A company is insolvent if it is unable to pay its debts as and when they fall due for payment [section 95A of the Corporations Act 2001 (Cth)].

A director should be aware of a company's financial state at all times and ensure that there is enough cash flow available to pay creditors. Allowing a company to continue to trade whilst insolvent may result in serious penalties for directors.

Section 286 of the Corporations Act 2001 (Cth) requires a company to keep written financial records to record and explain transactions and financial position and performance. Records may be kept electronically as long as it is possible to print the records to make them readily available for inspection. A company that fails to keep proper books and records may be considered to be insolvent.

A company is also required to lodge an annual statement with ASIC. The statement includes a solvency resolution which states whether the directors, in their opinion, consider that the company is able to pay its debts as and when they fall due.

If a company is unable to pay its debts, there are many options available to directors. More information is on the ASIC website.

If a company is in financial difficulty, a prudent director can get specialist accounting or legal advice. Following the right procedure is important and will help to avoid future liability for insolvent trading for the director.

One option open to directors is to appoint a voluntary administrator. An administrator follows a set process to take control of the company with the aim of saving the company and its business. The administrator investigates the company's financial position and consults with creditors. If saving the company is possible, the administrator will put forward a proposal for consideration by the creditors. The administrator may also suggest liquidation if appropriate.

A creditor can also apply to a court to wind up an insolvent company. This often happens after a statutory demand issued under section 459E of the Corporations Act 2001 (Cth) is not satisfied. A statutory demand is a notice stating that there is a debt owing of more than $4,000 by the company. The demand must be supported by an affidavit if the debt is not based on a judgment. The company has 21 days in which to pay the debt or make an arrangement to pay. If the company disputes the debt, it must file an application with a court to set aside the demand and serve the proceedings on the creditor before the expiry of the 21 day period.

If a statutory demand is issued to a company and not answered, the company is deemed to be insolvent for a period of three months.

Issuing a statutory demand is a technical process and a creditor should to get specialist legal advice. There are specific requirements regarding service and the form itself which if incorrect can result in the notice being set aside.

When a company is wound up, the court appoints a registered liquidator. The liquidator's role is to bring in the company's assets and then distribute them to the unsecured creditors. The liquidator can also make claims if there are unfair preferences or uncommercial transactions.

Employee entitlements and the costs incurred in winding up and getting in assets rank ahead of general creditors. Sometimes this means that creditors will only get a small percentage of their debt paid.