EVERYTHING YOU NEED TO KNOW (UPDATED 2023)
Continuing to incur new debts whilst a company is insolvent can lead to the company’s directors becoming personally liable for those debts. This guide tells you all you need to know about insolvent trading.
WHAT IS INSOLVENT TRADING?
Insolvent trading is the law under the Corporations Act section 588G that says that if a company is insolvent and a director allows the company to incur a new debt, then the director can be personally liable for the new debts incurred. The law makes directors responsible for ensuring that their company does not trade while insolvent. This is in addition to their general duties to act with care and diligence, in good faith, in the best interests of the company and not to improperly use their position or information received for personal gain.
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- What is Insolvent Trading?
- How is company insolvency specifically defined?
- How would I know if my company is insolvent?
- What does personal liability entail?
- How can personal liability be proven legally?
- Who would be considered a “director” for the purposes of insolvent trading?
- What should I do if my company is insolvent?
- If my company did trade while insolvent, what penalties can apply?
- Can a creditor take an insolvent trading action?
- What are the defences to an insolvent trading claim?
- Other questions
- Can a Holding or parent company be liable for insolvent trading debts?
- What’s the difference between civil and criminal insolvent trading?
- How long after liquidation can a liquidator commence an insolvent trading action?
- What do you do if a liquidator has sent you a letter saying you are liable for insolvent trading debts?
How is company insolvency specifically defined?
Solvency and insolvency are defined in the Corporations Act at Section 95A in this way: A person (a person is defined to include a company) 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. And a person who is not solvent is insolvent.
This means that if the company were to review all of its debts/invoices that are presently due and payable, and would not be able to pay them all out in full now, it is insolvent.
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How would I know if my company is insolvent?
As per the definition of insolvency above, if the company is unable to pay all of its debts as they fall due, it is considered insolvent.
It can be difficult to take an objective view of your company’s position, especially whilst still trading.
It is not uncommon for a struggling company to dip in and out of an insolvent state from time to time. The real concern is when a company becomes insolvent and cannot recover.
If you have any doubts, try our interactive tool: https://www.insolvencysolutionsgroup.com.au/is-my-company-insolvent/
What does personal liability entail?
Personal Liability is where a company’s debt is made to be the directors personal debt.
A director can be personally liable for any debt incurred after the date the company became insolvent. So, to be clear, a director cannot be personally liable for a debt that was incurred whilst the company was solvent, even if it remains unpaid as a result of subsequent insolvency.
The process a liquidator undertakes to establish insolvent trading is to inspect the company’s books and records and set a date where they believe the company first became insolvent. If they see debts incurred after that date, those debts become part of an insolvent trading claim against the directors.
How can personal liability be proven legally?
A liquidator has the right to issue an insolvent trading claim on a director without having to attend court. If the director disputes any of the facts surrounding the claim, they can challenge the claim directly. If a consensus cannot be reached between the liquidator and the director the matter can then proceed to court.
Who would be considered a “director” for the purposes of insolvent trading?
“Director” is defined as those formally appointed as a director, as per the official record, but it can also include a “shadow director” being someone who is acting in the position of a director, even if not formally appointed. Insolvent trading laws do not apply to management (unless they can be proven to be a “shadow” or hidden director)
What should I do if my company is insolvent?
If your company is insolvent, the first thing to ensure is that your company does not incur any new debts. A director should then seek professional advice on their options.
We have advised thousands of directors about insolvent trading and are very familiar with the laws. Contact us for free, confidential advice.
There are a wide variety of options which include voluntary administration, recapitalisation, liquidation and restructuring. Have a look at The Restructuring Spectrum to get a snapshot of the types of solutions available to companies that are insolvent.
If my company did trade while insolvent, what penalties can apply?
The penalties that apply for insolvent trading can be severe, they include:
- Disqualification from managing a company
- Fines of up to $200,000
- An order to pay compensation to the company equivalent to the loss suffered by creditors
- Insolvent trading is an offence and can be referred to the regulator for further investigation and possible criminal prosecution. In serious cases it can include a prison term.
Can a creditor take an insolvent trading action?
Yes, if a liquidator does not pursue an insolvent trading claim, the creditors of the company can take an insolvent trading action themselves. Creditors can only take action against directors for their own debts whereas a liquidator can pursue an insolvent trading claim on behalf of all creditors.
What are the defences to an insolvent trading claim?
There are defences available to a director accused of insolvent trading. Those defences are that:
- There were reasonable grounds to expect solvency;
- It was reasonable to rely on information from a competent and reliable manager;
- The director was not involved in management because of illness or for some other good reason;
- All reasonable steps were taken to prevent the company incurring the debt.
Can a Holding or parent company be liable for insolvent trading debts?
Yes, a holding company can also be liable for the debts of a subsidiary if it allows the subsidiary to trade while insolvent.
What’s the difference between civil and criminal insolvent trading?
Insolvent trading leaves a director open to civil and possibly criminal penalties. The difference is that civil proceedings are effectively chasing money from the director, whereas a criminal action is seeking a criminal conviction which can mean a prison term or some other penalty.
How long after liquidation can a liquidator commence an insolvent trading action?
A liquidator has six years from the beginning of the liquidation to commence an action for insolvent trading.
What do you do if a liquidator has sent you a letter saying you are liable for insolvent trading debts?
If you have received a letter from a liquidator saying you are personally liable under insolvent trading laws then it is a serious matter and you should immediately seek professional advice.