Trading While Insolvent Is Illegal

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Insolvent Trading is Serious

A Director must not allow a company to trade and incur debts when it is insolvent. Failure to comply may lead to the loss of personal assets.

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Insolvent Trading is Illegal. If a director allows a new debt to be incurred knowing the company is insolvent and unable to pay those debts as and when they fall due for payment , the director may be guilty of insolvent trading.

A director found guilty of insolvent trading may become personally liable for the repayment of debts incurred after the company became insolvent – and this may lead to a loss of personal assets and even personal bankruptcy.

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When is a company deemed to be insolvent?
A company is deemed to be insolvent when it cannot pay its debts as and when they become due for payment.

When determining the questions of insolvent trading, the court will consider the overall financial circumstances of a company as a matter of commercial reality. This means not only will the court review cash flow, but it will also consider the company’s balance sheet, asset values and realisability and the ability of the Company to raise funds in terms of equity or debt.

A company may also be deemed to be insolvent in circumstances where the directors do not cause books and records of account to be maintained. In such cases, a company may be presumed to be insolvent for as long as records were not kept.

What are directors required to do?

Directors must:

  • stay constantly aware of the financial affairs and position of the company.
  • prepare and review financial information regularly in order to determine that there are reasonable grounds to conclude that the company can repay its debts as and when they fall due for payment.
  • if they suspect insolvency, take positive steps to confirm the position of the company and realistically assess the available options.
  • seek appropriate advice from a suitably qualified person
  • act appropriately and in a timely manner to address the question of solvency

Who can make a claim for Insolvent Trading?
Liquidators may commence a claim for insolvent trading against directors personally. If such action is not taken, an individual creditor, with the consent of the liquidator may bring an action for their individual claims.

What are the Section of the Corporations Act that deal with Insolvent Trading?
Section 588G sets out the directors duty to prevent insolvent trading and Section 588M provides the process of a legal recovery claim for a breach of this duty.

What are the defences to a claim for Insolvent Trading?

A director may claim:

  • There were reasonable grounds to expect the company was solvent
  • The director relied on information being produced by a competent person that lead to the view the company was solvent
  • The director, for good reason, was not involved in the management of the company at the relevant time
  • The director took all reasonable steps to stop the company from incurring the debt

What are the penalties for insolvent trading?
A director may face civil and criminal sanctions for breaches of insolvent trading laws.

Firstly, a liquidator or individual creditors may bring proceedings against directors for compensation for the damages incurred.

A director may also face disqualification as a director if they are found guilty of insolvent trading. Further, fines of up to $200,000 as well as imprisonment for up to 5 years may apply.

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