Courts are often called upon to determine whether a company was insolvent at a certain time. Corporations Act section 95A(2) states that a person who is not solvent is insolvent. Under section 95A(1), a person is solvent only if they are able to pay all their debts as and when they become due and payable.

Guiding Principles

The test for solvency requires application of a number of guiding principles recognised by the authorities. In the case of Pearce v Gulmohar Pty Ltd,^[1] Justice Rangia usefully summarised those principles as follows:

1. Insolvency is a question of fact to be ascertained from a consideration of the company’s financial position taken as a whole.
2. The Court must have regard to the commercial realities. Commercial realities will be relevant in considering what resources are available to the company to meet its liabilities as they fall due, whether resources other than cash are realisable by sale or borrowing upon security and when such realisations are achievable.
3. The definition focuses on a “cashflow test” of insolvency, and not simply a “balance sheet test”. That said, a company’s balance sheet remains relevant because the cash flow position must be assessed by reference to the company’s financial position as a whole.
4. Insolvency is an “endemic shortage of work capital”. Such a position is to be distinguished from a temporary lack of liquidity. Thus, a temporary lack of liquidity is not equivalent to insolvency and, conversely, neither is availability of surplus assets at a particular point in time conclusive of solvency.
5. In assessing when debts are due and payable, the test is what debts are legally due, having regard to the agreement between the parties. This approach allows for situations where there is sufficient evidence of waiver of legal requirements, but reluctance by creditors to enforce legal rights is not sufficient. It does not matter that a creditor is unlikely to enforce its debt, because the statutory test is whether the debt is due and payable at law.
6. On this test, it is immaterial that a company disputes a claimed debt. Such a dispute may require some form of determination but does not alter whether the debt is legally due.
7. Where there are contract debts, it is for the party asserting that those debts are not payable at the times contractually stipulated to make good that assertion by satisfactory evidence.
8. The words “as and when they become due” are forward looking. That is, consideration is given to not only debts presently payable, but those that will become payable in the near future.
9. In assessing the assets available to pay the company's debts, the relevant question is as to what assets are capable of realisation within time to meet the company’s indebtedness.
10. Where the company is trading with no intention of selling stock-in-trade or inventory outside the ordinary course of business, the value of that inventory ought be excluded from the solvency analysis.
11. Similarly, assets required to operate the business as a going concern (such as plant and equipment) are also excluded. In Re Timbatec Pty Ltd [1974] 1 NSWLR 613, Chief Justice Bowen said that a debtor cannot rely on realising assets that would involve a cessation or breaking up of its business. If a company has to resort to selling assets that are essential to the continuation of its business, those assets are not to be included in a determination of solvency.
12. In proving insolvency, expert evidence from the liquidator may be relied upon.

Common Features

Justice Rangia also cited the list of common features in insolvency situations set out in ASIC v Plymin (No ) 1^[2]. The features are:

• Continuing losses.
• Liquidity ratios below 1.
• Overdue Commonwealth and State taxes.
• Poor relationship with present Bank, including inability to borrow further funds.
• No access to alternative finance.
• Inability to raise further equity capital.
• Suppliers placing the debtor on cost on delivery terms (COD), or otherwise demanding special payments before resuming supply.
• Creditors unpaid outside trading terms.
• Issuing of post-dated cheques.
• Dishonoured cheques.
• Special arrangements with selected creditors.
• Solicitors’ letters, summonses, judgments or warrants issued against the company.
• Payments to creditors of rounded sums which are not reconcilable to specific invoices.
• Inability to produce timely and accurate financial information to display the company’s trading performance and financial position and make reliable forecasts.

Justice Rangiah explained that this was merely a list of factors, the presence of one or more of which may indicate insolvency – a guide but not a checklist. He emphasised that not all factors need be present and that certain factors present in a given case may carry different weight according to the circumstances of the particular case.

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[1] [2017] FCA 660, [145] – [157] (citations omitted).

[2] [2003] VSC 123; (2003) 46 ACSR 126 at [386].

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The material distributed is general information only. The information supplied is not and is not intended to be, legal or other professional advice, nor should it be relied upon as such. You should seek legal or professional advice in relation to your specific situation.

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