Inadequate books and records in a liquidation – when is it a problem?
Directors are often concerned that they have not adequately maintained the company’s books and records and that this may be a problem if they place the company into liquidation. Well, yes, there is the offence under the Corporations Act (Section 286) for failure to keep adequate books and records but the more important issue for directors is the resulting “presumption of insolvency” for insolvent trading actions.
So let’s have a look at the Section 286, which requires that a company must keep written 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. That obligation to keep financial records extends to transactions undertaken by the company as trustee of a trust. The financial records must be retained for seven years.
So, yes, it is an offence if a company has not complied with those requirements.
But some technicalities. You should not read the above requirements as meaning that the company must have prepared financial statements up until the date of liquidation. The company must have maintained financial records but that is a requirement short of actually preparing financial statements (such as balance sheet and profit and loss statements). Take note of the words “would enable true and fair financial statements to be prepared”. So if you are considering placing your company into liquidation, it is not necessary to spend many hours or incur the expense of having your accountant prepare financial statements up until the date of liquidation.
So now, about the Insolvent Trading problems. If a director has not kept adequate books and records, or if the books and records are lost, then the director needs to be concerned about the Insolvent Trading laws. Insolvent trading laws can make a director personally liable for the debts of the company that are incurred after the date of insolvency. It was often a problem for a liquidator to prove insolvency when a director had “lost” or never prepared books and records. As a result, the law was amended so that if a director has failed to keep books and records or fails to deliver books and records to the liquidator, then the liquidator is allowed to “presume” that the company was insolvent for the period of time when books and records were not kept.
That’s a big presumption in the Liquidator’s favour and makes an Insolvent Trading action significantly easier for a Liquidator, a creditor or even the regulator.