Under the Corporations Act 2001 (the Act), the directors are entrusted with the responsibility to see that their company does not trade while it is insolvent.

This article aims to provide a summary to guide you on the duties of directors to prevent insolvent trading, the consequences of breaching the duties and the defences available to the directors.

Duties of the Directors

Under Section 588G of the Act, a director is required to prevent the company from incurring a debt if:

The company is already insolvent at the time the debt is incurred; or

By incurring that debt, or by incurring a range of debts including that debt, the company becomes insolvent; and

At the time of incurring the debt, there are reasonable grounds for suspecting that the company is already insolvent or would become insolvent by incurring the debt under Section 588G(1).

Consequences of Breaching the Duty

A Court may make one or more of the following Orders if a director is found by the Court to have breached the civil penalty provision in Section 588G(2) of the Act:

Compensation Order: Under Sections 588J and 1317H of the Act, a Court may pass an Order that a director is personally liable to pay a compensation to the company equal to the amount of the loss suffered as a result of the director failing to prevent the company from incurring debts while it was insolvent;

Pecuniary Penalty Order: Under Section 1317G of the Act, a Court may pass an Order that a director has to pay a pecuniary penalty to the Commonwealth of up to $200,000 if the Court finds that the director’s failure to prevent insolvent trading is serious or materially prejudices the interests of the company or the company’s ability to pay its creditors; and

Disqualification from Managing a Corporation: Under Section 206C of the Act, a Court may disqualify a director from managing a corporation for a period of time that it considers appropriate, if the Court is satisfied that the disqualification is justified.

A Court may make one or more of the following Orders if a director is found to have committed a criminal offence under Section 588G(3) of the Act:

that the director should pay a fine of 2,000 penalty units, which is equal to $220,000; or

that the director be imprisoned for up to 5 years.

Available Defences

Under Section 588H of the Act, directors have a number of defences available to a civil claim for insolvent trading under Section 588G(2) of the Act. However, these defences do not apply to a criminal offence committed under Section 588G(3) of the Act.

Directors have a number of defences with them, if they can prove that at the time the debt was incurred, the directors:

had reasonable grounds to expect and did expect that the company was solvent at that time and would remain solvent even if it incurred that debt and any other debts at that time under Section 588H(2) of the Act;

had reasonable grounds to believe and did believe that a competent and reliable person who was responsible for providing adequate information about the company’s solvency was fulfilling his/her responsibility and the directors believed that based on such information, the company was and would remain solvent even if it incurred that debt and any other debts at that time under Section 588H(3) of the Act;

because of illness or for some other good reason and did not take part in the management of the company at that time under Section 588H(4); or

took all reasonable steps to prevent the company incurring the debt under Section 588H(5) of the Act. Matters that may be considered when determining whether this defence is made out include but are not limited to:

any action the directors took to appoint an administrator to the company;

twhen that action was taken; and

tthe results of that action.

For additional information or assistance please contact our team of experts at Owen Hodge Lawyers.

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