A GUIDE TO AUSTRALIAN INSOLVENT TRADING

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.dissolve.com.au/information-centre/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 are the duties of a Director?

Under the Corporations Act 2001 (Cth), company directors hold significant legal responsibilities. Their duties are designed to ensure that they act with integrity, make informed decisions, and prioritise the interests of the company and its stakeholders. These obligations become important when a company facing financial distress. Failing to uphold these duties, can expose directors to serious consequences, including:

• Civil penalties – such as disqualification from managing companies or financial penalties.
• Compensation orders – to repay creditors or the company for losses caused.
• Criminal charges – rare but possible

General duties

Directors have general duties under both common law and the Corporations Act:

• Act with due care and diligence (s180) – Make informed decisions based on financial and business information.
• Act in good faith and in the best interests of the company (s181) – Prioritise the company over personal interests.
• Using their powers for a proper purpose (ss182-183) – Cannot misuse their role or access to benefit themselves or cause harm to the business.
• Avoiding conflicts of interest – Disclose personal interests and abstain from related decisions.

Duty to Assess the Company’s Financial Position

Directors must be proactive in understanding the company’s financial health. Ignorance or passive oversight is not an excuse – directors must act on warning signs of financial distress. This means:

• Monitoring cash flow, liabilities, and receivables
• Regularly viewing financial reports and forecasts
• Ensuring there are reasonable grounds to believe the company can pay its debts when they fall due.
• Seeking advice when in doubt (e.g. from accountants or insolvency professionals)

Duty to Prevent Creditor-Defeating Dispositions

A creditor-defeating disposition, as defined under s588FDB of the Corporation Act 2001 (Cth), is a transaction or arrangement made by a debtor company with the primary purpose of preventing, obstructing, or significantly delaying creditors from recovering debts owed to them. These dispositions typically involve conduct that reduces the pool of assets available to creditors, such as:

• Transferring assets for less than market value, or for less than the best price reasonably obtainable
• Granting uncommercial security interests or related entities or insiders
• Structuring arrangements that alter the company’s financial position to the detriment of creditors

Such conduct commonly arises during shortly before insolvency, particularly in illegal phoenix activity, where valuable assets are moved to another entity, leaving debts behind.

Duty to Prevent Insolvent Trading (s588G)

Directors must prevent the company incurring debts if:

• The company is insolvent at that time or becomes insolvent as a result of the debt incurred.
• There were reasonable grounds for suspecting insolvency.

Duty to keep books and records.

Directors can be held personally liable for company debts if records are inadequate. A court may presume insolvency during the period of non-compliance. Therefore, companies must maintain:

• Accurate financial records demonstrate transactions and positions.
• Daily cashbooks, ledgers, and supporting documents for at least seven years.
• Systems reporting and identifying financial difficulties early.

If my company did trade while insolvent, what penalties can apply?

ASIC may investigate and pursue enforcement action, particularly where the breach is serious, systemic, or reckless. The penalties that apply for insolvent trading can be severe, they include:

1. Disqualification from managing corporations under a court order (Corporations Act s206C)
2. Civil penalties, including fines of up to $1.65 million.
3. An order to pay compensation to the company equivalent to the loss suffered by creditors.
4. Insolvent trading is an offence and can be referred to the regulator for further investigation and possible criminal prosecution. In serious cases it can result in substantial fines or a term of imprisonment.

What could the civil penalties be?

Under s1317E and s1317G of the Corporations Act, if a director breaches the duty to prevent insolvent trading under s588G, they may face:

• A civil penalty of up to 5,000 penalty units – currently $1.65 million as prescribed by the Crimes Act 1914 and is currently $330 per one penalty unit (if committed on or after 7 November 2024)
• Three times the value of the benefit, if the director obtained a benefit from the breach.

When a corporation (not individual) breaches civil penalty provisions, the court may impose:

• The maximum penalty is 50,000 penalty units, amounting to $16.5 million.
• Three times the value of benefit obtained.
• 10% annual turnover up to 2.5 million penalty units, amounting $825 million.

Civil penalties do not require proof of dishonesty – only that the director failed in their duty while the company was insolvent or became insolvent because of the incurred debt.

What are the compensation proceedings?

Compensation is distinct from penalties; it aims to recover actual losses incurred by creditors due to insolvent trading. Under section 588M:

• A liquidator can sue a director to recover the total value of debts incurred while insolvent.
• The director may be held personally liable to compensate the company, equal to the total loss or damage suffered by creditors due to the insolvent trading.
• In some cases, creditors may seek leave from the court to bring proceedings directly (if the liquidator does not act)

This is separate from civil penalties and aims to restore creditors, not punish directors.

What could the criminal charges be?

Under section 588G, insolvent trading becomes a criminal offence if:

• The director suspected insolvency
• The company incurred debts when it was insolvent.
• The director’s failure to prevent the debt was dishonest as defined by criminal law standards.

If convicted, the director may face:

• A fine up to 5,000 penalty units (currently $1.65 million),
• Up to 15 years imprisonment, under the criminal code provisions relating to serious offences involving dishonesty, fraud, or company misconduct.
• Or both

ASIC can refer these matters to be prosecuted by the Commonwealth Director of Public Prosecutions (CDPP). Criminal proceedings require a higher standard of proof beyond reasonable doubt.

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.

At Dissolve, 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.

What is Small Business Restructuring?

Small Business Restructuring is a formal insolvency process that offers struggling small businesses the opportunity to restructure their financial obligations. Unlike liquidation, SBR allow businesses to remain operational while working out a payment plan to repay creditors over time. This process is tailored specifically to be more accessible and less expensive, helping business owners navigate through tough financial situations without losing control over their business.

The SBR process can be broken down into four phases. They are pre-appointment phase, commencement, the restructuring phase, and the plan phase, each offering a structured approach to support companies through their recovery. These three phases ensure the company can reorganise while minimising any disruption to operations.

What is Voluntary Administration?

Voluntary administration is a process under the Corporations Act, where an insolvent company is placed in the hands of an independent person who can assess all the options available. In a voluntary administration, the director appoints an administrator to oversee the running of the company for 30 days while they try to form a deal to be put to creditors. This process aimed to save the business or to at least achieve the best possible outcome for stakeholder and it ends when the decision is made to proceed with one of the three possible outcomes being to give control back to the company directors, execute a DOCA or place the company into liquidation. But a Voluntary Administration can also end if a court orders, for example that a liquidator be appointed.

What is Liquidation?

Liquidation is the process of finalising a company’s affairs and selling its assets to repay creditors and shareholders. Even if the company is solvent, the company and its directors may still consider liquidating it for tax benefits. There are different types of liquidation for these circumstances.
Most directors consider liquidation in circumstances of financial distress. But before a director turns to liquidation, there are a whole range of other solutions that can be considered. Those solutions come under the general banner of Corporate Restructuring. The overriding philosophy is to find the “Least Drastic Solution”.

What is Receivership?

Receivership is when an independent receiver is appointed. A receiver usually appointed by a secured creditor (e.g., a bank) under a security agreement (like a mortgage or change). Their main duty is to collect and sell assets to recover money owed. Receivership does not necessarily mean liquidation, although sometimes a receiver and manager is appointed, meaning they can also run the business temporarily to maximise asset values. The company itself may still have directors in office, but their control is limited.

What are the Consequences Of External Administration?

External administration can result in:

• Directors’ powers are suspended and handed over to the external administrator (e. g., administrator, liquidator, or receiver).
• Legal actions against the company generally frozen (a moratorium)
• Suppliers and lenders may stop providing goods or services unless paid upfront.
• Investigation into the company’s affairs and how it got into financial trouble.
• Possible winding up if a solution can’t be found.
• Potential sale of assets to repay creditors and employee entitlements are usually reviewed and may be prioritised for payment.
• Investigation into the company’s affairs and how it got into financial trouble.
• The company’s reputation is often severely damaged.
• There is a risk of personal liability for directors if they breached duties before administration.

What are the Directors’ powers?

When external administrators are appointed:

• Directors lose control of the company’s business, property, and affairs.
• They remain formally appointed but cannot act, such as bind the company to new transactions or contracts, without the external administrator’s consent.
• In voluntary administration, directors may propose a Deed of Company Arrangement (DOCA) to restructure and save the company.

What are the Directors’ obligations?

Even after external administration begins, directors must:

• Provide full cooperation, including making themselves available for interviews or meetings.
• Providing company books and records immediately.
• Avoid obstructing the administration process.
• Submit a Report on Company Activities and Property (ROCAP) detailing assets, debts, and financial affairs.
• Failure to meet these obligations can result in civil penalties, disqualification from managing companies, or even criminal charges.

What are Creditor meetings?

Creditor meetings are formal gatherings during external administration where creditors are given information about the company’s position. Typically occur within 8 business days (first meeting) and around 20-30 business days (second meeting) after Voluntary Administration begins. Creditors can vote on important matters, like whether to appoint a new administrator, to accept a proposed DOCA or move to liquidation. They may form committees to oversee aspects of the administration. These meetings help creditors influence what happens to the company, such as the company’s future and protect their interests.

What is Public examination?

Public examination is a court-supervised process where directors, officers, auditors, or others involved with the company can be compelled to answer questions under oath. It is designed to recover assets, clarify the company’s financial collapse, or uncover misconduct, such as insolvent trading, fraudulent transactions, and preferential payments to certain creditors. Liquidators, ASIC, and creditors can apply for public examinations. Public examinations can also lead to legal actions against wrongdoers based on evidence uncovered.

What is disqualification from managing corporations?

Disqualification means a person is banned from being a director or managing a company for a period set by the court or regulator. It prevents someone from being involved in management, board decisions, or control of any company. Disqualification can be ordered by ASIC (can impose up to 5 years) and the court (can impose longer or permanent, depending on the misconduct). It happens when a director has:

• Breached their duties.
• Been involved in multiple company that were liquidated within a 7-year period and leaving unpaid debts.
• Committed serious offences like fraud or dishonesty.

What are employee entitlement proceedings?

If a company goes into liquidation and employees are unpaid, then they become priority and must be considered before unsecured creditors. If the company cannot pay, the liquidator may:

• Pursue actions against directors for certain unpaid entitlements.
• Investigate whether directors breached laws, making directors personally liable.
• Use government schemes, such as the Fair Entitlements Guarantee (FEG) to pay employees

Directors who improperly allowed employee entitlements to remain unpaid could face civil penalties and compensation proceedings.

What is Director Penalty Notice?

A Director Penalty Notice (DPN) is a notice that the Australian Tax Office (ATO) can send to the director of a company. A DPN can make that director personally liable for three types of tax debts of a company:

1. Pay As You Go (PAYG),
2. Superannuation Guarantee Charge (SGC) liabilities,
3. Goods and Services Tax (GST).

There are two types of DPN. The first one is the Non-Lockdown DPN which gives a director 21 days to take certain actions to avoid personal liability. The second type is the Lockdown DPN, can make a director automatically personally liable if company tax returns or superannuation guarantee returns are not lodged within 3 months of their due date – there is no opportunity to avoid that liability once the DPN is served on the director.

How can you manage the risk of trading while insolvent?

Directors can manage and reduce the risk by:

• Staying informed – regularly monitoring financial reports, asking questions, and challenging assumptions
• Forecasting and stress-testing – preparing cashflow forecasts and testing whether the company can survive unexpected shocks.
• Seeking early advice – if there are signs of financial trouble, seek advice immediately. Insolvency practitioners, accountants, and commercial lawyers can provide a path forward.
• Documenting everything – maintaining proper books and records. Board minutes should record financial discussions, the basis for decisions, and any external advice taken.
• Avoiding new risky debts – directors should not allow the company to incur new liabilities unless they reasonably expect the company can pay them.
• Safe Harbour protections – under s588GA Corporations Act, Safe Harbour protects directors who take genuine steps to restructure and save the company. But directors must meet certain conditions.

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. Creditors usually need permission from the court to bring an action themselves, especially once a liquidator has been appointed. This right gives creditors a second chance to recover losses if the liquidator decides not to act.

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 at the time the debt was incurred, based on what they knew.
• It was reasonable to rely on information from a competent and reliable manager (e.g., a CFO) and it was reasonable to do so)
• The director was not involved in management because of illness or for some other acceptable reason (e.g., extended leave)
• All reasonable steps were taken to prevent the company incurring the debt, such as raising concerns, calling board meetings, or trying to appoint an administrator.

What is the Corporations Act?

The Corporations Act is a comprehensive set of laws that governs how companies in Australia are formed, operate, and are regulated. The Act is federal law but works with state and territory laws under a national scheme. It sets out the rules for:

• Company formation and management – how companies are registered, types of companies, and rules for running them.
• Directors’ and Officers’ duties – including duties to prevent insolvent trading, duties of care, acting in good faith, and avoiding conflicts of interest.
• Fundraising and disclosure – issuing shares, raising capital, and providing information to investors.
• Financial markets and services – licensing and conduct of financial services providers, and operation of stock exchanges like the Australian Securities Exchange (ASX),
• Enforcement and penalties – enforcement powers for regulators like ASIC, how breaches are investigated and the consequences, such as civil penalties, compensation orders, and criminal charges, for companies or individuals who do not comply.

What is Safe Harbour?

Safe harbour, founded in section 588GA of the Corporations Act, was designed to protect company directors from the risk of personal liability that may arise while making a legitimate attempt to save the business from insolvency, liquidation, or administration. In order to access Safe Harbour, the directors must start developing a course of action, such as restructure, after they suspect insolvency, and it must be reasonably likely to lead to a better outcome for the company and its creditors. They must continue paying employee entitlements and comply with tax reporting obligations during that time.
Safe harbour encourages directors to take early and proactive steps to turn around a distressed company without fear of insolvent trading liability. Safe harbour ends if the director stops taking reasonable steps, the plan fails, or the company is placed into administration or liquidation.