The obligations and responsibilities that directors must follow include: duty to act bona fide (in good faith) in the interests of the company as a whole, duty not to act for an improper purpose, duties of care and diligence, duty to avoid conflicts of interest, duty not to make improper use of position, duty not to make improper use of information, duty not to trade while insolvent (A Guide to Directors’ Duties and Responsibilities, 2008). As extensive as these duties and responsibilities are for the purpose of this paper the duty of focus is, duty not to trade while insolvent. Referring to section s588G of the Corporations Act 2001 (Commonwealth), directors have the duty to prevent their company incurring debts when the company is insolvent or would become insolvent (Corporations Act 2001 (Cth) s 588).
Firstly, it needs to be sought as to when s588G applies. It must be analysed whether the company was insolvent at the time or became insolvent by incurring that debt, whether the person was director when a company incurred debt and at the time debt was incurred there were reasonable grounds for suspecting insolvency. When a company incurs a debt for the purposes of s588G the type of debt must be identified as well as when the debt was incurred. There are two types of debts incurred, deemed debts and uncommercial transactions. Deemed debts are listed in s588G (1A) of the Corporations Act 2001 (Hanrahan, Ramsay & Stapledon 2011; Corporations Act 2001 (Cth) s 588)
To further define “debt”, Allan Topp of Sims Partners and Tim James, says, “debt” has been interpreted to bear its ordinary technical meaning as something recoverable by an action for debt and thus must be ascertained or capable of being ascertained. Therefore, a “debt” signifies an obligation for the payment of money or money’s worth. Many authorities suggest that the obligation must be for an ascertained liquidated sum (James & Topp 2000).
Now it can be further discussed the types of debts companies can incur. As previously stated before, one type of debt is uncommerical transactions; an uncommercial transaction is one that a reasonable person in the company’s circumstances would not have entered into having regard to the benefits and detriments to the company of entering into the transaction and respective benefits to other parties to the transaction. The liability of directors for insolvent trading therefore extends to circumstances where the company has not actually incurred a debt at the relevant time but entered into an “uncommercial transaction” (James & Topp 2000).
Drawing back to identifying insolvency within a company, to determine if a company is insolvent, a cash flow test must be used to determine if the company is able to pay all its debt as well as to determine what assets the company has (Hanrahan, Ramsay & Stapledon 2011). There are two presumptions of insolvency that will assist in providing a company was insolvent...