Insolvent Trading: Director Personal Liability

Four elements need to be present (s 588G):

1. 1.You were a director when the debt was incurred
2. 2.The company was insolvent at that time, or became insolvent by incurring it
3. 3.There were reasonable grounds at that time for suspecting insolvency
4. 4.You were aware of those grounds, or a reasonable person in a like position in a company in the company’s circumstances would have been aware

Insolvency has a statutory meaning. The Act defines solvency positively — able to pay all debts as and when they become due and payable (s 95A(1)) — and insolvency as simply not being solvent (s 95A(2)).

Two tests are applied in practice. The cash flow test asks whether the company can pay its debts as they fall due — this is the primary test. The balance sheet test asks whether liabilities exceed assets; it is relevant, but a company can be balance-sheet negative and still solvent if it can pay its bills.

The indicators pointed to after the fact are the ones the courts have used since ASIC v Plymin (2003) 47 ACSR 124: continuing losses, liquidity ratios below one, overdue Commonwealth and state taxes, a poor relationship with the bank and an inability to borrow further, no access to alternative finance, suppliers demanding cash on delivery, post-dated cheques, dishonoured payments, and special arrangements with creditors.

Four statutory defences exist (s 588H):

1. 1.You had reasonable grounds to expect, and did expect, that the company was solvent (s 588H(2))
2. 2.You reasonably relied on a competent and reliable person who was responsible for providing information about solvency (s 588H(3))
3. 3.You did not take part in management at the time, because of illness or another good reason (s 588H(4))
4. 4.You took all reasonable steps to prevent the debt being incurred, which includes moving to appoint an administrator or restructuring practitioner (s 588H(5)–(6))

Note the wording on the first: reasonable grounds to expect, not to hope. And on the fourth, the evidence that matters is what you actually did — sought advice, tried to raise capital, moved to appoint a practitioner — and whether there is a record of it.

Safe harbour was introduced to address a real problem: the insolvent trading rules created pressure to appoint an external administrator at the first sign of difficulty, even where continuing to trade would have produced a better outcome for creditors.

It provides protection where a director starts developing one or more courses of action reasonably likely to lead to a better outcome for the company than immediate administration or liquidation (s 588GA).

It is not automatic and it is not a shield you claim afterwards. It depends on keeping employee entitlements paid and up to date, keeping tax lodgements current, keeping proper books and records that comply with s 286(1), getting appropriate advice from an appropriately qualified person, and developing and actually implementing a plan (s 588GA).

Small Business Restructuring interacts with this directly, and the usual sequence is worth understanding. Safe harbour is the bridge before the appointment: while a director is engaging a practitioner and working up a plan, s 588GA is what protects continued trading. The formal appointment under Part 5.3B then takes over.

Once a restructuring is on foot, directors keep their management powers (s 453L) and debts incurred in the ordinary course are the company’s — which is a different position from a director trading on and hoping.

If you suspect your company may be insolvent, the exposure you are carrying is growing every month you continue as you are. Three things reduce it, and all three help whichever path you eventually take: keep employee entitlements and lodgements current, keep proper records, and get advice from someone qualified — and keep evidence that you did. Documenting a genuine effort is what the defences and safe harbour are built around.