WARNING SIGNS Ahmed Bise, Grant Thornton

OUTLINE

• Warning Signs for Distressed Businesses/Companies

• Dangers to Public Practitioners and/or Employed Accountants

• Survival Tips

KEY MESSAGES

• You SERVE but are not SUBSERVIENT to a Client

• Your Client’s problem is THEIR PROBLEM.

• Decisions from the HEART lead to HEARTBURN!

• Keep detailed FILE NOTES!

KEY MESSAGES

• Put it in WRITING! The importance CANNOT BE

UNDERSTATED

• If attending Directors’ meetings obtain a copy of the

minutes – check them and if you don’t concur send a

letter to state your position

• You may THINK that you know your client but under

pressure people CAN CHANGE AND TURN ON YOU.

NUMBER ONE CAUSE OF FAILURE!

DENIAL/RESISTENCE TO CHANGE

• "But in capitalist reality, as distinguished from its textbook picture, it is not (price) competition which counts but the competition from the new commodity, the new technology, the source of supply, the new type of organisation …competition which…strikes not at the margins…of the existing firms but at their foundations of their very lives." Joseph A Schumpeter, Capitalism, Socialism and Democracy

SIGNALS, NOISES & INDICATORS

Case law has identified the following indicia of insolvency:

• 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 company on COD, or otherwise demanding special

arrangements before resuming supply

SIGNALS, NOISES & INDICATORS

• Suppliers placing the company on COD, or otherwise demanding special

arrangements before resuming supply

• Creditors unpaid outside trading terms

• Issuing of post dated cheques

• Dishonoured cheques

• Solicitors letters, summons(es), judgements, warrants

• Payments to creditors of rounded sums

• Inability to produce timely and accurate financial information and make

reliable forecasts.

• DPNs and Garnishee Notices

ISSUES / TRAPS FOR ACCOUNTANTS

• A Compliance Issue: Where do the Notices go?

• For you personally: Are you an adviser?

• For the firm: professional fees

WHERE DO THE NOTICES GO?

• The ATO is entitled to rely on ASIC’s records to obtain a

director’s address and the Company’s registered office

• The onus is on the DIRECTOR to ensure that ASIC’s

records are correct

• Ensure that Directors are aware of their obligations in

this regard. Put it in writing especially where you are

aware of a Director changing address

WHAT DO YOU DO IF YOU RECEIVE NOTICES ON A CLIENT’S BEHALF?

• CRITICAL CONSIDERATION: TIME!

• IMMEDIATELY bring to the attention of your Client

• Ensure that your Client understands how the notices

operate. Forward the notice under a covering letter

stressing the notice's operation

• Consider whether there ARE solvency concerns. If so, or

you are unsure, suggest to your Client that they seek advice

DIRECTOR’S DUTY TO PREVENT INSOLVENT TRADING?

• Section 588G of the Corporations Act applies if:

(a) A person is a director of a company at the time when a company

incurs a debt

(b) The company is insolvent at that time, or becomes insolvent by

incurring that debt, or by incurring at that time debts including

that debt, and

(c) At that time, there are reasonable grounds for SUSPECTING that

the company is insolvent, or would become insolvent, as the case

may be …

WHAT IS A DIRECTOR’S EXPOSURE TO INSOLVENT TRADING?

• Section 588M(2) [Liquidator may recover from director] The company’s liquidator may recover from the director, as a debt due to the company, an amount equal to the amount of loss or damage.

A DEFENCE AVAILABLE TO A DIRECTOR THAT YOU SHOULD BE AWARE OF!

Section 588H(3) [Reliance on other person] … it is a defence if it is proved that, at the

time when the debt was incurred, the person:

(a) Had reasonable grounds to believe, and did believe:

i. That a competent and reliable person (the other person) was responsible for

providing the first mentioned person adequate information about whether

the company was insolvent, and

ii. That other person was fulfilling that responsibility, and

(b) Expected, on the basis of information provided to the first mentioned person by

the other person, that the company was solvent at that time and would remain

solvent even if it incurred that debt and any other debts that it incurred at that time.

WHAT DOES THIS MEAN TO YOU PERSONALLY?

A LIQUIDATOR’S ATTENTION MAY SWITCH TO YOUR ROLE!

OUCH!

$5,092,745.95

WHAT DOES THIS MEAN TO YOU PERSONALLY?

• A person(s) not formally appointed as a Director can be deemed to hold

the same statutory and fiduciary duties as a validly appointed director.

• Referred to as a ‘Shadow Director’

• There may be both civil and criminal sanctions for directors that breach

their duties whether they are validly appointed or not

• In chasing recoveries liquidators will cast a net as far and as wide as

possible!

• Accountants have an even higher level of onus

• PI insurance!

SHADOW DIRECTORS – DEFINED IN THE ACT

Section 9 of the Act defines a director as follows:

(a) A person who:

I. Is appointed to the position of a director, or

II. Is appointed to the position of an alternate director and is acting in

that capacity

(b) Unless the contrary intention appears, a person who is not validly

appointed as a director; if:

I. They act in a position of a director, or

II. The directors of the company or body are accustomed to act in

accordance with the person’s instructions or wishes.

SHADOW DIRECTORS – DEFINED IN THE ACT

• The statutory definition of a Shadow Director excludes persons that give ADVICE in the proper performance of functions relating to that person’s PROFESSIONAL CAPACITY, or the person’s business relationship with the directors of the company.

SHADOW DIRECTORS – FACTORS, TESTS, CHECKLISTS

PRINCIPLE DERIVED FROM CASE LAW: IT IS NECESSARY TO CONSIDER THE DUTIES

PERFORMED BY THE PERSON(S) IN VIEW OF THE OVERALL SCHEME OF A COMPANY’S

BUSINESS OPERATIONS

YOUR CLIENT IS STRUGGLING: HAVE YOU EVER?

• Directed a Client as to who should or should not be paid right now or next week

• Prepared budgets and cashflow forecasts and issued same to third parties under a

covering letter carrying your signature: banks, creditors, statutory authorities

• Negotiated contracts for clients

• Negotiated repayment plans for Clients (with the DCT in particular)

• Taken part in any day to day decision making

• Been seen by third parties as being your Client (Giving the impression that you are

in charge)

• Signed agreements on the Client’s behalf (with the DCT in particular)

• Countersigned cheques.

SHADOW DIRECTORS – THE COURT WILL CONSIDER

• The size of the company

• The internal practices or structure of the Company

• How the alleged shadow director is perceived by outsiders

• The person or group of persons responsible for decision

making

• The Court will refer to acts not on one individual occasion

but over a period of time and as a regular course of

conduct

SHADOW DIRECTORS – THE COURT WILL CONSIDER

• The exercise of board or top level management functions

• Has the person acted as the company in relation to matters

of great importance, in particular, in regards to the main

business activity?

• Performed a duty of a validly appointed director

• Signing of documents on the Company’s behalf

• Signing cheques.

SHADOW DIRECTORS – DEFENCE

THE ADVISER DEFENCE

The adviser is engaged to perform SPECIFIC

FUNCTIONS whilst the latter (shadow director)

is ENGAGED IN THE AFFAIRS OF THE

CORPORATION GENERALLY

TIPS FOR SURVIVAL

• Make it clear that you are at all times acting on your Client’s BEHALF!

• Make it clear that you have been INSTRUCTED!

• Make it clear that you are acting pursuant to INSTRUCTIONS from your Client!

• It MUST BE the Directors that take action; leave DECISION MAKING to the directors

• Give ADVICE not DIRECTIONS

• AT ALL TIMES act in accordance with you professional capacity

• Use well worded engagement letters

• Keep detailed notes of verbal advice, but better still PUT IT IN WRITING

• DO NOT take over financial management

• Remember the Directors make the decisions – the paper trail should demonstrate this

• Your PI insurance may not protect YOU!

FACT OF LIFE!

IN MY EXPERIENCE DIRECTORS OF FAILED COMPANIES WILL ALMOST ALWAYS BLAME

THEIR ADVISERS AND THE WORLD AT LARGE FOR THEIR PREDICAMENT!!!

A CONSIDERATION FOR THE FIRM!

• If anyone is going to have a reason to suspect that a Client may

have solvency concerns it is YOU!

• This is particularly the case where: your Client is unable to meet the

firm’s standard trading terms and conditions, demands have been

made, promises have been made and broken and the firm has

received demands and notices from creditors on a Client’s behalf

• Also you see the financial statements

• You are not a charity.

WHAT IS A PREFERENTIAL PAYMENT?

A transaction is an unfair preference if, and only if:

(a) The company and the creditor are parties to the

transaction, and

(b) The transaction results in the creditor receiving from the

Company, more than the creditor would receive from the

Company if the transaction were set aside and the creditor

were to prove for the debt in the winding up of the

Company.

SO WHAT MUST A LIQUIDATOR ESTABLISH IN ORDER TO RECOVER A PREFERENTIAL

PAYMENT? • That there is a debtor/creditor relationship in relation to an

unsecured debt

• The Company was insolvent at the time or became insolvent as a

result of the payment

• Consideration of a running account: Has the firm been preferred?

• Did the firm have reason to suspect that the Client was insolvent

and exerted pressure for payment?

• For non related parties that the transaction took place within 6

months of the commencement of the liquidation.

SO WHAT CAN THE FIRM DO TO PROTECT ITSELF FROM SUCH A CLAIM?

• Put simply: BE CAREFUL

• Advise your clients – put it in writing

• Future Work: If you are concerned insist on

payment up front BEFORE you do the work. This

gets around the requirement for a

debtor/creditor relationship but the

arrangement must be commercial.

ANY QUESTIONS?