Insolvency: The Red Flags Every Accountant Must Spot
This article will count 0.25 units (15 minutes) of unverifiable CPD. Remember to log these units under your membership profile.
If you’re an accountant in practice, insolvency is often your problem before it becomes anyone else’s. SARS letters, bounced payroll, judgment writs and sheriff returns usually arrive on your desk first.
Legal anchors
Insolvency Act 24 of 1936 — section 8 lists the “acts of insolvency” frequently relied on in sequestration applications.
Companies Act 71 of 2008 — contains the corporate winding‑up regime and the statutory business‑rescue procedure that commonly applies to struggling companies.
What to watch for — the classic red flags
These are practical indicators that a creditor or the court may rely on to start insolvency processes. None are automatic showstoppers, but they are serious:
Judgment and nulla bona: a judgment debt with a sheriff’s nulla bona return is a strong practical sign there are no attachable assets. (A nulla bona return is basically the sheriff’s way of saying that he/she could not find any attachable property belonging to the judgment debtor. In everyday terms, it means the sheriff went to enforce a judgment but found nothing he could seize to pay the creditor.)
Admissions of inability to pay: written admissions (letters, emails, text) that the debtor “cannot pay” are powerful evidential items in later insolvency proceedings.
Insolvency: The Red Flags Every Accountant Must Spot: last‑minute disposals or transfers to related parties can be attacked by liquidators/curators.
Insolvency: The Red Flags Every Accountant Must Spot: conduct that points to evading creditors will be heavily scrutinised in sequestration cases.
Important legal nuance: these acts give creditors strong evidence and may give rise to an adverse inference or presumption of insolvency that the respondent can attempt to rebut. They are not literal “automatic tickets” to sequestration. Courts weigh all the facts and keep a discretion.
Two different insolvencies
Technical (balance‑sheet) insolvency: liabilities exceed assets on paper. This matters for reporting and certain statutory regimes.
Commercial/cash‑flow insolvency: the business cannot pay its debts as they fall due. This is usually the practical trigger for creditor action or the need for rescue.
In practice, the practical trigger for creditor action is usually commercial/cash‑flow insolvency (see Insolvency Act 24 of 1936, s 8 and Companies Act 71 of 2008).
However, a balance‑sheet deficit is important (it affects solvency assessments and reporting) but may be discounted if there is a realistic and credible cash‑flow plan, creditor support or realizable assets.
Alternatives to liquidation
Business rescue (under the Companies Act) is a statutory restructuring procedure offering a temporary moratorium and an opportunity to rescue the company as a going concern. For many viable businesses, early business rescue preserves more value and jobs than liquidation.
ALWAYS consider business rescue early. Delays often kills rescue prospects and invites recovery claims for suspect transactions.
Director duties and adviser risk — avoid oversimplification
Directors: the Companies Act and common law impose duties. Continuing to trade recklessly or ignoring creditor interests near insolvency can create civil exposure (derivative claims, liquidator claims), but liability is fact‑specific, not automatic.
Advisers (including accountants): you may face negligence or professional‑misconduct claims if you facilitate improper transactions or fail to advise appropriately. Preserve records, document your advice, and avoid participating in opaque asset transfers.
Asset stripping, voidable transactions and recoveries
NOTE: Liquidators and curators can challenge certain pre‑insolvency disposals (preferences, transactions at undervalue, or fraudulent dispositions) and pursue recoveries. Warn clients that “last minute” disposals can be reversed and those involved may face claims.
Practical “first‑steps” checklist for accountants
Use this as a short protocol when a client shows signs of distress:
Preserve records immediately: bank statements, tax correspondence, asset registers, deeds, board minutes and all communications.
Prepare a 4–13 week cash‑flow forecast and a brief solvency check (balance sheet reconciliation). Be realistic and document assumptions.
Stop non‑commercial transactions: advise against dividend payments, unusual related‑party transfers, or asset disposals without independent justification.
If a sheriff’s nulla bona or judgment exists, prioritise contingency planning: creditor engagement, business‑rescue assessment, and asset tracing.
Consider moratoria / rescue options: discuss statutory business rescue or negotiated moratoria with major creditors. Early engagement with a business‑rescue practitioner can be decisive.
Advise directors on duties and recommend immediate legal/insolvency practitioner input where there is doubt. Record written advice.
Escalate promptly: if insolvency or wrongful conduct is likely, involve an insolvency lawyer and a licensed business‑rescue practitioner. Litigation and recovery options must be managed by specialists.
How to phrase risky claims in client communications (useful drafting tips)
Avoid absolute language such as “this will lead to sequestration.” Instead: “this is strong evidence creditors may use in a sequestration application.”
Replace “the burden shifts” with “the evidence may give rise to an adverse inference which the respondent can attempt to rebut.”
Replace “reckless trading charges” with “possible civil exposure for wrongful trading or breach of directors’ duties; criminal liability is rare and fact‑specific.”
Why this matters to your practice
Accountants are first responders. Your early, conservative advice preserves value and reduces your firm’s and the client’s exposure.
Timely documentation and early referral to specialists (insolvency lawyers and business‑rescue practitioners) materially improve outcomes.
Softening absolutist language in client communications reduces the risk of misleading statements that can be used against clients (or your firm) later.
Disclaimer
This article summarises statutory and practical principles under South African law. It is not legal advice for a specific matter. For case‑specific guidance, involve an insolvency lawyer or a licensed business‑rescue practitioner.
