Temporary measures which relieved company directors from personal liability for insolvent trading, enacted by the Federal Government in response to the COVID-19 pandemic, ceased on 31 December 2020. Accordingly, from 1 January 2021, directors who fail to prevent a company from incurring a debt while insolvent are potentially exposed to an insolvent trading claim in any subsequent liquidation of the company.
What is insolvent trading?
Section 588G of the Corporations Act 2001 (Cth)(Act) imposes a positive duty on directors to prevent a company from trading whilst insolvent. A company is insolvent if it is unable to pay its debts as and when they fall due (s.95A).
A director will breach the duty to prevent insolvent trading under section 588G if:
- they are a director of the company when the company incurs a debt; and
- the debt is incurred while the company is insolvent, or the debt causes the company to become insolvent, and
- the director is aware of reasonable grounds for suspecting the company’s insolvency at the relevant time; or
- a reasonable person in a like position would have been so aware.
The definition of a “director” under the Act is not limited to persons formally appointed as such and includes a person who:
- is appointed to the position of an alternate director and is acting in that capacity (regardless of the title of their position); or
- acts in the position of a director (despite not having been formally appointed); or
- the directors of the company are accustomed to act in accordance with the instructions or wishes of.
Directors who breach the duty to prevent insolvent trading may be ordered to compensate the company, or to pay a civil penalty (a fine). If the breach of duty involves dishonesty, the director may be held criminally liable.
An insolvent trading claim may be brought on the liquidation of the company by its liquidator, a creditor, or the Australian Securities & Investments Commission.
Defences
There are various statutory defences available to directors against an insolvent trading claim, namely:
- the director had reasonable grounds to expect (not just suspect) the company was solvent;
- the director relied on information provided by a reasonable, competent person;
- the director had a good reason for not taking part in the management of the company at the relevant time (e.g. illness);
- the director took all reasonable steps to stop the company incurring the debt;
- the debt was incurred on or after 19 September 2017 directly or indirectly in connection with a qualifying safe harbour plan;
- the debt was incurred in the ordinary course of business between 25 March 2020 and 31 December 2020 (qualifying for protection under the Coronavirus Economic Response Package Omnibus Act 2020); or
- the debt was incurred in the ordinary course of business between 1 January 2021 and 31 March 2021 by an eligible small business who has applied for restructuring relief under the Corporations Amendment (Corporate Insolvency Reforms) Act 2020)(more information is available about this process via this link).
Relief from liability
A court may excuse, either partly or in full, a director’s liability under s.588G if the director acted honestly and ought fairly be excused (ss.1317S and 1318(1). In considering whether to exercise its discretion to excuse a director, the court will have regard to any action taken by the director to appoint an administrator of the company (s.1317S(3)).
A mere absence of dishonesty is insufficient for a director to be excused from liability under ss.1317S and 1318(1). The director must also have acted honestly and without “carelessness or imprudence.[1]”
In determining whether a director “ought fairly be excused,” the court will consider the degree to which the director’s conduct fell short of the statutory standard; the seriousness of the contravention; and the potential or actual consequences of the contravention.[2] The relevant question is whether the director has acted honourably, fairly and in good faith, having regard to the standards of others of a similar professional background.[3]
Do you need help?
Hunt & Hunt’s national insolvency and restructuring team helps our clients resolve and/or pursue insolvent trading claims. We provide advice on the prospects of claims and the prospects of the defences available to directors. Hunt & Hunt has one of the strongest insolvency practices in the country, with considerable experience across all areas of insolvency litigation across all jurisdictions.
If you require advice or assistance, please contact our offices.
Authored by Binti Prasad and Matt Gauci, partners, Marcus Fogarty, associate, and Jessica Egger, lawyer.
[1] Hall v Poolman [2007] NSWSC 1330; ASIC v Healey (No 2) 284 ALR 734
[2] Ibid
[3] ASIC v Edwards (No 3) (2006) 57 ACSR 209
