A director has a duty to prevent insolvent trading by a company: Section 588G. This section of the Corporations Act 2001 will be breached when trading occurs and: The company is insolvent at the time, or becomes insolvent because of a debt; There were reasonable grounds for believing/suspecting the company was insolvent, or would be insolvent; The director was aware of these reasonable grounds, or a reasonable person would have been aware of the likelihood of insolvency.
A company is solvent when it has the ability to settle all debts when they fall due. If a company cannot do this, it is insolvent. Insolvency should be expressed by reference to the cash flow position of the trader (company) and not the overall balance between its assets and liabilities. Also, the availability of loan funds and the reliability of a promise to lend are relevant considerations for determining a company’s ability to pay.
The Corporations Act 2001 considers that a director is able to predict the financial situation of the company, based on a number of contingencies. An objective criteria is applied when assessing reasonableness as to the state of knowledge. The Court will make a judgment based on the facts of the individual case1 . The standard the Court sees as appropriate is that of a director of ordinary competence. Liability is not assessed on the personal characteristics of the particular director. The director does not have to be aware that the company is actually insolvent, the only criteria is that there were reasonable grounds for suspecting that the company could be insolvent.
A director can raise the following defences:
© Comasters 2001. Revised November 2003.
Important: This is not advice. Clients should not act solely on the basis of the material contained in this paper. Our formal advice should be sought before acting on any aspect of the above information.