Insolvent trading occurs when a company is unable to pay its debts as and when they fall due.
Section 588G of the Corporations Act 2001 (“the Act”), imposes a duty on the directors to prevent insolvent trading.
Under section 588G directors of an insolvent company are prevented from incurring further debts where a director has grounds for suspecting that the company is insolvent.
A person commits an offence if:
(a) company incurs a debt at a particular time; and
(b) at that time, a person is a director of the company; and
(c) the company is insolvent at that time, or becomes insolvent by incurring that debt, or by incurring at that time debts including that debt; and
(d) the person suspected at the time when the company incurred the debt that the company was insolvent or would become insolvent as a result of incurring that debt or other debts (as in paragraph (1)(b)); and
(e) the person’s failure to prevent the company incurring the debt was dishonest.
What needs to be proven?
A director becomes liable if there was a reasonable suspicion that the company was insolvent or would become insolvent. The test that applies is an objective test.
There are three methods used in court to prove insolvency:
1. Statutory presumption;
2. Direct evidence;and
3. Expert report/ evidence.
A person/director found guilty of the offence may be disqualified from managing a corporation or may face a penalty order of up to $200,000.00. However, a court may not disqualify the person or impose a penalty if it is satisfied that the person is fit and proper to manage a corporation.
Application for a civil penalty order may only be made by:
1. ASIC; or
2. a commission delegate; or
3. a person authorised in writing by the minister.
Applications must be made within six (6) years.
A person may be criminally liable if he/she acted dishonestly, recklessly and fraudulently intending to gain a benefit for either himself/herself or for another person.
The person, if found guilty, faces penalties of up to $200,000.00, or five (5) years in jail.
Only ASIC can commence the criminal proceedings through the Director of Public Prosecutions (Cth) pursuant to section 588G.
However, criminal proceedings cannot commence until civil proceedings (commenced by ASIC) have been decided/finalised in relation to the same offence. If the criminal proceedings are already afoot then criminal proceedings will be stayed.
On the other hand, when the criminal proceedings have been determined or disposed of by conviction, any civil proceedings stayed in relation to the same contravention must be dismissed.
However, in practice, it is most unlikely that the ASIC or the DPP will issue both civil and criminal proceedings in relation to the same civil penalty contravention.
Section 588H of the Act provides defences:
1. There were reasonable grounds to expect the company was solvent;
2. There were reasonable grounds to rely on the information provided by another competent and reliable person, which confirmed that the company was solvent at the time;
3. Director did not take part in the management of the company when the debt was incurred; and
4. The director took all reasonable steps to prevent incurring the debt – the court will look into all actions taken by the director at the time.
Directors’ liability regarding compensation for loss resulting from insolvent trading
A liquidator and creditors may recover from the director the amount of the loss or damage (section 588M).
Proceedings under this section may only be begun within six (6) years after the beginning of the winding up.
When holding company liable
Under section 588V, a holding company is liable for the debts of a subsidiary if a holding company has permitted the subsidiary to trade whilst insolvent if at the time there was a reasonable ground to suspect that the company was insolvent. The provision only applies to the relationship between the holding company and the subsidiary. It does not apply to related companies generally.
A holding company is liable in circumstances equivalent to those contained in section 588G. However, the provision requires the court to consider, at the relevant time of incurring the debt, the grounds of awareness of the corporation or its directors to suspect insolvency and objectively consider, in the contest of the nature and extent of the corporation’s control over the subsidiary, where a holding company or its directors in a like position would be aware of the subsidiary’s insolvency. There is no criminal liability for contravention by a holding company and a holding company and its directors have statutory defences comparable to those discussed in section 588H.
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Liability of directors under companies act | insolvent trading by company directors | insolvent trading claim