In our last article, we spoke about the benefits of maintaining financial records to monitor a business's financial health. If that wasn't motivation enough, we'll now visit how failure to maintain records can expose directors to personal liability if a Liquidator is appointed.
Generally speaking, a Liquidator is required to prove to the satisfaction of the Court that a company is insolvent when pursuing a director for an insolvent trading and/or a voidable transaction claim. However, failure to maintain adequate records means the Liquidator can now rely on a presumption of insolvency and it becomes the director's burden to prove the company was solvent. Ironically, this would be a difficult feat without the benefit of the records that they failed to keep.
Records Required to be Kept
There is no exhaustive list of the records required to be kept by a company – it will ultimately depend on its nature and size. Directors will be protected if a company keeps financial records that correctly record and explain its transactions and financial position and performance and would enable true and fair financial statements to be prepared and audited. These records must be kept for seven years.
In Fisher v Devine Homes Pty Ltd; Allen v Harb  NSWSC 8, the Court found that the presumption does not apply merely because of a failure to keep or prepare income tax returns, business activity statements, balance sheets of profit and loss statements. That is because a company carrying on a simple cash business could keep adequate records by maintaining invoices, cheque butts and bank statements.
Compare that to the findings in Swan Services Pty Limited (in liquidation)  NSWSC 1724, a large cleaning company, where the Court found that the records were inadequate because:
- In the years preceding the appointment of the Liquidator, the company only prepared signed financial statements for one year.
- There was a 6-monthly delay in preparing management accounts, which meant the financial position of the company could not be determined without relying on out-of-date material.
- Discrepancies between the income recorded on the income tax returns and unsigned financial statements.
The findings in Swan meant that the Company was presumed insolvent, allowing the Liquidator to pursue his claims relying on the presumption of insolvency.
A Liquidator's Claim
Failure to maintain adequate records creates a presumption of insolvency, which a Liquidator can rely upon to seek compensation for insolvent trading and other recovery actions. A company is considered insolvent throughout the entire period that records were inadequately maintained.
This means that if a business has never maintained sufficient records – a Liquidator can pursue the director personally for any debts incurred during the preceding seven years.
As we mentioned in last week's article, failure to maintain records can lead a company into insolvency simply because the business owners have no visibility over performance and cannot see the early signs of distress. It is essential for directors to ensure they maintain proper records not only for business survival but also because if they fail to survive and are wound up they may be subject to these provisions of the Corporations Act for failing to maintain adequate books and records.
As the quantum of unpaid debts typically escalates closer to the date of the Liquidators appointment, it is important that record keeping is always maintained because even a small gap could lead to a big exposure. If that's not possible, the early appointment of a Liquidator is imperative.
Importantly, this assumption can only be relied upon for claims against the directors and their related parties. It cannot be enforced against third parties. Directors are provided some relief if the inadequacies are only minor or technical, or the records are lost or destroyed (so long as they were not knowingly or recklessly involved in the disappearance).
In conclusion, directors should maintain proper record keeping. Accountant and tax agents should make the effort to ensure their clients are doing this. Programs like Xero, MYOB and Quicken make bookkeeping much easier today to meet the minimum obligations.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.