The Corporations Act requires directors to prevent their company from incurring debts which the company is not able to pay which is called insolvent trading.
If a director fails to prevent the company from incurring debts and the company is ‘insolvent trading’ then the director can become personally liable for those debts.
There are defences, but they are not easily accessed. The legislation has been framed on the basis that directors will acknowledge their responsibilities and take positive action if there is doubt as to the solvency position of the company.
The purpose of this information is to provide an overview of the insolvent trading regime, to assist your director clients in recognising the warning signs of insolvency, and to assist understanding as to what a director should do if they suspect a company may be insolvent or becoming insolvent.
In light of this, directors of insolvent or potentially insolvent companies are encouraged to read and consider carefully the contents of this information brochure.
Duty to not conduct insolvent trading
As well as general directors’ duties, one has a positive duty to prevent a company from insolvent trading. This means that before a new debt is incurred, a director must consider whether there are reasonable grounds to suspect that the company is insolvent or is likely to become insolvent as a result of incurring the debt.
An understanding of the financial position of the company only when one signs off on the yearly financial statements is not sufficient. One needs to be constantly aware of the company’s financial position.
What to do if your company is insolvent trading
If a company is trading insolvent, the directors cannot allow it to incur further debt. Unless it is possible to restructure, refinance or obtain equity funding to recapitalise the company. If you can’t achieve that you should seek independent professional assistance to consider if you should place your company into Voluntary Administration or Liquidation.