Insolvent Trading Laws – broken, yes, but changes shelved

In 2010, it was announced that the Government would review Australia’s insolvent trading laws, which are amongst the toughest in the world.  In brief, the law currently says that if a company is insolvent and the directors allow the company to incur new debts, then the directors can be personally liable for those new debts.  It was recently announced that the proposed changes, which would have put Australia on a similar footing to other countries, have been shelved.

Let me make my view clear – Australia’s insolvent trading laws are completely flawed.  Let me explain.

The basic philosophy of the insolvent trading law is sound – we do not want directors incurring new debts when a company is insolvent.  But let’s look at the laws in operation:

• For a large company the directors will, usually, be seeking sound advice from experienced professionals and the essence of that advice will be “why risk personal liability – if in doubt commence a Voluntary Administration“.  Most of the debate has been about this issue.  Directors of large companies would say that the threat of personal liability is too high – I’m not sure I agree but my view is not the relevant one – directors of large companies say they will pull the pin rather than risk personal liability.  The problem with that is that it will lead to premature Voluntary Administration appointments.  I say that because we also know that few companies manage to find their way through the Voluntary Administration regime to achieve a Deed of Company Arrangement (less than 1 in 3 do so) so some companies that could have traded out of difficulty will fail.
• For a small company the directors will have already provided personal guarantees to the Bank and major creditors and be fully invested in the business.  If the business fails, the director will often also loose all personal assets.  Hence, the threat of personal liability for some new debts is not much of a worry.  That director will usually roll the dice again and keep trading in the hope of finding a way out of the hole.  I can tell you that, as a liquidator, in most of the companies I liquidate there will have been insolvent trading, but it is rarely worthwhile to undertake a legal action because the director will usually have no money to satisfy a claim.

The law changes, now shelved, were largely along the line of a new “business judgement” rule which would have lowered the potential risk for directors.  A Business Judgement rule would have been nice for directors of large companies.  But it matters not as they have been shelved.

Further, a Business Judgement rule would have been irrelevant for directors of small companies.  For them, all of the reasoning outlined above would have still applied.  I explained in a past blog that Voluntary Administrations don’t work very well so most directors of small companies will continue to plug on well beyond the point where they should call for a VA.

So the insolvent trading laws don’t work for large or small companies and the proposed changes wouldn’t have worked either.  Back to the drawing board please!!