Trading while insolvent

As a company director a number of fiduciary duties are expected of the role, one such is the obligations set out in the Corporations Act 2001 s 588G to ensure the company is solvent when incurring debt. Generally, a company is considered insolvent when it cannot pay its debts as and when they are due and payable.

When considering insolvency, it is important to be aware of cashflow, but also the overall financial picture of the company including the balance sheet, assets and ability to raise funds. Accordingly, a company is only considered solvent when it has the capacity to pay all of its debts. Thus, a claim may be raised for insolvent trading when a debt is incurred at the time of insolvency.

Usually a liquidator makes an insolvent trading claim due to their obligations under the Corporations Act 2001. While pursuing this claim, some key elements need to be fulfilled.

  • The company goes into liquidation
  • The person acted as director when the debt was incurred
  • The debt was incurred when the company was insolvent or became insolvent due to the debt
  • There were reasonable grounds to suspect the company was or was going to become insolvent when the debt was incurred
  • The director reasonable ought to have been or was aware, that the company’s grounds showed grounds to anticipate insolvency
  • The director failed to prevent the company from incurring debt
  • The debt remains unpaid at the date of liquidation

A number of consequences for insolvent trading fall under criminal, civil and compensatory proceedings. Brief examples of these include, large fines up to $200000, an order to pay compensation equal to the lose suffered by creditors and criminal charges if dishonesty is found during the insolvent trading.

Despite the issues and severe consequences of trading while insolvent, a range of defences are available for company directors. Under the Corporations Act 2001 s 588H the defences available require that the director:

  • Did expect that the company was solvent at the time the debt was incurred
  • Had reasonable grounds to expect that it was solvent at the time
  • Expected that the company would remain solvent if it incurred debt at the time

Similarly, the director put forward the defence of reliance on the advice given by expert advisors on the matter, as long as certain criteria surrounding the legitimacy of the advice and adviser are met. Further to this, the director can also try and prove that they were ill or had good reason for not being involved in management of the company during the time that the debts were accrued.

Ultimately, it can be tricky trying to trade out of financial turmoil, however the best thing to do is to contact an insolvency expert or accountant as soon as possible. These individuals professionally can help guide you through financial trouble or help refer you to legal advisers. For more information, please contact Jonathan Paul McLeod at McLeod & Partners to help.