Every director of an Australian company is under a legal duty to prevent the company incurring a debt when the company is insolvent (or where that debt will cause the company to become insolvent).
The Australian Securities and Investments Commission's (ASIC) new Regulatory Guide sets out four key principles which directors should follow to meet their obligation to prevent insolvent trading.
The Regulatory Guide also sets out ASIC's approach to assessing whether a director has breached their duty.
In our Update of 4 December 2009 'ASIC issues draft guidance on insolvent trading', we discussed the release of 'Consultation Paper 124: Duty to prevent insolvent trading: Guide for directors' by ASIC. The Consultation Paper, which included a draft Regulatory Guide, sought feedback from directors, professional advisors and other interested parties.
Following extensive consultation, ASIC amended the draft Regulatory Guide and it was released on 29 July 2010 as 'Regulatory Guide 217: Duty to prevent insolvent trading: Guide for directors' (RG 217).
RG 217 sets out four key principles which ASIC considers directors should follow to meet their obligation to prevent insolvent trading. Directors should:
- keep themselves informed about the company's financial position and affairs;
- regularly assess the company's solvency and investigate financial difficulties immediately;
- obtain appropriate professional advice to help address the company's financial difficulties where necessary; and
- consider and act in a timely manner on the advice.
ASIC states that a director is less likely to breach their duty to prevent insolvent trading if they take into account these principles in carrying out their role. In particular, ASIC has indicated that directors who can show that they have followed the principles are more likely to be able to demonstrate that they took reasonable steps to comply with their obligations. This, in turn, is likely to assist a director who is defending a claim for breach of this duty and is endeavouring to establish one or more of the defences to section 588G(2) of the Corporations Act 2001 (Corporations Act).
Amendments made as a result of consultation
Key amendments ASIC made to the draft Regulatory Guide, as a result of the submissions received, include:
- an acknowledgement that 'the law in relation to insolvent trading involves complex legal and accounting issues. Directors should ensure that they understand their legal obligations and, if necessary, obtain appropriate advice';
- a statement that the 'actual steps taken by a director to comply with their duty to prevent insolvent trading will depend, in part, on all the circumstances of the company, including the size and complexity of the business as well as the skills and experience of the company's management and staff';
- an acknowledgement that, while determining whether a company is insolvent predominantly involves applying a cash flow test, a balance sheet test and examination of other commercial factors may also be relevant;
- a statement recognising that, in addition to ASIC, a liquidator or creditor of a company (with the consent of the company's liquidator or the Court) may bring a claim against a director to recover compensation for loss resulting from insolvent trading;
- a statement observing that any claim against a director for insolvent trading, whether brought by ASIC, a liquidator or a creditor, must be determined by the Court. A Court may consider some or all of the key principles in RG 217, or other matters, when determining whether a director has breached their duty to prevent insolvent trading; and
- the insertion of a reference to section 1317S of the Corporations Act, which gives the Court the discretion to exonerate a director from an application for a civil penalty where it considers that the director acted honestly and ought fairly to be excused.
Hall & Wilcox has substantial experience in assisting companies and directors in situations of financial distress, including:
- assisting directors to understand when their company will be regarded as being legally insolvent, or approaching insolvency;
- advising on situations that will be taken to constitute the incurring of a debt for the purposes of the insolvent trading provisions of the Corporations Act;
- advising on the alternatives available to deal with existing debts and debt facilities;
- assisting with debt restructures and liaising with lenders and their legal advisers; and
- advising directors of their potential liability and how the defences that are available might be satisfied.
Please contact a member of our Corporate & Commercial team if you have any queries or concerns regarding the operation of the insolvent trading provisions in the Corporations Act, your company's solvency or your duties and responsibilities as a director.
Andrew Sinclair, Trainee Lawyer, contributed to the writing of this article.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.