Insolvency – the Law

What is Solvency?

Solvency is defined by the Corporations Act as the ability to pay all debts as and when they become due and payable. A person or company that fails to do so becomes insolvent.

Who is responsible?

The Corporations Act specifies that directors are responsible for ensuring their company does not trade and incur debt while insolvent.

If a director breaches the insolvent trading laws, failing to prevent the company from incurring debts when the company is insolvent and being unable to repay those debts when they fall due, they may be held liable in the following ways:

• Personal Liability through Compensation proceedings
• Civil penalties
• Criminal sanctions in the event of fraud

Why do these laws exist?

These penalties are in place because a director allowing their company to incur debts it had no hope of repaying may cause others to suffer loss or damage as a result.

Accordingly, if it can be proved the director failed to prevent the company from incurring debt when it was insolvent, the corporate veil may be lifted and the personal assets of the director exposed.

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