This research report documents the findings of an empirical study of judicial findings (of superior courts) relating to the duty to prevent insolvent trading. The duty to prevent insolvent trading is the most controversial of the duties imposed upon company directors.
Those who support the duty argue that it provides appropriate protection for the unsecured creditors of companies. Those who oppose the duty argue that it has the effect of making directors unduly risk adverse which can result in directors too quickly putting companies into voluntary administration or liquidation for fear of personal liability (which may have a negative financial impact on unsecured creditors).
This guide is intended to help directors understand and comply with their duty to prevent insolvent trading.
It sets out:
the relevant legal background
key principles that we consider directors need to take into account in order to comply with the duty to prevent insolvent trading guidance on how to assess whether a director has breached their duty
Insolvent Trading – A feasible study
Insolvent trading occurs when a company incurs debts when it is insolvent. Breach of the duty to prevent insolvent trading can result in directors being held personally liable for the debts which are incurred by the insolvent company.
Legal Definition of Solvency
"Solvency" is defined in section 95A(1) as the ability to pay all debts as and when they become due and payable. A person or company which is not solvent is insolvent (s95A(2)).
2 The Duty to Prevent Insolvent Trading: An Overview
The duty to prevent insolvent trading is currently contained in section 588G of the Corporations Act.
It requires directors to monitor the financial status of their company continually to make sure that it is not trading while it is insolvent
Objective: protection of creditors that deal with companies
Statutory duty to prevent insolvent trading
The relevant provisions of section 588G of the Corporations Act read as follows:
Who owes the duty? - directors only
Section 9 of the CA defines a director to mean a person who is appointed to the position of a director; or is appointed to the position of an alternate director and is acting in that capacity, regardless of the name that is given to his/her position.
De facto director - someone who acts as a director even if they have not been validly appointed to act as a director
Shadow director - person in accordance with whose instructions or wishes the directors of the company are accustomed to act
When does a company incur a debt?
There are two types of debts that can be incurred for the purposes of section 588G
When is a company insolvent?
Under section 588G, a company must be insolvent when it incurs the debt in question or else it must become insolvent by incurring the debt. . Under section 95A, a company is insolvent if it is unable to pay all its debts, as and when they become due for payment. It has been said that the court must ascertain “the company’s existing debts, its debts within the near future, the date each will be due for payment, the company’s present and expected cash resources and the date each item will be received” in order to determine whether the company is able to pay all its debts as they become due for payment.It may be worthwhile to note that section 588E of the Corporations Act contains certain presumptions that may assist one to determine if a company is insolvent. For instance, section 588(4) of the Corporations Act states that where a company has failed to keep financial records in relation to a periods as required by section 286(1) or has failed to retain financial records in relation to a period for the 7 years...
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