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The Role of a Director: Duty to Prevent Insolvent Trading

11 August 2016

A Director, or a person who acts as a Director of a company, has a positive duty under Section 588G of the Corporations Act to prevent the company from trading if it is insolvent.

The role of a Director, whilst a privilege, also carries great responsibility.  A Director should be aware of his/her obligations as mandated by the Corporations Act 2001.  Once a company is in financial difficulty, or is insolvent, a Director's compliance or otherwise with his/her duties may come under scrutiny.

Section 588G of the Corporations Act requires a Director of a company to prevent the company from incurring a debt if:

  • The company is already insolvent at the time the debt is incurrred;  or
  • By incurring that debt, or by incurring a range of debts including that debt, the company becomes insolvent, and, at the time of incurring the debt, there are reasonable grounds for suspecting that the company is already insolvent, or would become insolvent by incurring the debt.

To fulfil this obligation, a Director must be constantly aware of the company's financial position.  This involves more than an annual review of the company's financial statements.

When is a company insolvent?

A company is insolvent if it is unable to pay all its debts when they are due.

ASIC Regulatory Guide 217 – Duty to prevent insolvent trading: Guide for Directors sets out further indicators of potential insolvency as follows:

1. The company has a history of continuing trading losses.

2. The company is experiencing cash flow difficulties

3. The company is experiencing difficulties selling its stock, or collecting debts owed to it.

4. Creditors are not being paid on agreed trading terms and/or are either placing the company on cash-on-delivery terms or requiring special payments on existing debts before they will supply further goods and services.

5. The company is not paying its Commonwealth and State taxes when due (e.g. pay-as-you-go instalments are outstanding, goods and services tax (GST) is payable, or superannuation guarantee contributions are payable).

6. Cheque are being returned dishonoured.

7. Legal action is being threatened or has commenced against the company, or judgements are entered against the company, in relation to outstanding debts.

8. The company has reached the limits of its funding facilities and is unable to obtain appropriate further finance to fund operations – for example, through:

  •  negotiating a new limit with its current financier; or
  •  refinancing or raising money from another party.

9. The company is unable to produce accurate financial information on a timely basis that shows the company's trading performance and financial position or that can be used to prepare reliable financial forecasts.

10. Company directors have resigned, citing concerns about the financial position of the company or its ability to produce accurate financial information on the company's affairs.

11. The company auditor has qualified their audit opinion on the grounds there is uncertainty that the company can continue as a going concern.

12. The company has defaulted, or is likely to default, on its agreements with its financier.

13. Employees, or the company's bookkeeper, accountant or financial controller, have raised concerns about the company's ability to meet, and continue to meet, its financial obligations.

14. It is not certain that there are assets that can be sold in a relatively short period of time to provide funds to help meet debts owed, without affecting the company's ongoing ability to continue to trade profitably.

15. The company is holding back cheques for payment or issuing post-dated cheques.

Consequences of Insolvent Trading

There are serious consequences for a Director who fails to fulfil his/her duty to prevent insolvent trading.  These consequences may affect a Director personally.

A Director may face not only civil penalties, but compensation proceedings and criminal charges (if the Director is also found to have been dishonest).  Further, the Director may be disqualified from managing a corporation for a period of time.

The Corporations Act provides some statutory defences for Directors, however these are unlikely to apply if it is evident a Director has not maintained current knowledge of the company's financial position.

Action

To fulfil your duty as a Director to prevent the company from trading while insolvent, and to avoid any penalties, civil or criminal charges or disqualification it is vital that you:

1. remain informed as to the financial position of your company and ensure the company maintains adequate, timely books and records;

2. promptly investigate financial difficulties;

3. obtain professional advice;  and

4. act in a timely manner.

Acting promptly will also maximise the likelihood of being able to achieve a successful restructure and save the business and company.

If you suspect your company is in financial difficulty, it is important to act immediately and obtain professional advice about the best course of action in your circumstances.

Acting promptly will not only ensure you fulfil your duties as a Director, but allow the greatest possible likelihood of being able to achieve a successful restructure and save the business and company.

If you suspect your company is in financial difficulty and would like to take advantage of the guidance and assistance of an experienced, independent advisor, call Rodgers Reidy now for a confidential discussion in relation to your specific business circumstances.

Further resources:-

1. ASIC Information Sheet 42 – Insolvency: A guide for directors 
2. ASIC Regulatory Guide 217 – Duty to prevent insolvent trading: Guide for directors

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