Duty to prevent insolvent trading

Director’s duty to prevent insolvent trading

Australia has strict laws against companies that continue to incur further debt despite being unable to pay their previous ones. Directors of a company are legally obliged under the Corporations Act 2001 (Cth) to take reasonable steps to prevent this from happening. But as a director, you might not even be aware of your company’s financial status. That means you could be unwittingly enabling insolvent trading to take place within your company. 

Unfortunately, in the eyes of corporate insolvency laws, ignorance is no defence. So how can you protect yourself from inadvertently engaging in insolvent trading? And what are the consequences if you do trade while insolvent?

This article by our insolvency lawyers will explore what constitutes insolvent trading. We’ll discuss defences to an allegation of insolvent trading and the potential penalties for directors who engage in this behaviour.

What is insolvent trading?

Insolvent trading is when a company continues to trade even though it cannot pay its debts. The Corporations Act 2001 (Cth) imposes on company directors a duty to prevent insolvent trading. A breach of this duty can lead to civil penalties or even criminal charges.

When is a company insolvent?

A company is insolvent when it is unable to pay its debts as and when they fall due. This means the company does not have enough money to meet its financial obligations.

Directors have a duty to prevent insolvent trading. If a company is unable to pay its creditors, its directors must stop the company from incurring further debt.

If directors continue to allow the company to trade while it is insolvent, they may be held personally liable for the new debts the company incurs. 

If you are a director of an insolvent company, it is important that you immediately seek professional advice from an insolvency lawyer. They will be able to advise you on your rights and obligations, as well as help you to navigate the complex insolvency process.

How do you prove insolvent trading?

To prove insolvent trading, it must be shown that:

  • The company carried on incurring costs after the point at which it became unable to pay its bills when those bills became due and payable. (It’s crucial to remember that tax is a liability. So being unable to pay the any tax bill counts in this.)
  • There are reasonable grounds to believe the company was insolvent at the time of the relevant transaction. (The test for whether a company could pay its debts at a point in time is a complicated one and can be contested by experts.)
  • The company directors were aware (or should have been aware) of the company’s insolvency at the time of the transaction. There are various ways of showing that directors should have been aware of the company’s inability to pay its debts.

Is insolvent trading illegal?

Yes, insolvent trading is illegal. Section 588G of the Corporations Act 2001 (Cth) imposes a duty on a company’s director to prevent the company from incurring a debt if there are reasonable grounds for suspecting that the company is insolvent. 

If a company director permits the taking on of new debt despite knowing the company is insolvent, they may be charged with insolvent trading. A director found to have allowed insolvent trading to occur may have personal liability for the repayment of debt accumulated after the company’s insolvency. This can result in a loss of personal property and in extreme cases, bankruptcy.

What are the consequences of trading while insolvent?

A director who trades while insolvent may receive a penalty of imprisonment of up to ten years and/or a $1,110,000 fine.

There are also several civil penalties that can be imposed, including:

  • Disqualification from managing companies for up to 20 years.
  • Personal liability for debts incurred by the company while insolvent.
  • Orders from the court requiring the directors to pay compensation to creditors. In many cases, there is no limit to the compensation payments that must be paid out.

Who can bring an action against insolvent trading?

Liquidators have a legal obligation to investigate insolvent trading claims. If those claims are valid, they may begin proceedings against those involved.

However, other parties may also have the standing to take an insolvent trading action. The creditors of a company may choose to act on their own to recoup their losses. But this can only take place if the liquidator decides not to pursue an insolvent trading claim. The liquidator’s or the court’s approval is required if creditors wish to proceed with their own insolvent trading litigation.

An important distinction between these claims is that a creditor can pursue an insolvent trading action against directors only to recover their own debts. On the other hand, a liquidator has broad authority to act on behalf of all creditors. Once a liquidator has begun taking legal action, a creditor cannot independently pursue an insolvent trading action.

Is there a defence against insolvent trading?

Directors may defend themselves against an insolvent trading claim by providing evidence for one of the following:

  • The directors had reasonable grounds to believe the company was solvent at the time of the dispute and was at no risk of becoming insolvent.
  • The directors had reasonable grounds that they were being provided accurate and up-to-date information on the company’s financial position by reliable and competent members of staff.
  • The directors were unable to participate in the management of the company at the time the claim took place, due to illness or other extenuating circumstances.
  • The directors had taken reasonable steps to prevent the company from incurring further debts.

If you are a director of a company that is facing possible insolvency, it is important to seek advice as soon as possible to ensure you understand your rights and obligations.

How do I avoid insolvent trading?

1. Understand your financial position

It’s important to have a clear understanding of your company’s financial position at all times. This means regularly reviewing your income and expenses, as well as any debts you may have. This will help you to identify any potential financial problems early on and take action to avoid them.

2. Make the appropriate inquiries

If you’re concerned that your business may be insolvent, it’s important to make the appropriate investigations. This includes talking to your accountant or another financial advisor, as well as conducting your own research.

3. Keep up with your tax obligations

Making sure you stay on top of your tax obligations is another way to avoid insolvency. If you fall behind on your taxes, you could end up owing a large amount of money. This could put your business in serious financial trouble.

4. Monitor your cashflow

It’s essential to maintain a healthy cash flow in your business. This means regularly reviewing your income and expenses. You should also make sure you have enough money coming in to cover your outgoings. If you have reasonable grounds to believe your business is starting to experience cashflow problems, take action immediately to correct the situation.

5. Avoid taking on too much debt

Taking on too much debt can also lead to insolvency. If you’re not careful, the interest payments on the debts incurred could start to eat into your profits. This will leave you with less money to pay your other bills. If you’re already struggling to make ends meet, incurring further debts might not be the best solution.

6. Get professional help if you find yourself in financial difficulty

If your business is already in financial difficulty, it’s important to get professional help as soon as possible. An insolvency practitioner can advise you on the best way to deal with your debts and help you to negotiate with your creditors. They can also help you to put together a repayment plan that will make it easier for you to pay off your debts over time.

Insolvent trading is a serious issue in Australia. If you are found to be trading while insolvent, you could face heavy penalties. This may include fines and possibly up to ten years prison time. If you are concerned that your business may be at risk of insolvency, seek advice from a legal expert as soon as possible.

Receiving an insolvent trading claim

If you are served with an insolvent trading claim, you should seek advice immediately. The consequences of an insolvent trading claim can be serious. So, it’s important to understand your options and get legal help.

There are several defences to insolvent trading claims. So, make sure you get a legal advisor who specialises in corporate insolvency. A corporate insolvency lawyer can advise you on whether any of these defences apply in your case.

What should I do if my company is insolvent?

If your company is insolvent, you should immediately seek professional advice. Insolvency practitioners can assist you in reviewing your options. They can also help you develop a plan to restructure or exit your business.

There are several different ways to deal with insolvency. The most appropriate option will depend on your specific circumstances. In some cases, it may be possible to restructure your business and avoid liquidation. However, if your company is unable to pay its debts as they fall due, you may need to consider appointing a voluntary administrator or liquidator.

Directors of the company are legally obliged to make sure your company does not trade while insolvent. This means stopping all trading activities and ceasing to incur any new debts.

If you continue to trade while insolvent, you may be liable for damages and penalties. You could also be barred from managing companies in the future.

Know your obligations. Protect yourself and your company

Company directors need to be aware of their duties under the Corporations Act. Especially when it comes to insolvent trading. Ignorance of the law is no excuse. Directors can be held liable for any debt incurred due to their company going into liquidation. By understanding your legal duties, you can take steps to ensure that your company does not fall into financial difficulty and put yourself at risk of personal liability.

If you are a director of a company that is insolvent, or trading whilst insolvent, you need to take immediate action to protect yourself and the company.

Our lawyers can advise you on the best course of action and help you protect your interests. Call us for a confidential chat on 1300 286 578 or email us at info@tdllaw.com.au

Important note on this article

This article discusses the general state of affairs, which could change at any time because the law can change at any time. Also, your situation is unique, so an article like this one can’t give you all your options, and some of the options discussed here might not apply to you. For those reasons and others, you mustn’t treat what you’ve read here as legal advice for you. What you should do as soon as possible is get legal advice specific to you if you are affected by anything discussed above.

Liability limited by a scheme approved under Professional Standards Legislation.

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