Premature appointment of a voluntary administrator is sometimes a temptation, so there has been recent changes to the Corporations act to allow a ‘Safe harbour’ which offers directors protection against personal liability of an insolvent trading claim. There are conditions attached to such protection:

• Tax records are up to date.
• All employee entitlements are up to date.
• There is a concrete, stress tested plan to trade out of the difficulties, that does not include optimistic forecasts and hopes that ‘something’ will turn up.

From March 25th as part of the governments response to the Corona induced problems, the ‘Safe harbour’ provision have been extended. You are now allowed to incur debts in the course of ordinary trading for the next 6 months, and the thresholds for issuing statutory demands have been increased. This is  not a ‘get out of gaol’ card, simply a recognition of the reality of the current situation, and other director duties are not impacted. For details talk to your accountant.

The plan.

As noted, hope and rosy projections do not constitute a plan. There has to be specific actions taken to stabilise the financial situation, that will necessitate some challenging decisions about asset disposal, restructuring of operations and perhaps personnel, and managing the manner in which further costs are incurred. Together these should offer a concrete pathway to rebuilding the financial capacity of the business to trade its way out of insolvency.

The obvious elements of the plan will be:

• Assessment and reordering of the cost base. Removing, reducing and deferring as much cost as possible, both fixed costs like rent, and discretionary costs like planned capital investments, and revenue generation activities that do not have a short term payoff.
• Ensuring you have accessed government and provider assistance
• Communication with all stakeholders. Employees, funders, suppliers, regulators, landlords and key customers.
• Aggressively managing your cash conversion time by extending by agreement, payment terms to creditors and chasing debtors, early, politely, and often. This is just managing your working capital. The cash flow forecast is the essential tool for doing this. every change you make should be reflected in the cash flow forecasts.

The key ‘takeaway’ is to manage your cash.