Welcome to part 10 in this series. In this 10th and final part of this series, we'll be focused on insolvency. 

First, we will explore what insolvency is and the key duties directors have to prevent insolvent trading. Second, we'll review the potential consequences for directors personally, if the organisation continues to operate while insolvent. Finally, we'll identify some potential warning signs of impending insolvency and when the directors may want to obtain immediate professional advice. 

Let's begin by explaining what is meant by insolvency. An organisation is insolvent if it is unable to pay its debts as and when they become due and payable. Directors need to know if the organisation has enough cash, that is readily accessible to pay debts when they are due. Directors have an essential legal duty to ensure that their organisation does not operate while insolvent. 

For organisations registered with the ACNC, governance standard number five states that responsible people must “ensure that the charity's financial affairs are managed responsibly and not to allow the charity to operate while insolvent.” 

For those organisations that operate as a company, for example, a company limited by guarantee, directors have further duties under the Corporations Act. The Corporations Act states that a director must prevent a company from incurring a debt or financial obligation if the company is insolvent, or by incurring the debt, becomes insolvent, and if there are reasonable grounds for suspecting that the company is insolvent or would become insolvent. 

These duties require that directors actively monitor solvency and liquidity. It's important to note that ignorance is not an automatic defence for a director. If another director acting reasonably in the same position would've suspected insolvency. 

If directors allow an organisation to continue to operate while insolvent, they potentially expose themselves personally to significant legal, financial, and reputational consequences. For organisations that operate as a company, the potential consequences for directors include being sued personally for any debt incurred when there are reasonable grounds suspecting that the company is insolvent as well as penalties or fines. 

The corporate regulator, the Australian Securities & Investments Commission, ASIC, may investigate and commence civil proceedings against the directors. In the most serious cases under the Corporations Act, if the director's failure to prevent insolvent trading was dishonest, it may result in a criminal liability, the penalty for which can include fines and or imprisonment. 

For an organisation registered with the ACNC, but which is not a company, for example, an incorporated association, the consequences may include investigation by the ACNC, removal from the ACNC register and reputational damage. Under the Director Penalty Regime, the Australian Taxation Office can hold directors personally liable for unpaid tax obligations, including pay as you go, PAYG, withholding tax goods and services tax, and unpaid employer superannuation contributions owed by the company. 

Beyond the legal liabilities, being associated with an organisation that traded while insolvent can seriously damage the professional reputation of the director. This can impact their ability to be appointed to or serve on other boards and their professional credibility in the arts and cultural sector. 

Let's now turn to some potential warning signs of impending insolvency. Directors should be alert to both financial and non-financial indicators. Depending on the particular circumstances of your organisation, one or more of the warning signs we discuss here may not mean that your organisation is currently insolvent, however, they are signposts, which indicate that the directors may need to give increased focus to the organisation's solvency and liquidity. 

Common warning signs include: The organisation is operating with persistent net deficits or losses, that is expenses are greater than revenue over several years. The organisation has negative cash flow from operations, that is payments to employees, artists, and suppliers regularly exceed the income received in cash. The cash balances and net reserves are declining over several years. 

That there has been a significant decline in ticket sales without any corresponding expense reductions. There is declining support from the audience, members, donors, corporate sponsors, or government funding agencies. There is an over-reliance on one major source of funding. For example, a single corporate sponsor. 

The organisation has difficulty paying bills on time or is repeatedly asking suppliers for extensions of time to pay. Their suppliers are withdrawing credit or a threatening legal action against the organisation to recover unpaid money. The organisation is relying on short-term borrowings, such as loans from directors to fund day-to-day expenses. 

There's a reliance on grants, sponsorships or donations it hopes to get but that are not yet secured to fund ongoing operating costs. There are delays in paying staff or artists wages, superannuation, or other entitlements. That business activity statements are being lodged late and the payment of PAYG and GST obligations is delayed and that there are unexplained budget variances or poor financial reporting to the board. 

Other warning signs may include the artistic programme spending continues unchanged despite increasing financial stress. There is turnover in the CEO or other leadership positions, board instability or governance conflict. The organisation has difficulty in attracting or retaining staff, or there is staff and artist unrest or burnout, and that the organisation lacks a clear strategic and financial sustainability plan. 

A warning say may also come from discussions with the auditor or from their audit opinion. On occasions, the auditor will include in their opinion what is known as an emphasis of matter relating to the going concern. This is used when the auditor believes there is significant uncertainty about the organisation's ability to continue operating for at least 12 months, but it has been appropriately disclosed in the financial statements, and the auditor can still issue an unmodified or clean audit opinion. 

It's used when the financial statements are not incorrect, but the situation is serious enough that the auditor draws special attention to it. In part six of this series, we discussed how directors should read and interpret the financial statements of the organisation, in particular, how to look for warning signs regarding financial sustainability. 

If directors suspect that their organisation is insolvent or is approaching the point of insolvency, they should immediately seek legal and specialist insolvency practitioner advice. 

To summarise the key learnings from this part of the series, first we discuss what is insolvency and the key duty directors have to prevent insolvent trading. Second, we discuss the potential consequences for directors personally if the organisation continues to operate while insolvent. Finally, we identified some potential warning signs of impending insolvency and when the directors may want to obtain immediate professional advice. This is the final video in this series, and we hope that these resources have assisted you to understand your fiduciary responsibilities with respect to the financial management of the organisation, and have further assisted you to improve your skills in reading and interpreting the financial information you receive. Additional resources can be found in the link in the description of this video.