If you are a director of a company, you must be constantly aware of the business’ financial situation. If your company is at risk of becoming insolvent, you must act fast. Trading while insolvent can have serious consequences and may expose your personal finances to pay off the debts of the company. This article will explain the risks of insolvency and how to minimise them.

What Are the Risks?

The risks of insolvent trading, particularly towards individual directors, are very serious. They can come in the form of:

  • fines;
  • civil compensation claims; and
  • criminal penalties.

The type of penalty will depend on the severity of the breach and any surrounding circumstances. More specifically, the penalties have been laid out below:

Penalty

Explanation

Disqualification

If you are found guilty of a criminal offence of insolvent trading, ASIC will disqualify you as a director.

Civil Fines

Personal fines can be as high as $200,000.

Compensation

ASIC may initiate civil claims on behalf of the creditors against directors for compensation. Directors are also vulnerable to similar claims brought personally by liquidators or creditors.


There is technically no limit on how high compensation payments can go. A large claim could potentially result in your bankruptcy. This means that you will be disqualified from being a director or continuing in your current position.

Criminal Penalties

Directors can face five years in gaol for any criminal aspect related to insolvent trading.

How to Minimise the Risks of Insolvent Trading

Stay Informed

As a director, you must do a number of things to stay informed about the financial position of the company, including:

  • being knowledgeable about your duties as a director;
  • keeping all financial records and other information that may be relevant to the finances of the company; and
  • gaining an understanding of the cash flow of the company.

Investigate

If the company is not in a strong financial position, you should be quick to:

  • take steps to understand where exactly the company stands financially;
  • look at what can be done to manage the financial instability;
  • avoid taking on new debts;
  • consider areas of the business that could be made leaner by making staff redundant;
  • ensure the company has systems to investigate whether or not the company will remain solvent upon taking any new debts.

Overall, you must be very involved in your company and should know exactly where the company’s money is being spent.

Obtain Advice

When it comes to obtaining advice, you should act quickly. You will need to find the right financial adviser and get advice about the financial stability of the company. They will be able to guide you on how you may be able to overcome the obstacles.

You can rely on this advice as a defence to any potential legal claims that may arise out of the company’s insolvency. The availability of this defence, however, hinges on whether you have given your accountant complete and up-to-date instructions.

Insolvency Safe Harbour

In certain circumstances, you may be protected from civil insolvent trading liability under the safe harbour provisions of the Corporations Act. The safe harbour provisions exclude liability if:

  • after you started to suspect that your company may become insolvent, you started to courses of action that were reasonably likely to lead to a better outcome; and
  • the debt is incurred directly or indirectly in connection with that course of action.

However, you will not be exempt from legal responsibility if the company is not meeting its tax obligations or failing to pay employee entitlements.

Act Quickly

When ASIC investigate your company over insolvent trading, they will examine:

  • the minutes of board meetings; 
  • other materials and correspondence that may illustrate that you were aware the company was unable to meet its debt obligations; and
  • any internal documents that provide a better picture of the company’s financial position.

ASIC, or a liquidator, is looking to see if you and any other directors have been active, efficient and honest in the steps you have taken to avoid incurring additional debt. You must become heavily involved in the company’s affairs once there is any concern that the company is struggling to pay its debts.

Importantly, following ASIC does not:

  • provide immunity from prosecution; or
  • limit the action creditors or a liquidator may take against you or any other directors if you traded while insolvent.

Liquidator Claims

If the liquidator finds, during the process of winding up the company, that you or any other directors have breached their duties to the company, it may commence court proceedings against you. When a liquidator makes a claim against you for insolvent trading, they will typically aim to recover an amount equal to the debts you owe.

Other common claims that liquidators may make against directors if the company is in liquidation include:

  • uncommercial transaction claims;
  • unfair preference claims;
  • director loan account claims; and
  • breach of directors duties claims.

Liquidators will commence such proceedings to maximise the assets available to be distributed to the company’s creditors. A liquidator may choose not to proceed with a claim against directors in situations where there is a lack of funds to do so, or there are low prospects of success.

COVID-19 Changes to Corporate Insolvency Laws 

In March 2020, the government introduced legislative changes to respond to the increasing economic threat posed by COVID-19. These amendments seek to provide a safety net for businesses who are experiencing financial hardship so that they can continue to operate during and after the pandemic. The temporary provisions specific to corporate insolvency law is that:

  • the threshold at which creditors can issue a statutory demand has been increased from $2,000 to $20,000;
  • the time that companies have to respond to statutory demands has been increased from 21 days to six months;
  • directors and holding companies have relief from any liability for new debt incurred during the period a company trades whilst insolvent provided that the debt is incurred in the ordinary course of the company’s business; and
  • the Treasurer now has the ability to provide targeted relief for classes of persons. This enables companies to deal with unforeseen events, rather than issuing a request to ASIC, which is usually a time consuming and delayed process.

The temporary provisions are expected to last until October.

Key Takeaways

As a director, you are required to become involved in the company’s affairs to whatever extent is necessary to ascertain the true financial position of the company. If you believe that your company may become insolvent, you need to act quickly and take all necessary steps to prevent this from happening. If you are worried about the financial position of your company and wish to have a lawyer or financial adviser advise you on your position, contact LegalVision’s insolvency lawyers on 1300 544 755 or fill out the form on this page.

About LegalVision: LegalVision is a tech-driven, full-service commercial law firm that uses technology to deliver a faster, better quality and more cost-effective client experience.

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Jessica Coventry
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