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01 Sep 2010

Duty to prevent insolvent trading: Guide for Directors


4 min

In July, ASIC released Regulatory Guide 217 with the above title. The guide is intended to assist directors understand what insolvent trading is and how to comply with their duty to prevent it. It also sets out some factors that ASIC and insolvency practitioners will take into account when assessing whether a director has complied with that duty and whether any claim (civil or criminal) is warranted.

Whether the company is solvent or not is one of the most important parts of any insolvent trading claim. The guide (at RG217.18) sets out an explanation of solvency as defined in section 95A and tests used to determine it.

“The company’s ability to pay its debts should be determined by reference to the actual circumstances of the company. Determining whether a company is insolvent predominantly involves applying a cash flow test. This requires realistically assessing whether the company’s anticipated current and future cash flows will be sufficient to enable current and future liabilities to be paid as and when they fall due for payment.”

As practical advice for directors, the guide sets out what is expected of directors – a To Do list. In summary:

  • Directors must ensure that company’s keep proper financial records and “take reasonable steps to remain properly and fully informed about the financial affairs.

  • Directors should regularly assess the company’s solvency.

  • Directors should take steps to confirm the company’s financial position immediately upon identifying any concerns about the company’s position.

  • Directors should seek appropriate advice and consider and act upon that advice in a timely manner.

Directors who do not cause the company to keep proper records (you cannot manage what you do not measure), actually know what those records say (preparing and then ignoring records is not helpful, you need to look at them), and act on appropriate advice risk breaching their duties if the company becomes insolvent.

One factor that we often come across as a defence to an insolvent trading claim is the 588G(2)(b) claim that a competent and reliable person was preparing information that made the director believe that the company was solvent.

The Act actually says that this competent and reliable person (who must be both competent and reliable) must be providing the director with adequate information for the director to make his or her own assessment. "She'll be right mate!" does not fulfill that obligation. So:

(i) The information has to be provided to the director, not just prepared;
(ii) The information has to be adequate; and
(iii) The director must read it and form an opinion.

In many cases we find that, if the information provided was adequate, it would have clearly shown that the company was insolvent, but in many more cases we find that the “competent and reliable person” may have prepared some information, but that it was never provided to the director – or if provided, the director never looked at it. The competent and reliable person gave some "She'll be right mate!" advice to the director and the matter was forgotten.

The guide sets out some guidance in this area. In summary it says:

  • The director should first establish that the person is competent and reliable.

  • This person must also have access to the records to be able to provide adequate information to the director.

  • The director should consider the information to be able to “understand the financial effect of the advice they receive" and be satisfied that the information is accurate and complete.

The guide can be accessed through ASIC’s website at Regulatory Guide 217 - Duty to prevent insolvent trading: Guide for Directors.

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