Director’s Duties – Duty not to trade whilst insolvent

Date: May 16, 2014
Document Type: Article

As a director of a company, you have many duties and obligations arising from common law and statute. It is important to be aware of these duties regardless of how large the company is or how much involvement you have in the company.

The main duties of a director include:
  • Duty to act in good faith
  • Duty of care, diligence and skill
  • Duty to avoid conflicts of interest
  • Duty not to improperly use your position or information
  • Duty not to trade whilst insolvent

Failing to be aware of the existence and extent of these duties can get you into trouble with, amongst others, ASIC and can cause significant personal liabilities.

This article addresses the duty not to trade whilst insolvent. Other articles on this website will address other duties.

Duty not to trade whilst insolvent

As a director, if you suspect your company is insolvent or may become insolvent, you have a positive duty to prevent the company from incurring further debts.

Insolvency is determined based on whether a company is able to pay all their debts as they become due and payable. Having enough assets will not necessarily mean a company is solvent, if they cannot readily be made available for repaying debts.

Insolvent trading occurs when a company incurs a debt whilst insolvent (or becomes insolvent as a result of incurring the debt) and there are reasonable grounds for suspecting at the time that the company was insolvent.

If you, as a director, fail to prevent insolvent trading you will have breached your duty if:

  • you were aware of grounds for suspecting the company is insolvent; or
  • A reasonable person acting in your position in the company’s circumstances would be so aware.

You don’t have to be certain the company is actually insolvent, only that there are reasonable grounds for such a suspicion.

Australia’s regime is regarded as one of the strictest in the world. It imposes a duty on a director to prevent insolvent trading by the company, regardless of whether the director had a role in making the company insolvent.

What do I have to do?

The most important safeguard against insolvent trading is taking an active interest in the financial capabilities of the company. Ignorance of the company’s financial position is not a defence to a breach of the duty.

If you suspect your company is in financial difficulty you cannot put your head in the sand and hope it will go away. Increased financial monitoring, more vigilant safeguards and engagement with banks and financiers as early as possible can all help avoid a breach of the duty but are not a fail-safe.

Since it is often difficult to identify insolvency and given the onerous duty on you as a director to prevent insolvent trading, we highly recommend you seek legal and financial advice as early as possible if you suspect your company is in financial trouble.

What happens if I breach this duty?

You may be liable for civil penalties under statute such as fines, orders to pay compensation for damage suffered by the company or creditors and disqualification from directorship.

If you have been intentionally dishonest or reckless in breaching this duty, you may be criminally liable which could entail much larger fines and even imprisonment.

If you need advice please phone us.
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