Insolvent trading is when directors allow their company to incur debts when the company was insolvent. The liquidator can make a compensation claim against a director if those debts are unpaid when the liquidation commences. A director may be held personally liable to compensate creditors for the amount of the unpaid debts incurred from the time the company became insolvent to the liquidation’s start.
Factors in Insolvent Trading
Aside from the company being in liquidation, the factors in an insolvent trading claim are:
- The company must have been insolvent when the debts were incurred;
- The debts must remain unpaid at the time of the liquidation;
- The claims must be made against people who were company directors at the time debts were incurred; or
- There were reasonable grounds for the director to suspect the company was insolvent.
How do Directors Become Liable for Insolvent Trading Claims?
Section 588G of the Corporations Act sets out the director’s duty to prevent insolvent trading and sets the parameters by which a liquidator can initiate the process for making a claim against a director. Directors contravene this section by allowing the company to incur a debt when they are aware of grounds to suspect the company was insolvent.
When directors breach their duty, the provisions of section 588M allow compensation to be recovered from that director. A claim is possible where the creditors suffered loss or damage because of the company’s insolvency and the debt was wholly or partly unsecured.
What Defences Are Available to Directors?
The Corporations Act provides statutory defences for directors. The burden of proving these defences is on directors. The statutory defences can be summarised as:
- The director had reasonable grounds to expect (not just suspect) the company was solvent;
- A reasonable, competent person produced information that would reasonably lead to a belief that the company was solvent;
- The director had a good reason for not taking part in the company management at the relevant time; or
- The director took all reasonable steps to stop the company incurring the debt, including attempting to appoint a voluntary administrator to the company.
The courts have made it clear that the position of director carries certain responsibilities, which cannot be avoided, including the duty to keep informed about the company’s solvency.
How long do Liquidators have to take action for Insolvent Trading?
Liquidators have six years from the beginning of the liquidation to commence an action for insolvent trading.
Proceedings must be commenced by way of the filing of an application with the court within that six-year period. It is not sufficient to just issue a demand.