If your company is struggling to pay its debts when they fall due, your company could be insolvent. As a general rule, insolvent companies may not continue trading. As a director, you could be in breach of your director's duties if the company keeps trading while insolvent. In doing so, you could face:

  • civil penalties;
  • compensation proceedings to personally cover the debts incurred by the company; or
  • criminal charges.

Temporary changes to insolvency laws during COVID-19 give some protection to companies having financial difficulties due to lockdowns and other trading restrictions during the pandemic. This article will explain:

  • the signals to tell if a company is trading insolvent;
  • a directors' duties regarding insolvent trading;
  • the current COVID-19 changes; and
  • steps to avoid insolvent trading.

What Is Insolvent Trading?

Your company is insolvent if it cannot meet its debt obligations when they are due. If there is a reasonable basis to suspect your company is insolvent, yet the company continues to incur debts, then you are likely trading while insolvent. Signs of insolvent trading include:

  1. liabilities greater than assets;
  2. problems selling stock or collecting debts;
  3. declines in the company's revenue and customers leaving;
  4. creditors not extending your debt facility;
  5. suppliers cutting off delivery due to overdue payments or offering delivery only on cash-on-delivery terms;
  6. overdue taxes and superannuation liabilities;
  7. solicitors' letters, demands and other court documents relating to unpaid debts; and
  8. issues with directors, the board or management staff.

How Do I Know if My Company Is Trading While Insolvent?

It can be difficult to determine whether a company is insolvent at a certain point in time. Your company's balance sheet and cash flow is one indicator of its financial position. However, these do not always tell the full story.

For example, if assets listed on a balance sheet can not be liquidated (turned into money) to pay debts, then this may indicate insolvency.

If you have any concerns about a company's solvency, you should seek advice from an insolvency practitioner to help determine its status.

What Risks Do Directors Face if a Company Is Trading Insolvent?

If you are a company director and a company enters liquidation, the liquidator may issue court proceedings against you for allowing the company to incur debts when you reasonably suspected the company was insolvent. The court claim will seek to recover money against you personally, as the director of the company (now in liquidation). Any funds claimed will be added to the pool available for the liquidator to distribute to creditors as part of the liquidation process.

What Are My Duties as a Director Regarding Insolvent Trading?

As a director, you are legally obliged to prevent your company from trading while insolvent. The duty applies when there are reasonable grounds of suspecting the company is, or will become, insolvent. The duty includes the general duties to:

  • act with care and diligence;
  • ensure you are always aware of the company's financial affairs; and
  • ensure the company does not further trade insolvent if you suspect the company is insolvent.

Is There a Defence to Insolvent Trading?

The Federal Government introduced new laws to protect directors from insolvent trading claims in 2016. These laws, called the safe harbour regime, allow directors to argue that a debt a company incurred while it was insolvent was 'reasonably likely to lead to a better outcome for their company and its creditors' than going into voluntary administration or liquidation.

The Federal Government extended the safe harbour laws in March 2020 under special, temporary COVID-19 provisions, in an effort to give companies further time to try and trade out of difficult conditions. The COVID-19 provisions were initially meant to apply until 25 September 2020. However, the Government has now extended them until 31 December 2020. During this period, directors will not be liable to insolvent trading claims where a debt was:

  • incurred before the appointment of any administrator or liquidator; and
  • necessary to facilitate the continuation of the business.

These debts include any that the company incurred to keep the business afloat, such as debts incurred to:

  • pay wages; or
  • move the business's operations online.

How Can I Avoid Insolvent Trading?

Even with the existence of safe harbour laws, directors should be aware of the signs of insolvent trading. If evident, directors should take steps to improve the company's operations. The following steps will help avoid insolvent trading:

  1. Review and revise: keep informed about the company's financial position with frequent reviews of company records and trading practices;
  2. Investigate: if you have concerns about the company's solvency, take steps to investigate more closely;
  3. Get advice: call in your accountant or insolvency practitioner if you have any doubts. Assessing solvency is often a complex accounting process that requires expert assistance; and
  4. Move quickly: take steps to investigate, get help, and fix any insolvency issues if you have any suspicions.