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guide to insolvent trading

The Australian Securities and Investments Commission (ASIC) considers directors to be the gatekeepers of our financial system, and if performed properly, a director will make sure investors are confident and informed, and our markets are fair, orderly and transparent.

Accordingly, a director has a positive duty to prevent insolvent trading under s 588G of the Corporations Act 2001 (Cth). They must also be aware of the company’s financial position on a regular basis.

SV Voidables are well experienced in recovering and defending insolvent trading claims. If you are served with an insolvent trading claim, give one of our experts a call on 1800 246 801.

Elements of insolvent trading claims

The debts were incurred at a time when the company was insolvent and remained outstanding on the date of the Liquidators appointment

Insolvency

The test of insolvency incorporates the cash flow tests and balance sheets tests of insolvency. Basically, where a company is unable to pay debts as and when they fall due and payable, then the company is insolvent

Balance sheet test            

  • Not the definitive test of insolvency
  • An assessment of the company’s financial reports to ascertain a snapshot of the company’s financial position at the time of the transaction
  • A comparison of current assets to current liabilities is regularly used to measure the working capital of the company (known as the liquidity ratio)
  • Requires an assessment of the financials, and potential adjustments, to ascertain the correct position or performance of the company

Cash flow test

  • Regarded as the best test of insolvency
  • Looks at all of the available assets of the company, including those assets or funds it may otherwise be able to acquire (eg from bank loans, undrawn overdraft facilities, related parties, equity contributions), and assesses whether the company could can pay its due and payable debts now and into the immediate future

Remained outstanding on the date of the Liquidators appointment

If a debt was incurred whilst the company was insolvent and never repaid in full by the time the company is placed into Liquidation, then the director may be liable for the sum of that outstanding debt.

The person is a director of the company at the time of incurring the debt

Section 9 of the Corporations Act 2001 (Cth) says that:

"director" of a company means:

  • a person who:
    • is appointed to the position of a director; or
    • is appointed to the position of an alternate director and is acting in that capacity;

Regardless of the name that is given to their position; and

  • unless the contrary intention appears, a person who is not validly appointed as a director if:
    • they act in the position of a director; or
    • the directors of the company or body are accustomed to act in accordance with the person's instructions or wishes.
The director had reasonable grounds to suspect or know that the company was insolvent when it incurred those debts
ASIC Chairman, Greg Medcraft, highlighted a number of areas ASIC believes would be applicable to all directors in ensuring they are performing their duties effectively, including:
  • Scepticism: directors must question the information provided to them. There is no defence for wilful blindness.
  • Accounting knowledge: directors are expected to have financial literacy and basic accounting knowledge. That is, be able to read a balance sheet and profit and loss statement.
  • Accountability and control: it is up to directors to ensure the executive has systems, protocols and controls to ensure sound corporate governance. It is about having the right level of effective risk management.
  • Culture: directors should also ensure that their stewardship drives the right compliance culture in their organisation.
 

Contact our Voidables team

If you have any questions relating to our Voidables services, please contact one of our expert advisors.

 

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