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.
A quick explanation of Insolvent trading laws is:
The following things need to apply for a director to be personally liable for insolvent trading:
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.
Determining if a company is insolvent is a very complicated area of the law. We provide a very useful online tool at our "Is my company insolvent?" page which can be helpful in doing an initial analysis.
No. The insolvent trading laws make a director personally liable only for new debts incurred after the date the company became insolvent.
“Director” is defined as those formally appointed as a director, as per lodgements at ASIC, 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.
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. 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.
The penalties that apply for insolvent trading can include:
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.
Insolvent trading is an offence and can be referred to ASIC for further investigation and possible criminal prosecution. In serious cases it can include a prison term.
Yes, a holding company can also be liable for the debts of a subsidiary if it allows the subsidiary to trade while insolvent.
There are defences available to a director accused of insolvent trading. Those defences are that:
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.
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.
A liquidator has six years from the beginning of the liquidation to commence an action for insolvent trading.
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.