Company directors generally think about what they need to do to make their business successful. While times are good they do not think about how their duties change if things don’t go to plan. In these circumstances, directors’ duties are no longer owed to shareholders, but creditors who may not be paid. A key duty directors need to be aware of in the circumstances is the duty to prevent a company from trading while it is insolvent.
As well as being a breach of your duties as a director, allowing a company to trade while insolvent may have serious financial impact on you personally. Directors can be held liable for insolvent trading. This means you could be personally liable for your company’s unpaid debts incurred while your company was insolvent.
When is a Company Insolvent?
Section 95A of the Corporations Act deals with when a company is solvent and insolvent and it provides as follows:-
(1) A person is solvent if, and only if, the person is able to pay all the person’s debts, as and when they become due and payable.
(2) A person who is not solvent is insolvent.
While typically long winded of legal wording, it means a company is insolvent if and when it is unable to pay amounts which it owes when they become due and payable. There are various indicators which are relevant in determining when a company is insolvent. However, determining insolvency is done on a case by case basis and company directors should obtain professional advice if required.
Claim by a Liquidator for Insolvent Trading
A liquidator can pursue a claim for insolvent trading against a director of a company, if:-
- The person was a director of the company at the time when it was insolvent;
- During the period which it was insolvent the company incurred debt(s) owed to creditor(s) which have not been paid; and
- At the relevant time, the director had reasonable grounds for suspecting that the company was insolvent, or a reasonable person in the director’s position would have had reasonable grounds for suspecting that the company was insolvent.
Subject to any defences available to the director, a liquidator can pursue an insolvent trading claim against the director if the above factors are satisfied for the amount of any unpaid debts which the company incurred while it was insolvent. For example if a company was insolvent for six months before the date of liquidation and it incurred unpaid debts totalling $400,000 during this period, the liquidator of that company may be able to pursue an insolvent trading claim against the company’s director(s) for $400,000.
Defences Available to a Director to a Liquidator’s Claim for Insolvent Trading
There are a number of defences available to a director in respect of a liquidator’s claim for insolvent trading under the Corporations Act, including at the time when the company incurred the debts which are the subject of the insolvent trading claim:-
- The director had reasonable grounds to expect (and did expect) that the company was solvent;
- The director was relying on a competent and reliable person to produce or provide financial information regarding the company and based the information actually provided, the director reasonably believed that the company was solvent;
- The director did not take part in the management of the company due to illness or some other good reason; and
- The director took all reasonable steps to stop the company incurring the debt or debts which are the subject of the insolvent trading claim.
Claim Against a Holding Company for Insolvent Trading
It’s a little known fact that a liquidator can also pursue a claim against a holding company for insolvent trading. This means if one of the insolvent company’s shareholders owns more than 50 percent of its shares, it could also be liable for insolvent trading.
Claim by a Creditor for Insolvent Trading
A creditor of a company can also pursue a claim for insolvent trading in respect of its own outstanding debt.
However, a creditor can only pursue a claim for insolvent trading if they receive the written consent of the liquidator or the leave of the Court. Generally a creditor will only be able to obtain the liquidator’s consent or leave of the Court if the liquidator does not intend to pursue their own insolvent trading claim.
Offence of Insolvent Trading
It is also an offence for a director, or directors, to trade a company whilst insolvent. The ASIC may investigate any circumstances of asserted insolvent trading and in some cases they may commence criminal prosecution against a company’s directors.
Advice Regarding Insolvent Trading
If you are worried about your risks as a director of an insolvent trading, it’s a good idea to get help early. If you’d like to discuss your concerns and get answers today, pick up the phone and get in touch.