What is insolvent trading?

Insolvent trading occurs when a company is unable to pays its debts when they fall due. It is important to understand that it is a company, not a director, who is legally prohibited from trading while insolvent. A director, however, has a duty to prevent the company from trading whilst insolvent, and to ensure it is solvent prior to incurring additional debt.

Section 558G of the Corporations Act 2001 (Cth) sets out a director’s statutory duties under legislation. In the event a company becomes insolvent, the director risks being held personally liable to pay compensation for the unpaid debts if the company subsequently goes into liquidation.

What are the elements of insolvent trading?

In order for a former director to be held liable for not preventing insolvent trading by a company, pursuant to Section 588G of the Corporations Act 2001 (Cth), a liquidator must be able to satisfy the following:

• A person is a director of a company at the time when the company incurs a debt;
• The company is insolvent;
• The company incurs a debt at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt;
• There are reasonable grounds for suspecting that the company is insolvent or would so become insolvent as the case may be; and
• The director knew, or ought to have known, that the company was insolvent at the time.

Are there any defences to insolvent trading?

Section 588H of the Corporations Act 2001 (Cth) provides four statutory defences for a director as follows: The director had reasonable grounds to expect (just merely suspect) that the company was solvent;

• The director had reasonable grounds to expect (just merely suspect) that the company was solvent;
• The director relied on information provided by a competent and reliable person that led to the view that the company was solvent;
• The director, at the key time, did not take part in the management of the company due to illness or for some other good reason; and
• The director took all reasonable steps to prevent the company from incurring the debt.

What are the consequences of trading while insolvent?

Broadlyspeaking, there are three consequences a director may be subjected to if found to be liable for insolvent trading. These include:

1. Civil penalties may arise against a director of a company. Monetary penalties up to $200,000 may be issued.
2. Compensation claims can be made by wholly or partly unsecured creditors.
3. Criminal sanctions may apply given insolvent trading is an offence. They can be referred to ASIC for further investigation and possible criminal prosecution. Serious offences can include imprisonment. Further, directors who are found guilty may be disqualified altogether by ASIC.

As a director, what do you do if you suspect the company is experiencing financial difficulty?

If a director suspects a company is in financial difficulty, it is prudent to obtain legal and/or professional accounting advice as soon as possible. This increases the likelihood the company will survive, as advice can be provided in relation to identifying an appropriate strategy and developing a preliminary action plan to restructure and turn the company around. Alternatively, voluntary administration may be a better option that is designed to resolve a company's future direction efficiently. An independent and qualified voluntary administrator can take full control of the company and try to implement ways to save either the company or its business. If neither is possible, they will start administering the company’s affairs. Using the company's deed of company arrangement, if possible, they will try to give creditors a better return than what they would get by putting a company into liquidation.

How Sharrock Pitman Legal can help?

It is imperative a director is involved in the company’s affairs on a day-to-day basis, especially with regard to understanding the true financial position of the company. If you believe or suspect that your company may become insolvent, you need to act swiftly and take steps to prevent this from happening. If you have any concerns about the financial position of your company and wish to have a lawyer or financial expert advise you on your position. if we can assist you, please contact us at Sharrock Pitman Legal via email sp@sharrockpitman.com.au or telephone on 1300 205 506.

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The information contained in this article is intended to be of a general nature only and should not be relied upon as legal advice. Any legal matters should be discussed specifically with one of our lawyers.

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