Insolvent Trading and Directors’ Liability

insolvent tradingTrading during insolvency can have serious consequences for directors due to duties arising under the Corporations Act. Penalties such as heavy fines and imprisonment may apply.

To prevent insolvency trading, it’s important to know what conduct it covers. If a company is pursuing transactions or commercial activities while they are unable to pay back their debts as they become due, this constitutes trading while insolvent. If a company has failed to keep records as required, they must be presumed insolvent. This means that many directors of companies with poor record keeping could be at risk of insolvent trading offences.

Directors are liable under a duty to prevent insolvent trading if:

  1. They are a director at the time the company incurs a debt; and
  2. The company is insolvent at the time or becomes insolvent as a result of the debt; and
  3. There were reasonable grounds to suspect the company is/would be insolvent.

If accusations do arise, there are several defences to insolvency trading. These include:

  1. Having reasonable grounds to expect the company was solvent;
  2. Relying on information provided by others;
  3. Due to illness or other good reason, the director has failed to participate in company management; or
  4. Taking all reasonable steps to prevent the company from trading.

If a director suspects that their company may be insolvent, they should stop trading immediately and seek advice before continuing. Before trading, directors should also ask “would a reasonable person have entered into this transaction, given the circumstances of the company?” This may help to minimise the risk of trading while insolvent.