To trade insolvent or not trade insolvent—that is the question.
The Australian Securities and Investments Commission (ASIC) have invested time and effort promoting the fact that it is the “duty of directors to prevent insolvent trading”. ASIC Regulatory Guide 217 titled “Duty to prevent insolvent trading: Guide for directors”, guides directors to understand and comply with their duty to prevent insolvent trading. The Guide highlights section 588G of the Corporations Act 2001, which imposes a positive duty on directors to prevent insolvent trading. It highlights four key principles that help directors to discharge that duty:
- A director must stay informed about company financial affairs, and regularly assess the company’s solvency.
- Immediately upon identifying concerns about the company’s financial viability, a director should take positive steps to confirm the company’s financial position and realistically assess options to remedy those concerns.
- A director should obtain appropriate advice on:
- the solvency of the company and whether the company is at risk of trading while insolvent.
- the options available to the company to deal with its financial difficulties.
- whether it is realistically possible for the company to trade while attempting to restructure the company’s affairs to meet its obligations (including potentially renegotiating its obligations) and return the company to long-term financial health.
- A director should consider and act appropriately on advice received in a timely manner.
The Guide also includes a useful summary of factors ASIC uses to assess whether a director breached their duty to prevent insolvent trading.
The ultimate decision maker on insolvent trading claims is the court, not a liquidator, or the ASIC. It is important to note the actions of a liquidator (or creditor) seeking financial compensation for insolvent trading are very separate from any action that ASIC may take (which may include seeking that criminal sanctions be imposed).
The Corporations Act provides statutory defences for insolvent trading claims; however, the burden of proving these defences is on directors. Where a director does follow the four key principles and reasonably expects that the company is solvent and will remain solvent, demonstrating that they took reasonable steps to comply with their duty is more likely.
The key messages for advisors and their clients are:
- Have systems and procedures to enable directors to proactively monitor the company’s financial and solvency position.
- Investigate financial difficulties thoroughly.
- Seek and act on advice in a timely manner (if circumstances warrant it).
As an aside, not only are directors (and shadow directors) at risk of a claim for insolvent trading, but so too are holding companies (section 588V of the Corporations Act). This exposure can sometimes be overlooked in asset protection planning strategies.
It should be noted that the Federal Government has issued draft legislation aimed at providing directors with a 'safe harbour' from personal liability for insolvent trading in certain circumstances. The policy intention behind the safe harbour reforms is to avoid circumstances where a director prematurely moves a company into formal insolvency to protect their own liability from insolvent trading, and therefore provide businesses a better opportunity to restructure outside of a formal insolvency process. This will be achieved through providing directors with protection from personal liability insolvent trading in certain circumstances, while they are engaging in a legitimate restructure of the company.
The safe harbour reforms have not been finalised and do not yet have an implementation date. Worrells will provide an update on the reforms in due course.