“Insolvent Trading” or “Trading While Insolvent” occurs when a company is unable to pay its commitments and yet continues to trade and incur new liabilities. In this scenario, directors of the company can be personally liable for the new debts.
A range of options is available to directors who suspect insolvency, but most importantly directors need to act immediately if they suspect that the company is insolvent. Figuring out if your company is insolvent is critical, because there are many legal consequences that can follow if you suspect the company is in difficulty but fail to act.
The Corporations Act advises that the overriding question a director must answer is: is the company able to pay all of its debts as and when they become due and payable?
In the following circumstances, directors may be personally liable for insolvent trading by the company:
• a person is a director at the time a company incurs a debt;
• the company is insolvent at the time of incurring the debt or becomes insolvent because of incurring the debt;
• at the time the debt was incurred, there were reasonable grounds to suspect that the company was insolvent;
• the director was aware such grounds for suspicion existed; and
• a reasonable person in a like position would have been so aware.
The law provides that the liquidator, and in certain circumstances the creditor who suffered the loss, may
recover “an amount equal to the loss or damage suffered” from the director. Similar provisions exist to pursue
holding companies for debts incurred by their subsidiaries.
A defence is available under the law where the director can establish:
• there were reasonable grounds to expect that the company was solvent and they actually did so expect;
• they did not take part in management for illness or some other good reason; or,
• they took all reasonable steps to prevent the company incurring the debt.
The proceeds of any recovery for insolvent trading by a liquidator are available for distribution to the unsecured creditors before the secured creditors.